August 12, 2011: Market Update

Aug 15, 2011   //   by Bruce Mason   //   Weekly Market Update  //  No Comments

Bottoming Out

How to make sense of this week?  It was a week which saw volatility increase to 2008 levels, trading volume pick up significantly and market point swings which would make even the most avid roller coaster fan a little queasy.  A combination of investors fleeing to “safety”, high-frequency computer trading and an economic and political environment of uncertainty led to one of the wildest weeks in the stock market since perhaps 2008.

The roller coaster ride started last Friday after the close of the markets when the S&P rating agency followed through on its threat to downgrade the U.S. credit rating from AAA to AA+.  While this surprised some, for many it is an affirmation that the U.S. has to get its financial house in order.  Ironically, despite the downgrade, investor poured into Treasury’s this week pushing rates down to levels we haven’t seen in quite some time.  The 5yr TSY is trading at 0.95% while the 2yr TSY is at 0.18%.  Shorter term treasury rates are even lower at 0.01% on the one and three month Treasury bill.  For those investors that didn’t trust the good faith and credit of the United States there was always gold.  Gold skyrocketed to over $1,800 per ounce before slowly falling to end the week around $1,740.

As if the downgrade wasn’t enough, the bears turned their sights on Europe and pushed hard on French banks.  Last week we talked about how fear over sovereign debt problems had spread from Spain to Italy.  This week the fear continued to move closer to the heart of Europe with the stability of France and its banks.  Societe Generale was rumored to have significant exposure to risky sovereign debt, despite European stress tests stating otherwise.  Some even compared Societe Generale to Lehman Brothers just before its collapse in 2008.  To be honest, the European stress tests were very suspect and that unknown contributed to the short-selling.  Ironically, in the middle of this story, S&P reiterated its AAA credit rating on France making many wonder how France could be seen as less financially risky than the United States.  Your guess is as good as any.

Then there were the statements from the Federal Reserve (FOMC) meeting which did nothing to assuage fears.  The FOMC has further downgraded its outlook on the U.S. economy saying that growth is much slower than expected.  They now believe downside risks have increased due to a further deterioration in the labor markets.  For some this was seen as a message of hope that the Fed will resume further quantitative easing, i.e. QE3, later this year.  The markets shot higher until the bears had a chance to dump a glass of cold water on their optimism by suggesting that the Fed really meant to say that there would be no further easing until after the next presidential election in 2012.  This took the air out of the balloon and the market dropped significantly.

My point in recounting this week isn’t to scare you.  It is to explain why the markets moved so dramatically.  In fact, the market may have just lived through 4 consecutive 90% trading days. That is a session where 90% of the stock trading volume and the number of advancers versus decliners are to one sided.  This is extremely rare with this week being only the second time since 1940 that four consecutive 90% days have been registered.  And most unusual of all, there is no historical precedent where we had four consecutive 90% days that saw each reversed in the next trading session, i.e., Down Up Down Up.  The chart below further demonstrates the percentage move over these four consecutive days.

As we said last week, these are unprecedented times.  The good news is that despite the wild gyrations of the market this week, it looks to end pretty close to where it started.  That may come as a surprise to some but for all the gnashing of teeth, we its only off by about 200 points.  We’re not out of the woods yet, but its weeks like this that help form the bottom that investors are so eagerly awaiting.  While we hope the coming weeks aren’t as volatile as the one that just finished and the news shows some improvement, we believe this process will eventually work itself out and create the much needed footing to head higher.

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