CHARTS SUGGEST THAT STOCKS HAVE TAKEN A TURN FOR THE BETTER -- VANGUARD TOTAL STOCK MARKET ETF BREAKS THROUGH RESISTANCE BARRIERS -- FOREIGN STOCK ETFS ARE ALSO BOUNCING -- HONG KONG LEADS EMERGING MARKET REBOUND -- DON'T GET COMPLACENT ON INFLATION
STOCKS APPEAR TO HAVE TURNED THE CORNER ... Stocks had a very good week. Major U.S. stock indexes had their best week in two months, with all of them gaining more than 2%. Small caps and the Nasdaq led the market higher. The S&P 600 Small Cap Index hit a record high, while the Russsell 2000 isn't far behind. Sectorwise, energy and financials were the two strongest sectors. A three-year high in crude oil raised inflation expectations which boosted bond yields and bank shares. That also explains why rate-sensitive utilities lost the most ground (more on that shortly). Technology stocks were also market leaders. A strong transportation group (rails and truckers) helped boost industrial shares. Defensive staples lost ground. All of which suggests that stock investors have turned more optimistic. Our first chart supports that more optimistic view. The Vanguard Total Stock Market ETF (VTI) ended the week above its April high and the falling trendline drawn over its January/March highs (see circle). Its RSI and MACD lines have also turned positive. That signals that the three-month triangle formation is finally being resolved to the upside.
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Chart 1
FOREIGN STOCKS ARE ALSO BOUNCING ... It's also encouraging to see that foreign stock indexes are starting to rise or, in the case of emerging markets, at least starting to stabilize. Chart 2 shows the MSCI EAFE (EFA) climbing to the highest level since February. That puts it in sync with rising U.S. stock indexes. The EAFE includes foreign developed stocks in Europe, Australasia, and the Far East. Two of its biggest gainers were Britain and Japan. Emerging market stocks have had a tougher going recently, owing primarily to rising U.S. bond yields and a stronger dollar. EM bonds and currencies have taken a hit for the same reasons. Chart 3, however, shows the MSCI Emerging Markets (EEM) gapping higher this week off its 200-day moving average (red circle). It also found support along its February low (flat line). It still needs to clear its 50-day average (blue arrow) to signal an upturn, but this week's rebound is encouraging. It's hard to imagine a global stock rally without some help from emerging markets. Chinese stocks traded in Hong Kong gained more than 3% this past week which led the EEM higher. That's another good sign for global stocks.
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Chart 2
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Chart 3
DON'T GET TOO COMPLACENT ON INFLATION ... I read in the paper today that stocks rose this week because of relatively mild inflation numbers. April's headline CPI and PPI numbers were reported at 2.5% and 2.6% respectively. Their core numbers (excluding food and energy) were slightly lower, but also above 2%. Apparently, economists were expecting even higher numbers. Some observers interpreted that as evidence that the inflation threat is being overstated. Chart 4 raises a couple of questions that challenge that view. If investors don't expect higher inflation, why were energy stocks the week's strongest sector (+4%)? Investors buy energy stocks as a hedge against higher inflation. And why where utilities the weakest sector (-2%)? Investors sell utilities as a hedge against rising interest rates which are caused by higher inflation. That doesn't seem to support the low inflation rationale for this week's stock gains. Neither does the fact that input costs to companies are rising much faster than headline inflation numbers. A Thursday Wall Street Journal article ("Firms Struggle to Pass on Higher Costs") points out that costs to companies for things like fuel and metals rose 4.7% in April from a year earlier (gasoline prices were up 14.6%). That makes it more expensive for companies to make their products and transport them. According to the article, those higher costs are pressuring companies to raise their prices. When they pass their costs onto other companies receiving those goods, it will be just a matter of time before those companies pass them onto us. As usual, investors are already preparing for that. It usually takes economists a little longer.
