CHIPS GO FROM LAGGARDS TO LEADERS AS SMH CLEARS APRIL HIGH -- AMAT AND INTEL CLEAR 200-DAY LINES -- FINANCIAL SPDR NEARS UPSIDE BREAKOUT -- METLIFE HITS THREE-MONTH HIGH -- TIPS AND JUNK BONDS BENEFIT FROM QE2
SEMICONDUCTOR HOLDERS CLEAR APRIL HIGH ... The ability of any stock index or group to clear its April high is a sure sign of strength. In case you haven't noticed, the Semiconductor Holders are doing just that today. I point that out because, up until a couple of months ago, chip stocks were market laggards. Chart 1, however, shows that's no longer the case. Not only is the SMH clearing its April, high, but the SMH/SPX ratio (below chart) has been rising since early September. A number of individual stocks in the group have hit new 52-week highs including (in order of size) Texas Instruments (TXN), Analog-Devices (ADI), Altera (ALTR), Linear Technology (LLTC), Broadcom (BRCM), KLA-Tencor (KLAC), and Novellus (NVLS). One of the biggest chip stocks (which is often viewed as a group bellwether) is Intel which has been a group laggard. But it too is is starting to look a lot stronger. Chart 2 shows Intel trading at a new three-month high after clearing a six-month down trendline and its 200-day moving average. The strong upturn in semiconductors also carries good news for the broader market since it's a big part of the technology sector. And the market is usually stronger when the technology sector (and the Nasdaq) are leading it higher. Another heavily weighted chip stock, Applied Materials, has also just cleared its 200-day line (Chart 3).
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Chart 1
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Chart 2
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Chart 3
FINANCIAL SPDR NEARS BULLISH BREAKOUT ... We've pointed out several times that the inability of financial stocks to turn up was weighing on the stock market. That may not be the case for much longer. That's because Chart 4 shows the Financials SPDR (XLF) challenging six-month highs along the 15 level. A decisive close through that chart barrier would constitute an upside breakout and a buy signal in the financial sector. So far, most of the upside impetus is coming from brokerage, investment management, and insurance stocks. Chart 5, for example, shows Metlife (MET) hitting a three-month high today and approaching a test of its August high near 43. Bank stocks are showing some improvement but continue to lag behind. Chart 6 shows the PHLX Bank Index clearing its 50-day average. It still needs, however, to clear its autumn highs near 48. One of the hopeful side-effects of QE2 is a steeper yield curve with most downside pressure on rates in the five-year maturity. A wider yield curve normally helps banks because they borrow short (pay interest) and lend long (interest gets paid to them). Needless to say, a stronger financial sector would be a good sign for the stock market and the economy. Higher share prices may also tempt banks to start lending some of their winnings. I assume that's one of the things the Fed had in mind.
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Chart 4
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Chart 5
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Chart 6
TIPS AND JUNK GAIN THE MOST FROM QE2... Chart 7 shows the strongest and weakest bond categories since June. The weakest has been the 20+ T-Bond (black line) which has been dropping since midyear. That partly because the Fed isn't planning to buy longer-maturity bonds. Apparently, it's buying is going to be concentrated in the middle of the yield curve (around five years). With yields so low, investors are being forced to look for higher yield with more risk. That explains why the Corporate High Yield ETF (blue line) has been the strongest part of the bond market. Right behind junk bonds are TIPS (red line) which are benefiting from increased inflation expectations resulting from QE2 (and a falling dollar).
Chart 7
FED POLICY FAVORS FOREIGN SHARES AND COMMODITY ASSETS... Chart 8 shows a few other side-effects of QE2. A falling dollar has the effect of pushing money into overseas markets. The blue line represents EAFE iShares (Europe Australasia and Far East) which has gained 7.6% since April versus the S&P 500 (red line) was has gained half as much (3.9%). A second side-effect is that investors are being forced into higher-yielding foreign stocks (and currencies) in a search for higher yields. That helps explain why Emerging Market iShares (black line) have gained more than 15% since April and are leading the global rally. Commodities and stocks tied to them are another beneficiary of the falling dollar. Chart 9 shows the relative strength of gold miners (blue line), basic materials (red line), and energy shares (green line) versus the S&P 500 (flat line) since March. Gold miners started outperforming the S&P 500 in April, basic materials in July, and energy shares in November. The reason why energy shares have lagged behind is because oil has been the last of the major commodities to achieve a bullish breakout. That of course is one of the dangers of QE2. The Fed is deliberately weakening the dollar in an attempt to create some inflation (and lessen the chance of deflation). Problem is those higher commodity prices (like food and fuel) are going to show up sooner or later in grocery stores and gas pumps. When the happens, the Fed may have to start worrying about how to solve an inflation problem that it created. For now, there's an old Wall Street warning never to "fight the Fed". At the moment, Fed policy favors riskier assets like stocks, emerging markets, commodities, junk bonds, and foreign currencies.
Chart 8
Chart 9
AUSSIE DOLLAR REACHES PARITY WITH US... The Aussie Dollar is the best example of a high-yielding currency attracting a lot of money. After the Aussie central bank hiked interest rates this week, the XAD hit a record high and reached parity with the U.S. Dollar (Chart 10). The Aussie Dollar is also benefiting from rising commodity exports (especially to China). The Aussie dollar gets a double boost from a weak U.S. currency and rising commodities. Interestingly, the Aussies (along with other Asian countries) are starting to raise rates to slow inflation at the same time the U.S. is lowering rates to create inflation. At the moment, however, we have little choice but to follow the trend of foreign currencies (and stocks) higher and take advantage of those trends for as long as they last.
