GBR Market Wrap, May 20, 2011

In this Week’s Issue

• Weekly Snapshot
• Market Barometers
• Weekly Chart
• Recommended Read
• Recommended Video: The S&P at 400?

Weekly Snapshot

• China overtook India to become the largest market for gold bars and coins (FT)
• German producer prices rose by a stronger than expected 6.4% y/y in April (Reuters)
• Bank of Japan has kept its key interest rate unchanged at zero to 0.1% (NY Times)
• Greece is unlikely to trim budget deficit to 7.6% of GDP this year (Economist)
• Japan’s GDP fell 0.9% in Q1 of 2011, a 3.7% annualized decline (Reuters)
• Dominique Strauss-Kahn has resigned as managing director of the IMF (Bloomberg)
• U.S. existing-home sales eased 0.8% in April; 12.9% below April 2010 (NAR)
• U.S. industrial production was flat in April after having increased 0.7% in March (Fed)
• Euro area external trade surplus was €2.8 bn in March 2011 (Eurostat)
• Euro area annual inflation was 2.8% in April 2011, up from 2.7% in March (Eurostat)
• U.S. reached the legal limits of its $14.3 trillion debt ceiling on Monday (Reuters)
• U.S. housing starts were 523,000, 23.9% below the revised April 2010 rate (ESA)

Market Barometers

Weekly Chart(s)

The U.S. reached the legal limits of its $14.3 trillion debt ceiling on Monday and could go into a technical default in August if politicians won’t raise the debt ceiling (I think we can also discount that any serious budget cuts will be implemented in the near future). Considering this budgeting quagmire, one would have to view the impact on the U.S. Treasury market as fairly negative. Bill Gross, the head of one of the largest Bond managers PIMCO, took that view as PIMCO recently started shorting U.S. Treasuries in the hope of rising interest rates. Yet, the markets haven’t been budging so far. Although pressure on the U.S. administration to reduce their debt burden has been rising, Treasury yields show no signs of an end to the multi-decade trend towards lower rates. The end of the so-called “Debt-Super-Cycle” has been suggested to arrive this summer when the Fed’s QEII program (Quantitative Easing) ends. However, Treasury yields now look a whole lot more like QEIII is on the horizon. Is Bill Gross going to be smiling sometime soon or will we become more like Japan?

Recommended Read
Funding long-term liabilities with short-term debt has been the name of the game keeping some financial institutions as well as numerous governments financially above water. How long this will last and how much longer they are allowed to “float” without having to tread any water (in form of higher interest cost) is the million dollar question of course. In her article “Watch out for tail risks hanging over Treasuries” Gillian Tett discusses some additional issues that could make it more difficult for U.S. coffers to stay above water:

Those 10-year bond rates are still laughably low, meaning financing costs are cheap. But if sentiment ever swings violently, there could be a nasty wake-up call. That is a sobering thought at a time when Washington is also living with a form of political “rollover” risk, namely the danger that Congress keeps staving off any stable, long-term debt deal and resorting to short-term, temporary budget fixes, which like those bonds need to be continually renewed in a peculiarly hand-to-mouth way.

Recommended Video: The S&P at 400?
Last week, we discussed whether the good old “Sell in May” rule should be considered. Indeed, financial markets are sometimes experiencing a lack of investor interest during the summer months.  Who can blame the punters if they prefer the surfboard over a trading screen…

More importantly, the argument can be made that stock prices may have run a bit ahead of what would normally be considered a healthy rate of appreciation. Having witnesses this week’s stellar IPO of LinkedIn, whose stock price more than doubled on the first day of public trading, it does indeed bring back memories of the roaring 90’s.  No wonder then, that more critical voices are now being heard now. None could be more critical than that of stock market historian Russell Napier. In a recent interview with John Authers, he suggests:

“The real bear market in the S&P has yet to come and could push the US equities index down to 400.”

One might not agree with his target of 400 for the S&P but he does have some convincing arguments to be concerned about risky assets.

Click on the image to play in a new window

Good luck and good investing!

Clemens Kownatzki, MBA is an adjunct professor of financial risk management at the Graziadio School of Business and Management, as well as the founder and CEO of FX Investment Strategies, a Registered Investment Advisor. In addition to running his investment advisory firm, he is a contributing author at SeekingAlpha.com and BusinessInsider.com. He also authored the book, Money Music 101, available on Amazon and Kindle, in addition to publishing the popular investment blog www.fxinvestmentstrategies.com along with a weekly newsletter.

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