What a Week: Risk Aversion
Ever-rising crude oil prices, a record current account deficit and a profit-warning from
General Motors
(GM) - Get Report
sent the major indices in a downward spiral this week. Meanwhile, Treasury bonds gained and credit spreads widened in a sign of Wall Street's diminished appetite for risk.
The
Dow Jones Industrial Average
fell 1.3% this week, closing at 10,627 on Friday. The
S&P 500
shed 0.8% for the week to 1189, and the
Nasdaq Composite
fell 1.6% to 2007. Adding to the rout was concern over next week's release of February producer and consumer prices, which could show oil and other inflationary pressures seeping into the economy. And of course, the
Federal Reserve's
rate-setting body meets on Tuesday. The market widely expects a 25-basis-point rate hike, but will the FOMC abandon its moderate pace going forward?
Crude oil prices, which reached a new high of $57.50 per barrel on Thursday, remained a constant pressure on stocks throughout the week. The April contract finished at $56.72 in Nymex trading, up more than $2.00for the week compared with $54.43 at last Friday's close.
The 10-year Treasury bond rose, while its yield fell to 4.51% from last week's high of 4.56%. The move marked a reversal of the downward trend seen over the past four weeks. Treasuries began selling off mid-February after Fed Chairman Alan Greenspan said that puzzlingly low long-term bond rates were a "conundrum."
But this week, there was another conundrum. The Philadelphia Stock Exchange Housing Sector's Index, which typically gains as Treasury yields drop, actually fell more than 10 points to 482.13 this week.
Toll Brothers
(TOL) - Get Report
was one of the weaker members of the index amid news of heavy insider selling. The was also weakness in other real-estate related names such as
Fannie Mae
( FNM) and
Doral Financial
(DRL)
.
A lower 10-year yield normally means lower mortgage rates, which boosts housing demand and housing stocks. So why not this time?
Well, this week's rush into Treasuries was not linked to a lower outlook for interest rates. Instead, it was fueled by GM's profit-warning on Wednesday. GM, with its $45.7 billion in corporate debt, has the lowest investment grade from Standard & Poor's. And S&P now views the automaker's rating outlook negatively.
The GM news prompted an exodus out of the corporate and emerging market debt markets and into the safety of Treasuries. By extension, anxiety over credit worthiness is not a positive for the mortgage market. Is the market beginning to fear a speculative bubble in housing, which some have been predicting for several years?
Wednesday did show signs of continued strength in the housing market, as housing starts rose 0.5% in February to 2.195 million annualized units, the highest rate in 21 years.
"If housing starts stay at these levels for another couple of months, then we may get somewhat concerned about overbuilding," says Jason Schenker, economic analyst at Wachovia. "But for now, there's jobs, there's growth, and still very low rates historically."
But the bigger risk picture has changed. Credit spreads will continue to widen for a while, according to Tony Crescenzi, Miller Tabak's chief bond strategist and contributor to
RealMoney.com
While Treasuries eased slightly on Friday, he noted that mutual funds data were showing impressive outflows from high-yield corporate bonds. "It's unlikely this is just a one-week event," he says.
And there was a worrying research note from Merrill Lynch Friday. Merrill analyst Jacob de Tusch-Lec noted that liquidity growth appears to be slowing down and that the Market Volatility Index on the Chicago Board Options Exchange is up 8% for the week. While this may have been exacerbated by options expirations and the reweighting of the S&P 500 on Friday, it's worthwhile to note that the index is also up 20% for the month.
The market at large does seem to be increasingly worried about the impact of surging crude oil prices, of the gigantic twin U.S. deficits, and of the weak dollar on the economy.
Wednesday also brought more bad news on that front. The current account deficit widened to $187.9 billion in the fourth quarter, above expectations for a deficit of $183 billion. The deficit also compares with an upwardly revised number of $165.9 billion in the third quarter. As SW Bach strategist Peter Cardillo put it: "The question remains will the world continue to finance the U.S. deficit?"
Tuesday's release of January capital inflows data equally failed to reassure anybody, although they appeared to be good at first. The biggest jump in foreign buying came from hedge funds based in the Caribbean. Meanwhile, China barely increased its positions.
The dollar did gain on the week, apparently encouraged by the perspective that higher rates in the U.S. compared with other regions of the world will continue to attract deficit financing funds. The dollar rose to 104.77 yen in late New York trading Friday compared with 103.86 last week. The euro fell to $1.3311 from $1.3457 at last Friday's close.
But with higher market volatility and a slowdown in liquidity, there could still be big trouble for a U.S. market that was expecting a big return of the retail investor this year.
According to another research note from Merrill Lynch, U.S. investors seem to be looking outside of their borders to make money. Strategy analyst Sarah Franks says that mutual fund -- and institutional -- flows into non-U.S. equities has been strong and has kept rising over the past month.
Why? According to a Merrill survey of fund managers, investors are more upbeat about the economic and profit outlook outside of the U.S. They also expect the Fed to be more aggressive than other central banks. The banking sectors and credit growth both in Asia and Europe seem to have improved. Global equity markets are seen as undervalued, while the U.S. is seen as expensive. Finally, the yen and emerging market currencies are also seen as undervalued, while the dollar, despite its sharp decline over the past year, is seen at fair value.
In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send
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