Financial Market UpdateStrategicPoint of View®
May 9, 2011
LAST WEEK
Last week saw extreme weakness and volatility in commodities spillover into equities, and by Friday all major indices had slid over 1%. However, that pullback was quite mild compared to the major commodities that saw record price declines during last week’s five day trading session. Silver, for instance, dropped 27% last week, and Crude Oil slumped over $16 a barrel, or 14.7%. That drop in Oil was the largest weekly loss in dollar terms, since oil trading began on the NY Mercantile Exchange in 1983.
The commodity pullback was joined by a strong surge in the US Dollar. The Dollar Index rose 2.5% last week, the first weekly rise in six weeks. Some of that surge can be attributed to Friday’s strong jobs report that showed the economy created 244k new jobs last month. This marks the third consecutive month of job growth in excess of 200k. Bright spots were also seen in the retail, health care and manufacturing sectors.
Lastly, the Treasury market continued to strengthen last week, as we saw 10-Year Treasuries close the week yielding 3.16%, a far cry from the 3.55% they were trading at last month. With the Fed’s Quantitative Easing Part Two (or QE2) set to end in June, the rally in bond prices, and thus fall in yields is quite curious. Investors traditionally rush to the safety of Treasuries when issues, either economic or geopolitical, appear on the horizon. It remains to be seen if this recent rally in Treasuries is the result of the Fed finishing its final purchases for QE2 or, more troublesome, a reaction to growing acceptance that the global economy is weakening.
S&P 500: 1,340 (down 1.72% for the week and up 6.56% on the year)
NASDAQ: 2,827 (down 1.60% for the week and up 6.58% on the year)
Dow: 12,638 (down 1.34% for the week and up 9.17% on the year)
US Treasury 10 yr: 3.16% (from 3.30% last week)
Crude Oil (April): $97.18 (from $113.92 last week)
Gold (April): $1,495.4 (from $1,565 last week)
USD/Euro: $1.4312 (from $1.4810 last week)
THIS WEEK
The economic calendar is quite full this week, as Wall Street waits for the latest readings on Retail Sales, Producer Prices, Consumer Prices, and finally, weekly Jobless Claims. First-quarter earnings reports are slower this week, but there are a few common household names set to report. Walt Disney reports Tuesday, while Wednesday we will see Cisco Systems and Macy’s.
COMMENTARY
As the weather gets warmer, the ride down route 95 (especially on Friday nights after a long week at work) starts to resemble what it feels like to watch the stock market. The driver of each car, just like each individual investor, is processing constant changes in a massive amount of information, often at high speed which forces investors and drivers alike to make adjustments very quickly. Some drivers, like high-flying stocks, act irrationally and drive far too fast switching between lanes without much regard for other drivers. Other drivers, perhaps excited about the start of the weekend, will have their radio too loud which can be quite distracting to themselves and other drivers. Cautious drivers, like cautious investors, have to choose to ignore the noise and other speeding cars and perhaps instead choose to pull aside and let them pass. For drivers and investors alike, distractions are everywhere, and to excel at either task, one has to analyze the new information and decide what’s important and what should be ignored.
Occasionally accidents do occur and fellow speeders and cautious drivers alike all slow down to asses the situation and make sure the road is clear to pass. The term “rubbernecking” has grown in our lexicon, and in general describes the action as people slow down to look at an accident. In general they have no connection directly to the accident; it’s more of a curiosity factor to what has just happened. Last week, we found ourselves rubbernecking at the scene of the silver sell off.
Silver, as you may know, has been on quite a run-up to start 2011. The entire investing market for silver is quite small- in fact, in the 1980’s two brothers, sons of a Texas oil tycoon, almost successfully cornered the entire silver market. In addition, many silver investors employ leverage and can buy up to as much as twelve to thirteen times as much silver for dollars that they have. Combine those two factors, and volatility becomes the accepted norm.
Many investors, like watching a speeding car fly down the fast lane, felt that the price of silver had run up too far and too fast and was due for a serious correction. Most chose to move aside and let the speeding car pass them, knowing that the movement in silver didn’t seem to be rational and would not last. As a sign of just how crazy it has been lately, a few days over the past few weeks, the silver Exchange-Traded fund, symbol SLV, was the most active stock in the entire US market!
This past week, those same investors’ fears were validated as the price of silver fell 27% in just five trading days. Imagine if the Dow Jones Industrial Average had a pullback like that, it would have to fall over 3,400 points! One would assume that if the stock market were to pullback that severely that there would have to be some major economic news or geopolitical incident that investors could point to in order to explain a major sell off like that. While it would do little to soothe the pain, if equity markets were ever to plunge that much in such a short time, the fact that they could point to an event or news item to at least explain the drop would make it easier to accept. The pullback in silver was not accompanied by such a major event.
Sure, there were some news stories about major hedge funds selling their silver, and there were also reductions in the amount of leverage that commodity traders could use, but it was not as if a mining company suddenly announced the discovery of a huge new source of silver. The drop was anything but orderly, as this speeding car started to careen out of control. For most investors, rubbernecking from the safety of our own portfolios, we couldn’t help but shake our head as the price just continued to fall. This is what makes investing in commodities so much more challenging.
Major price spikes can be followed by major drops in prices, and for the most part there is little to no explanation, other than the speculators all chose to run in the same direction. When companies release major news, such as a new product line or exceptional earnings, it’s not unusual for the price of their stock to rise fairly quickly and quite far. However commodities don’t have earnings reports, nor do they invent new products. In normal times, the price of commodities generally moves in reaction to the supply demand characteristics. It goes without saying that the past few months have not been normal times, as prices have been driven primarily by speculators. While investors can make money during these times, it’s more speculation than investing. The risk/reward is much like the driver speeding down the highway in busy Friday traffic. That driver may make it home sooner than you, but by speeding they have increased their possibility for an accident. Drivers and investors alike must decide if the risk is worth the reward. For many investors, including us, we choose to be cautious and let the speeding driver pass us by, resting comfortably in the slower lanes as we know the odds are we will still accomplish the main goal, arriving home, or in retirement, safely and soundly.
*Past performance is not indicative of future results. Indices are unmanaged and you cannot directly invest in them. The Nasdaq Composite Index measures all NASDAQ U.S. and non-U.S. based common stocks listed on the Nasdaq Stock Market. The S&P 500 index is based on the average performance of 500 industrial stocks monitored by Standard and Poor’s. The data referred to above was taken from sources believed to be reliable. StrategicPoint Investment Advisors has not verified such data and no representation or warranty, expressed or implied, is made by StrategicPoint Investment Advisors.
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