By Pete Biebel, Vice President
The market had another strong week. The broad averages all gained nearly 2%. The S&P 500 has pushed beyond the upper end of the range I had been expecting. While it’s nice to see the averages continue higher, it’s a little unnerving seeing how frothy the market is getting.
Seeing the market perform so well in the face of concerns like a plodding recovery, fiscal irresponsibility, looming international financial crises and continuing high unemployment is like seeing an overweight, pack-a-day smoker with bad knees leading in a 10-K. Where I had expected to see a wheezing, coughing market stumble into a correction, it instead kicked up its heels and sprinted higher. Each time it appeared to be reaching the point of exhaustion, it ran beyond what seemed plausible.
There’s little doubt that much of the impetus for this behavior has been from external, stamina-enhancing sources. We’ve known for a while that the Fed’s quantitative easing has been helping to juice the performance of the stock market. Although the Fed’s mandate was never to run the market averages to new highs, their monthly liquidity injections have served to turn our Ralph Kramden economy into a Steve Austin market.
Another part of the explanation is that factors like unemployment, higher payroll taxes and higher gasoline prices have very little impact on the people who are investing in stocks. For investors, the stock market is the only game in town. The Fed’s purchases have pushed fixed-income prices to very expensive levels. Bonds provide very little hope for a decent return. As long as the equity averages keep trending higher, those investors have little choice but to throw more money at the stock market.
A third source of buying power is the covering of short sale positions. Many traders have doubted the ability of the market to continue higher. The more aggressive of those traders have repeatedly attempted to bet on a market top by short-selling stocks. Those shorts have repeatedly been crushed by the market’s run and have repeatedly been forced to pay up to close out the losing positions. The percentage price increases in the most shorted stocks has been two to three times greater than the rest of the market.
As I mentioned last week, we’ve recently seen the buying shift to the more cyclical, speculative sectors away from the conservative, defensive sorts of stocks which had been the leaders in the early stages of the rally. Volume is still questionably low. The short squeeze, the sector rotation and the low volume are signs that the market’s legs are beginning to wobble. If we could see its heart-rate monitor, it would probably be glowing red. While there are no signs that the market has gone into shock, it does seem to be hyperventilating. If our hero stumbles now, he’s in danger of being trampled by a herd suddenly running in the opposite direction.
On the positive side, the market’s upward momentum, which had leveled-off through March and early-April, has ramped back up to its highest level in two years. That suggests that, even if a short-term pullback is right around the corner, a higher high is still likely over the intermediate-term. Four sectors in particular, Consumer Staples, Consumer Discretionary, Financials and Healthcare, have also achieved levels of upward momentum that are probably too high to suggest that a long-term top is at hand.
I had expected that the 1650 area on the S&P 500 (SPX) would be the average’s upper boundary over the past few weeks. The index nosed through 1650 last Wednesday and Friday’s new record closing high at 1667 is about one percent above that level. I’ll guess that the averages will not be able to climb much beyond current levels. The frothiness suggests we need a time-out. A blow-off rally that quickly reverses is still a possibility, but less likely now after last week’s action. The odds are against our runner continuing much further, but that doesn’t mean he won’t. I just wouldn’t bet on it.
Three or four weeks of dull, sideways action, similar to the average’s behavior through March, would help to restore the strength in market’s weary legs. The risk is that we won’t get off that easily. Even a short-term pullback could bring much greater volatility. The 1600 level is about the mid-point of SPX’s April/May advance. Dropping back to that level would only be about a 4% pullback.
One topic you might want to discuss with your financial advisor is how much the sector weightings in your portfolio have changed over the past six months. A little rebalancing now could be just what the doctor ordered.
The big event on this week’s calendar of economic news is a pair of items from the Federal Open Market Committee on Wednesday. At 10:00 EDT, Chairman Bernanke will testify before the Congressional Joint Economic Committee. Even more significant will be the release of the minutes of the FOMC’s May meeting at 2:00 that afternoon. Of particular interest will be any comments regarding the potential tapering of the Fed’s quantitative easing program and to what degree they address evidence of excessive risk-taking.
Scheduled economic reports on Thursday include the weekly Initial Jobless Claims and New Home Sales. Initial Claims have continued to trend lower despite last week’s unexpectedly high 360,000 reading. This week’s report is likely to come in around 345,000 for the week ended 5/18, a level that is just above the four-week moving average. The rate of New Home Sales, after trending higher for the past two years, has been hovering near its four-year high. The annual rate of new home sales in April is expected to come in around 425,000 units, above March’s 417,000, but not quite back to January’s 437,000.
An update on Durable Goods Orders will be released on Friday. While the consensus expectation is for an increase of a little over one percent, many expect a weaker number. The volatile Transportation component is expected to help the overall number. The consensus on the “ex-Transportation” reading is for just a 0.4% increase.