Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
Close to Overdone In All Directions
Momentum gained from last week’s QE-favorable FOMC minutes, combined with month-end performance gaming, propelled stock indexes to new highs by the end of trade Thursday. Coincidentally, this happened while the Fed was relatively inactive during the week, pumping less than $8 billion into bonds (only $35 billion for May). This implies that there was a fair bit of short covering behind the melt-up in stocks. ETFs that short stocks have seen much larger inflows at the expense of long ETFs leading up to this week. Although profits in the trade have been elusive so far, it’s the lower upside volume in stocks that supports these bearish bets.
Of course, higher stock prices led to the casual dismissal and rationalization of worse-than-expected economic data. Cases in point include a sizeable downward revision (1.0% to -0.1%) in U.S. first-quarter GDP, lackluster durable goods orders, and sluggish pending home sales for April (0.4% month-over-month and -9.4% year-over-year). Consumer spending fell 0.1% in April – which is a first for this year. It helps explain why retail (and banking) sector stocks have had a hard time breaking out to the upside with the broader market.
On the macro front, inflation (of an extremely secular kind, in our opinion) is pressuring more than one central bank to scale back its stimulus efforts. Brazil, South Africa, Hungary, Japan, and perhaps China rounded out the list of countries in the news this week that are taking steps to raise rates or tiptoe around QE (in the case of Japan) to stave off pricing pressures – even if it means crimping GDP. Japan’s decision in particular will have a profoundly negative systemic effect on PIIGS debt – as it began to do this week. In any case, this is an extremely important consensus-forming development, as it puts inflation rather than deflation at the top of the worry list among banks. Though slow to concede, the Fed is coming around as its QE programs gradually lose influence over the long end of the curve.
Ironically, gold has undergone a rather untimely and unwelcome correction as these and other fundamentally bullish events unfold. In such a context, it’s clear that this selloff has been largely technical, perhaps triggered by the short squeeze in stocks. And this correction has not entailed the large volumes witnessed in previous corrections. Downside from here may therefore be limited. Given that fact, 1,200 may not be in the cards – let alone 1,100 or lower, as some pundits suggest.
Also of note, gold deposits at the COMEX have increased steadily leading up to and during this sell-off, by as much as 14.0%, or a little over 1.0 million ounces since mid-March of this year. This means that the smart money is sticking with their gold bets at a time when small investors are being chased away and most likely moving into grossly overvalued stocks. The late day rally in gold and general softness in stocks on Friday could be a preview of coming attractions, though such things often take time to play out.
Best Regards,
David Burgess
VP Investment Management
MWM LLLP
