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In Like a Bull, Out Like a Bear

August is shaping up to be a difficult month in the markets, with bulls and bears each looking for a market direction.

Most of the United States is familiar with March slogan "In like a lion, out like a lamb," which illustrates the weather for many of the states that experience winter weather conditions.

Ahead of the 4th of July holiday, most of the broad benchmarks rose sharply and set new highs. Then there were signs of weakening, and the apparent start of a correction, that left the Dow Jones Industrial Average (DJIA) with a year-to-date deficit.

Once again, geopolitical events have impacted the markets, but the bulls are attempting to defend their position. August is looking to be a more complex month, requiring more attention, creativity, and defensiveness.

When we looked at the month-to-date performance of the S&P 500 Index and the DJIA at the close on July 30, those benchmarks were up 0.4% and 0.3%, respectively. Then Argentina defaulted on its debt, sending markets around the globe lower. Those benchmarks ended the month with losses of 1.5% and 1.6%, respectively.

Argentina's default followed the downing of a Malaysian Airlines jet flying over the Ukraine, as well Israel's movement of ground forces into the Gaza Strip. Subsequent economic sanctions against Russia, and failed attempts at a cease fire in the Middle East, have resulted in mounting geopolitical tensions, which have impacted markets globally.

There has also been some weakness in the credit markets. Last month, demand for paper declined -- likely a pause as investors took profits. However, that did not stop a flurry of mergers and acquisitions and stock repurchase programs.

Commodities
Despite the hostile actions in July, gold prices dropped. Gold Sept. 14 futures (GC/U4) fell back below the $1,300/ounce level. Silver Sept. 14 futures (SI/U4) slipped 3% last month, ending below $20.50/ounce. Energy prices were also lower. West Texas intermediate crude Sept. 14 futures (CL/U4) plunged 6.9% in July, falling back below the $100/barrel threshold, while Brent crude Sept. 14 futures (CB/U4) sank 5.4% below $107/barrel.

Commodity prices are lower despite the jump in the gross domestic product (GDP), which we discuss in detail later. What is interesting is that, when economic activity is on the rise, energy prices should also be increasing. Additionally, conflicts like the one between the Ukraine and Russia, along with the sanctions being imposed on Russia, normally would cause oil and gold prices to rise.

Most agricultural commodities other than live cattle were lower. Cocoa and coffee prices were higher.

Currencies
The US dollar index appears to have turned the corner, at least for the short term. It reached an eight-month high in July and has been strong against the euro, yen, pound, Canadian dollar, Swiss franc, Australian dollar, and New Zealand dollar.

The Fed
Evidence that the economy is stable has enabled the Federal Open Market Committee to continue cutting its quantitative easing program. However, several outspoken committee members, who also happen to be "hawks," have called for higher interest rates next year.

However, the long-term trend remains weak for the yield on the benchmark 10-year T-note, though the rate may be bottoming.

The economy
According to the US Bureau of Economic Analysis, the GDP surged 4% in the second quarter, beating analysts' forecasts. We believe the reason for the sharp jump is weather impacts on economic activity during the winter months, which resulted in a final revision in the first-quarter GDP to a drop of 2.1%. The second-quarter rise appears to be a weather-related "snap back."

We would have anticipated that commodity prices would have been on the rise with such a strong GDP report. However, as we normally do, we speak with many business leaders, and we are finding that activity may not be that robust. Those sentiments are echoed by the SPDR S&P Retail ETF, which measures the movement of a basket of retail companies. The ETF declined 3.3% last month.

Inflationary pressures may be starting to rise, as illustrated by the 0.4% rise in the seasonally adjusted producer price index. This may provide some of the rationale for expected higher rates.

Equities: A deeper view
Equities continue to be aided by the credit markets, which have provided the fuel for M&A and stock repurchases. However, we began to see an erosion in the broad strength last month. The internal market indicators have weakened.

Small-cap shares have not fared well. The Russell 2000 Index of small-cap stocks dropped nearly 8% from an all-time high set July 1 to the close July 31.

On Aug. 1, the number of stocks setting 52-week highs dropped to 20, the lowest number since Oct. 6, 2011. This indicates how weak the broad market really is, despite the levels for the indices and averages.

The strongest industry groups in July included healthcare services (+1.9%), outsourcing and IT consulting (-1.5%), healthcare equipment (-1.8%), telecommunications (-2.2%), and metals and mining (-2.2%). The weakest groups included homebuilders (-10.2%), oil and gas equipment (-9%), oil and gas exploration and production (-8.6%), pharmaceuticals (-8.4%), and mortgage finance (-7.7%).

What to watch for
Most companies are reporting better-than-expected results, but those that are disappointing investors are being severely punished for it. We expect this to continue.

The August-to-October period is the weakest three months of the annual seasonal cycle. We expect higher levels of volatility this month, along with a higher probability for a correction. Therefore, we are a suggesting the use of more defensive strategies where appropriate.

Michael J. Levas has been in the investment management business for over 25 years and is the founder, senior managing principal & chief investment officer at the Olympian Group of Investment Management Companies. Prior to Olympian, he was a VP and Portfolio Manager in the ... View Full Bio
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Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
8/13/2014 | 3:58:54 PM
Back to Iraq?
The escalation in Iraq is another geopolitical situation that should be watched. Although President Obama has stated no US troops will be put back on the ground, the situation could get out of control quickly.
Nathan Golia
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Nathan Golia,
User Rank: Author
8/20/2014 | 3:52:11 PM
Re: Back to Iraq?
It's been a crazy summer geopolitcally speaking, even at home with the unrest in Ferguson, Mo. How these events affect consumer attitudes and confidence is important going into the fourth quarter.
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