Sunday, March 20, 2011

Market Update

Weekly Recap - Week ending 18-Mar-11

It could have been worse. That is the lingering thought entering the weekend after an active week of trading dictated by a dynamic flow of scary-sounding headlines related to Japan's nuclear crisis and the unrest in the Middle East that had the S&P 500 down as much as 4.2% at its worst level of the week.

Fortunately, a nuclear meltdown at the Fukushima complex continues to be averted along with a proliferation of Libya's civil war to other key oil-producing states in the Middle East, namely Saudi Arabia.

Yet, while the worst-case scenarios were avoided in both situations, it is a stretch to say market participants are at ease heading into next week. There is a palpable air of uncertainty regarding the geopolitical environment that can turn sentiment in a hurry if developments take a turn for the worse in Japan, the Middle East and, lest we forget, the European Union, which continues to grapple with its sovereign debt problems.

Faced with the thought of a nuclear meltdown, though, it is understandable that the sovereign debt problems in Europe would be relegated to a back burner issue. There are, as one might put it, more important matters to deal with.

There was little mistaking that Japan's troubling situation at the Fukushima nuclear complex was the focal point for the capital markets this week, along with the rebuilding effort that lies ahead for Japan. Those issues manifested themselves in the Volatility Index (VIX), which spiked as much as 55% this week, and in the Japanese yen, which hit a record high of 76.35 against the dollar.

By the same token, those very items provided a glimpse of the relief trade that was established in the latter part of week. Specifically, the VIX Index closed 22% off its high on Wednesday (though still up 22% for the week), while the yen weakened to 80.88.

Those "relief" trades were catalyzed by several factors: (1) G7 finance ministers and central bankers announcing a coordinated intervention to stem the yen's strength (2) Libya announcing an immediate cease fire in the wake of the UN approving a no-fly zone resolution that was all but certain to lead to an attack on Libya's air defense systems and (3) Japan's ability to prevent a worst-case scenario of a nuclear meltdown.

Not to be forgotten in the relief mix was a decision on Tuesday by the FOMC to leave its monetary policy unchanged, including its intention to carry out a $600 bln bond purchase program through June, a vote by Congress to pass a 3-week continuing resolution for federal government spending, and word that certain banks have been permitted to raise dividends, and subsequently did, after the Federal Reserve conducted another stress test.

The economic releases this week fell to the mixed side, with a very disappointing Housing Starts and Building Permits report for February offset by a remarkably strong Philadelphia Fed Index for March.

As expected, the PPI and CPI reports brought some headline surprises that were driven by rising food and energy costs, but core prices were contained in both reports, demonstrating that there hasn't been much pass through of the higher food and energy costs to other areas. It is evident that inflation is picking up overall, but for the core gauges the Fed watches, there is nothing in the data that would lead one to think the Fed is on the cusp of a major change in its monetary policy.

Next week the Existing Home Sales and New Home Sales reports for February will be the featured items on the economic calendar.

Remarkably, for all of the talk about global economic slowdown concerns that permeated the market this week, several cyclical sectors were among the relative strength leaders, including energy (+0.5%), basic materials (+0.01%), financials (-1.5%), and industrials (-1.6%).

As the aforementioned performance list indicates, relative strength this week was oriented more in terms of which sectors went down the least versus which sectors went up the most.

The S&P 500 ended the week down 1.9%. That isn't great, but pitted against the challenges of a potential nuclear meltdown, escalating violence in the Middle East and North Africa, a Moody's downgrade of Portugal's debt, and lousy housing starts data in the U.S., it could have been -- and might have been expected to be -- a whole lot worse.

--Patrick J. O'Hare,

IndexStarted WeekEnded WeekChange% ChangeYTD %
S&P 5001304.281279.21-25.07-1.91.7
Russell 2000802.83794.66-8.17-1.01.4