January 21, 2014

Last month, in Scrooge Denied, we noted how the strength of the Bulls kept the Bears, or Scrooge in this case, from turning and keeping prices lower. The "Santa Claus Rally" emerged shortly after our letter and pushed prices to new all-time, or 13-year highs. Scrooge was chased by a reindeer led sleigh and the Bears were forced to cover in a short-squeeze that lasted to the last day of the year. While there has been some signs of weakness as the new year began, we view this as a pause and not a reversal.

For the month of December the S&P 500 Index (SPX—1,846.88) added another 2.3% while the Dow Jones Industrial Average (DJIA—16,561.12) surged nearly 3%, both closing at new all-time highs. The Russell 2000 Index (RUT—1,162.73) climbed 1.7%, showing that small-cap issues were also strong.

An interesting point was that US shares continued to gain after the Federal Open Markets Committee (FOMC) announced that it would begin to taper its aggressive stance. The threat of such action had taken the market lower several times before but the actual act of doing so was embraced by Bulls, which sent short-sellers scrambling once again.

Other countries also saw shares rise sharply in December. Belgium, France, Germany, Switzerland, Italy, Spain, the UK and Japan had respectable increases as well.

The New Year has gotten off to a weak start, something that we can see was anticipated. It will be a hard act to follow for the Bulls following 2013's show. It is like a little known comedian getting up to the microphone following a performance by the likes of Robin Williams. However, the weakness is not bad and the benchmarks have actually held very well so far. In fact, the mixed to higher performance on Friday following an extremely disappointing Employment Situation Report illustrates that Bulls remain in control.

Commodities Are A Mixed Bag

Precious metals continue their decline last month, with the February Gold Futures (GC/G4—$1,204.80) dropping below the 1,200 mark on the last day of the year before bouncing. Gold was down 3.4% month/month while silver fell 5.4%. Industrial metals, such as high grade copper, were sharply higher.

On the other hand energy prices were sharply higher. The West Texas Intermediate Crude Oil Feb. Futures (CL/G4—$98.70) rocketed 6.0% and closed below the best levels set on Dec. 29th. Brent crude futures were only 1.3% higher.

Agriculture prices were lower last month and continued to fall into the new year, even as bad weather impacted much of the country. The S&P GSCI Agricultural Index (GKX-352.50) plunged 3.7% in December to the lowest level in years.

Currencies

Despite the "tapering," which we will discuss shortly, the US Dollar Index (DXY) slid against several major currencies. These included Euro, British Pound and Swiss Franc. The "greenback" was strong against the Canadian Dollar and Japanese Yen. The New Zealand Dollar, which was choppy but little changed versus the US counterpart, was sharply higher against the Japanese Yen, rising 3.7%.

The Fed

Last month we got one uncertainty out of the way ... the time that the FOMC would begin to taper or lift its foot off the proverbial stimulus gas pedal. This month we got the uncertainty with a positive vote to approve Janet Yellen as the next Fed head.

In what might have been as his final public appearance as Chairman of the Federal Open Market Committee, Ben Bernanke stated that interest rates will remain low for the foreseeable future. While the economy is on a growth path, there are no signs of building inflationary pressures and the rate of growth remains subdued. While interest rates may edge higher in the markets, there is no real upward pressure. This should continue to aid the credit and equity markets.

The Economy

As we noted earlier the economy is on a growth path. However the number of jobs created last month was only 74,000, the lowest level in three years. The unemployment rate sank to 6.7%, nearing the Fed's target. However that is not necessarily a "good thing." The rate appears to be dropping because more people are leaving the workforce versus new jobs being created.

It is also important to know that the quality of jobs being added has not been great. Additionally, many people are being moved to part-time or seeing hours reduced due to the costs of the Affordable Care Act, commonly referred to as "Obamacare."

There are also concerns about the impact of Obamacare on the economy. Thoughts are split. Some analysts believe it will result in a rise in activity while others are concerned that the costs will have negative impact.

Equities, A Deeper View

The markets advance has been broad and strong. The NYSE Advance-Decline Index and NYSE New High-New Low Index have been positive, setting new highs. The same is true for the Nasdaq. Also rising have been the volume advance-decline indices. One negative point has been the drop in volume. The lack of a classic 10% correction has kept many would-be buyers on the sidelines.


View Larger

On the positive side, the disappointing jobs report failed to depress the benchmarks, thus resulting in slight weakness. This shows how robust the Bulls truly are.

The strongest industry groups in December included casinos & gaming (+13.6%), homebuilding (+10.5%), aluminum (+10.4%), oil & gas refiners (+9.8%) and diversified metals & miners (+8.7%). The weakest groups included gold (-7.4%), automobile manufacturers (-4.4%), hyper & supercenters (-3.4%), healthcare technology (-3.1%) and household products (-3.0%).

What To Watch For

We continue to believe that the bull market is alive and well, but a bit tired. Economic growth and strong credit market demand could lead to another year of double-digit percent gains for the major benchmarks. Also adding to potential strength is the mid-term elections, which should create a more friendly political environment, further boosting stock prices.

Gold and other precious metals remain weak. There has been a slight positive movement for energy but not enough to impact inflationary numbers or the markets in a meaningful way.

The extreme high prices for stocks and the averages and indices that measure them increases the risk factor potential, especially in the absence of a traditional 10% correction. Furthermore, as we wrote this letter, the CBOE S&P 500 Implied Volatility Index (VIX) was at a five plus month low (see chart).

For the long-term (more than six months) we are positive and constructive. For the intermediate-term we are positive but exercising restraint and caution given the rising probability for either a traditional correction (more than 10%) or non-traditional correction (between 4% and 10%).

ABOUT THE AUTHOR
Michael J. Levas has been in the investment management business for over twenty years and is the founder,senior managing principal & director of trading at the Olympian Group ...