The Market Correction that Was?

Last week, the S&P 500 abruptly halted its (months long) grind higher finishing (-1.0%) lower while the Dow Jones Industrials managed a somewhat flattish performance (-0.09%). The market appears to be sensing a softening in growth momentum (i.e. compared to January and February) as the first few March data points (U.S. manufacturing and non-manufacturing ISMs and ADP/BLS jobs reports) have printed on the lighter side of expectations. There is now legitimate fear that fiscal headwinds (tax hikes + sequester spending cuts) could have a larger impact in Q2’13 compared to Q1’13. With that, more red flags have been unfurled (Italy’s non-government, Cyprus, Portugal, China, commodity slump, North Korea, Iran, lower expectations of US growth) and are now flapping at full mast in the impending winds of change. So, where’s the market correction? Why have stocks been so stubborn to re-trace? It’s all so profoundly difficult to understand or reconcile with a market sitting near all-time (nominal) highs!

However anxious we may be for a healthy correction, allow me to propose that perchance we had one already? A market tweaking – one that struck while we weren’t looking? Or, one that we weren’t looking for! Whatever you want to call it (i.e. divisive divergence, rotating adjustment?) we did have something – it was a correction without a crash! A deep reflection of the innumerable (new and old) global uncertainties that surround us.

Look closely at what transpired last week. The Dow Jones basically scratched (-0.09%), while the S&P500 fell (-1.0%), the NASDAQ dropped (-2.0%) and the Russell 2000 lost (-3.0%). Healthcare, REITs, Telecom, and Utilities names all rallied last week while Airlines, Networking, Steel, and Semiconductor stocks got hit. This dynamic has been in place for weeks but most recently has picked up a lot of steam. There is this seemingly one-off trend whereas money is moving swiftly to “safe haven stocks” leaving cyclical names in the dust. In corrections past, investors would dump stocks wholesale!

On a Year-to-date basis some of the worst performing stocks also happen to be cyclical stocks: ANR, BTU, CLF, FCX, JOY, POT, and WLT to name a few. On the flipside, the bulk of the S&P500 near +9.0% gain is attributed to stocks recognized as “safety issues”: BMY, BRK, JNJ, KO, PEP, PM, T, and VZ. From a fundamental or even historical perspective this sort of stock market nuance doesn’t make sense and its one that should have investors big and small questioning the health of the economy and stock market in general. Yet, in the end, we must remember that convention, fundamentals, historical standards, nor intuition will help you navigate our current state of stock market action! We are in the midst of a not ever tried (concerted) global monetary policy “experiment” – it’s working for now but I shudder to think how it will eventually end up! Personally, I’m not preparing for an “Armageddon scenario” but am surely stepping aside waiting patiently for a better reason to be fully allocated to equities.

Regarding the Bank of Japan’s monetary policy and US Treasury rates: US Treasury yields have plummeted over 25bps (basis points) since early March driven by Eurozone stability threats, disappointing economic data, and the most recent Quantitative Easing (QE) program announced by the Bank of Japan. Today, UST yields are now just 32.50bps from their lowest point set on July 24, 2012.

The Bank of Japan’s policy initiative is powerful (i.e. increase monetary base an estimated $600-$700+ billion per year (US$) combined with the purchase of $500 billion (US$) of Japanese government bonds) and the longer-term consequences are hazy at best. Short-term, this “new money” entering the system will simply add to the old theme of too much money chasing too few bonds in the higher-quality space as the nominal difference between Japanese Government Bonds (JGB) and 10-year US Treasuries (UST) is currently trading at 116bps (JGB yield 53bps vs. UST yield 169bps). This new demand source for the US 10-year Treasuries could keep U.S. rates ridiculously cheap (all things considered) and potentially could have new-fangled implications for the current Fed policy.

Larry Shover, SFG Alternatives

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