Off to a bad start
2005 has kicked off to a weak start in equities. Not surprising, considering the one-way market of the last year's fourth quarter. But is it really anything to worry about? While I think so, it is prudent to not get carried away by a few days weakness and sell the house and go short. I recommended selling back in early December, saying that there was enough distribution for this rally to be dead and the action so far in the first two days of January support that claim. I will reiterate that that rally is dead. But is this just a correction or the start of a new bear phase. It stills seems to early to tell, but there are a few key items to watch for.
The most important item is the bond market. Recently, I have called for a sharp rise in bond yields and I stick by that. But it is wise to re-examine the results and the fact is that we have not made significant headway on the upside yet. While it seems that we are setting up for a move higher in yield, it seems to be best to wait for a move above 4.44% on the ten-year as confirmation that higher yields are here to stay. A drop below 4.05% would call this forecast into question. Yields bottomed at the end of October, since I usually figure that bonds lead stocks by about three months, this would suggest a stock market high in late January. Also the dollar has steadied. A firmer dollar and higher US bond yields would go hand in hand and would signal trouble for US equities, as well as global economic growth.
Secondarily, and less important, but worrisome, is the excessive bullishness among investment advisors shown by the Investors Intelligence report of 62.1% of advisors bullish. Basically anything above 50% is a warning flag, but this number is the highest in five years! In other words, investors are as bullish as they were in early 2000!!! With the leap in speculative IPO activity and M&A business, it seems as though a lot of froth has returned to the market. My plan is to stay liquid and see how January is going to behave for stocks and stay away from bond unless yields rise above 5%, which I still believe that they will. Also, there seems to be consensus that the Fed is going to have to raise rates to 3.25 - 3.5% this year. Since consensus can often lead to failure, how could this be proven wrong? Either the economy collapses and the Fed is forced to keep rates low or there remains significant economic pressure and the Fed is forced to raise rates farther and faster than anyone anticipates. My guess is that the latter is the more likely scenario. Let's say 40% probability of 4.5% Fed Funds, 50% of 3.5% and 10% chance of 2.5%. You don't hear too many people discussing this possibility and maybe that is because it is way off base, but it seems that it should at least be considered and hedged against.
Finally, gold is backing off its high levels. While ultimately gold may turn out to be the best thing to own in this decade, for the next year or so, the yellow metal is likely to be a poor performer. So, in short, if yields and the dollar are headed higher, stocks could be in trouble and gold likely to slip in the intermediate term, cash is looking pretty attractive.
The most important item is the bond market. Recently, I have called for a sharp rise in bond yields and I stick by that. But it is wise to re-examine the results and the fact is that we have not made significant headway on the upside yet. While it seems that we are setting up for a move higher in yield, it seems to be best to wait for a move above 4.44% on the ten-year as confirmation that higher yields are here to stay. A drop below 4.05% would call this forecast into question. Yields bottomed at the end of October, since I usually figure that bonds lead stocks by about three months, this would suggest a stock market high in late January. Also the dollar has steadied. A firmer dollar and higher US bond yields would go hand in hand and would signal trouble for US equities, as well as global economic growth.
Secondarily, and less important, but worrisome, is the excessive bullishness among investment advisors shown by the Investors Intelligence report of 62.1% of advisors bullish. Basically anything above 50% is a warning flag, but this number is the highest in five years! In other words, investors are as bullish as they were in early 2000!!! With the leap in speculative IPO activity and M&A business, it seems as though a lot of froth has returned to the market. My plan is to stay liquid and see how January is going to behave for stocks and stay away from bond unless yields rise above 5%, which I still believe that they will. Also, there seems to be consensus that the Fed is going to have to raise rates to 3.25 - 3.5% this year. Since consensus can often lead to failure, how could this be proven wrong? Either the economy collapses and the Fed is forced to keep rates low or there remains significant economic pressure and the Fed is forced to raise rates farther and faster than anyone anticipates. My guess is that the latter is the more likely scenario. Let's say 40% probability of 4.5% Fed Funds, 50% of 3.5% and 10% chance of 2.5%. You don't hear too many people discussing this possibility and maybe that is because it is way off base, but it seems that it should at least be considered and hedged against.
Finally, gold is backing off its high levels. While ultimately gold may turn out to be the best thing to own in this decade, for the next year or so, the yellow metal is likely to be a poor performer. So, in short, if yields and the dollar are headed higher, stocks could be in trouble and gold likely to slip in the intermediate term, cash is looking pretty attractive.
posted by Matt Butler at 9:28 AM
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