The Bottom Line: A Major Market Event pending

Posted by Don Vialoux - Timing the Market

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Three of four major events that could influence equity markets have passed and one more event is pending:

  • Mid-term U.S. election results revealed on Tuesday evening concluded with a gridlocked Congress as generally expected. Initial reaction by equity markets was minimal.
  • The FOMC announced plans for Quantitative Easing II on Wednesday that was slightly more than expected. The market was expecting a cash infusion of $500 billion through Fed purchase of short term Treasuries. Actual was $600 billion to be extended over an eight month period averaging $75 billion per month. Reaction (surprisingly) was minimal immediately after the announcement. U.S. equity indices on Wednesday afternoon recorded slight gains. The fireworks came overnight after the close on Wednesday and most notably on Thursday.
  • The October employment report on Friday was better than expected thanks mainly to greater than expected hiring by the non-private sector. Reaction to the report was muted.

What happened on Thursday? Federal Reserve chairman Ben Bernanke’s highly unusual “Op-ed” comment in the Washington Post published Thursday morning was the trigger that caused a buying stampede into equity markets as well as short covering. The U.S. Dollar immediately broke support and commodities priced in U.S. Dollars immediately charged higher. The article defended a decision by the Fed to target asset prices as part of its monetary policy. The market quickly assumed that the Fed’s focus included prices of equities as well as commodity-like assets. U.S. equity and U.S. priced commodities virtually exploded on the upside on Thursday morning. In addition, major U.S. equity indices broke above mid April highs and attracted additional technical buying. Is this a one time event or is it an event that will have a lasting impact on equity markets, commodities and currencies in the weeks ahead? Part of the answer could come this week when the fourth market moving event occurs.

The fourth market moving event occurs this Wednesday when the G20 first ministers’ meeting is held. Focus of the meeting is currency. An attempt will be made to stabilize world currencies including a halt in the fall in the U.S. Dollar and a fairer value for China’s currency. G20 leaders have raised grave concerns about the currency war caused by the U.S. and China. Without an agreement, the possibility of a trade war is high. Recent weakness in the Baltic Dry Index already is an early warning signal and could be the “canary in the coal mine” during the next few weeks. Without an agreement, the U.S. Dollar will move lower and equity markets and commodity prices initially will move higher. However, their gains will quickly evaporate if a trade war is triggered. With an agreement, the U.S. Dollar will recover at least briefly and equity and commodity prices will come under profit taking pressures. However, intermediate and long term implications for equity markets and commodity prices are positive. Colour me skeptical! Look for a “comforting” statement following the meeting that will promise to take steps to stabilize currencies. However, the political will by major countries (notably the U.S. and China) to implement change is not strong. Let’s hope for the best and prepare for the worst.

Year end transactions for tax purposes in the U.S. remain on hold. Timing will depend on the political will by Congress to extend the Bush tax cuts for at least another year. Delays on the decision to extend the cuts will compress the time that investors will have to complete yearend transactions and will create significant volatility in equity markets as year end approaches. Obama mentioned over the weekend that he is willing to negotiate.

Large cash positions held by individuals and corporations remain on the sidelines and are likely to remain there until new policy directions are determined by the new Congress.

The recovery in China is significant and important for the recovery in world equity markets during the next 12 months.

Seasonal influences on world equity markets between now and next May are positive. The current quarter and the first two quarters of next year historically are the strongest three quarters in the U.S. Presidential cycle.

Short term momentum indicators for most markets that were overbought prior to last week became more overbought last week. In most cases, short term momentum indicators have yet to show signs of peaking after last week’s upside move.

The Bottom Line
Use weakness into November as an opportunity to acquire attractive equities and ETFs. Preferred selections are economically sensitive sectors such as China, technology, consumer discretionary, materials, Canadian financial services, lumber and industrials.

….don’t forget to look at Don’s 40+ Charts and analysis HERE