Consolidation Week Indicates Bulls in Control

Saturday, September 11, 2010

bull marketStock consolidated for the week following jump off lows at 1,040

The S&P 500 posted a marginal 0.46% gain for the light volume Labor Day week following the solid 3.75% jump in the prior week. Stocks started the week lower after the Wall Street Journal published an article Tuesday morning arguing that "Europe's recent 'stress tests' of the strength of major banks understated some lenders' holdings of potentially risky government debt". Markets soon shrugged off the doubts and were greeted with a drop of 27,000 in initial jobless claims on Thursday providing most of the upside price action for the week.

Futures closed near highs of the week indicating nothing but the probable continuation of the short-term bullish trend. I added back some long exposure later this week after selling about half on Tuesday's weakness. I was looking for a bit deeper retracement but alas it did not come so I was forced to pay up a bit in some names as I shifted out of my SPY holding and bulked up the individual companies I already hold. I also added some small exposure in IMAX and WFMI, two companies I have liked for a long time. They both dominate their respective niches and have substantial room to grow as they steal market share from entrenched, less innovative competitors. These initial positions are very small and will grow if my belief that last Tuesday was the buy of 2010 continues to prove itself and eventually I shift out of leaders into smaller companies. The point is far from here though, leaders have a long way to run, especially a company like AAPL which upon clearing the high end of the range at $270 should be off to the races.

The market also has a lot to prove but you never get paid waiting for full confirmation. I see a lot of technicians out there highlighting the downtrend the S&P is at but I am ignoring it. I am also ignoring the top end of this 4-month range around 1,120 because I think it will play no role now that it has been recognized by too many. Typically once it's proclaimed that stocks are in a range they break out of it.

Doctor Copper and T-bonds took some needed rest

Copper fell for the week dropping 2.8% but created no real worry of a breakdown at this point. Copper and equities have moved in tandem since the March 2009 bottom with copper leading the charge higher off every significant bottom. In this last push higher off the July lows in equities and June bottom in copper, equities have lagged. It's only an indicator and the correlation is far from 1-to-1; I believe equities can continue rallying to "catch up" even if copper sees some more downside.

30-year Treasury bond futures fell 0.8% for the week after a 1.6% drop the week prior. The flow of capital out of equity mutual funds into bond funds has been months in the running starting in May, much of the exacerbation of this trend blamed on the flash crash. The month of July saw a total outflow from equity fund over $10 billion. For the week ended September 1st, equity funds lost $9.5 billion nearly reaching the total outflows from July. Bonds funds received inflows of $6.7 billion for the week. Perhaps this large uptick in outflows is coupled with rampant pessimism and marks the final exhaustion of selling as the last of retail throws in the towel on equities. (Data from ICI)

Yellow line is regression from low to high, and extended.

Agriculture commodity rally is getting frothy

The huge moves of late in many commodity markets are becoming quite extended. Particularly, oats, corn, wheat and sugar have been in rally mode for a few months now. I highly recommend against playing any ETFs to capitalize on this trend because of contango risks. There's a bunch of agriculture ETFs (DBA, AGF, JJG, GRU) but I think investors are much better served by finding companies that will tend to benefit from higher commodity prices rather than trying to trade the underlying through ETFs. Often the returns from the underlying commodity will be much greater than businesses in the short-term but trading futures markets requires a great deal of education and management of the same contango risks ETFs face. I expect these commodities to begin dominating headlines sooner or later and "biflation" or "agflation" may become the new words of the day.

Brandon R. Rowley
"Chance favors the prepared mind."

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