V or W recovery for racing TSX?

Is this a V or W shaped recovery? The TSX has rallied 32% since the low on March 9, 2009. It closed at 7566 on March 9, 2009 and is now hovering at 10,000. The chart below illustrates the price appreciation of XIU, which is an exchange-traded fund by Barclay’s iShares that represents the top 60 stocks listed on the S&P/TSX. The current price has surpassed the 10, 50, 100 and 200 day moving averages. All of theses signs are bullish, however, the 10,000 mark is another point of interest. On May 6, 2009 the current price exceeded 10,000 moving on to form its first top reaching over 10,100 and formed it’s second top on May 20, 2009 where it got over 10,200. Although the technicals have been bullish of late, there has been no breakout to give us a bullish or bearish signal in the last 2 weeks. Things appear to have quieted down on the technical rally and be warned now of a “double top”.

Some positive support for the Canadian market is that Canada is one of the strongest countries in the G7. “It looks as though global investors are focused on Canada as the standout from G7, with its strong financial system and significant commodity complex, despite its trade exposure to a crippled US consumer, and the BRICs with their strong consumer/producer pairings.” Posted by Greenlight Advisor on May 25, 2009. The Canadian dollar has recently breached 89 cents and Oil has risen to the $60 level from below $35.

Although the above are all positive signs there are several things that point to what I call a W shaped recovery. The first was quoted in Globeinvestor article “Oil hovers near $61 ahead of OPEC meeting”. “The $60 level implies that we’re going to have a V-shaped recovery in the global economy, and there’s very little evidence of that,” said Victor Shum, an energy analyst with consultancy Purvin & Gertz in Singapore. The second relates to an article in Greenlight advisor.com relating to Richard Russell, Dow Theory Letters, May 18, 2009 where he offers wisdom regarding upside moves in bear market rallies. He defines a secondary reaction to be an important advance in a bear market, usually lasting 3 weeks to many months, during which, the price moves 33% to 66% of the primary price change since the last preceding secondary reaction. A primary movement has an average duration of 95.6 days and a secondary movement averages 66.5 days. We have broken through that so none of this may apply, however, he suggests, “bear market rallies are technical phenomenons which do not necessarily reflect on business.” Richard Russell warns, “Rallies in a bear market are sharp, but experienced traders wisely put out their shorts again when the market becomes dull after a recovery.” Thirdly ‘tis’ the season to “Sell in May and go away”!

Green Shoots - Tulips or Weeds

While a stock market rally after the March 9 low was expected and called for, 9 weeks and 30%+ later, it has surprised many people, including us, in its size and duration. Is it 1982 all over again?

If you recall, the bear market rally never ended, despite the poor fundamentals and technicals. Fast-forward 2 1/2 decades and it's a similar picture. Will the market 'melt up' and pull the economy with it?

Back then, interest rates were on their way down from being over 20% - today, they're already at 0%. The latest phrase to explain the current rally is "green shoots" - small improvements in the economic and corporate data. Don't get me wrong, growth is still in decline, it's just not falling as much as expected, and that's being interpreted as good news (check out the following link to the Wall Street Journal: http://online.wsj.com/article/SB124208415028908497.html). Ultimately we will need to see growth at the end of the tunnel so, where is it going to come from?

The consumer is the growth engine and their ability to consume has been seriously curtailed - rising unemployment and shrinking investment portfolios. They used to be able to borrow against the equity in their home but that's gone too. Besides, the easy money is gone. Those who were handing it out are all out of business. So governments and central banks are filling the void by acting as spender and lender of last resort. Can they keep it up until the consumer is back on her feet or, are we facing a Japanese economic scenario - domo arigato?

So, bear market rally or, bull market?

We think the question to ask is: depression or recession?

Our answer would be recession - There's just too much fiscal and monetary stimulus on a global basis for a depression to unfold. Which means corporate bond yields are still very attractive. In fact, year-to-date they've outperformed stocks as spreads continue to narrow plus they offer better capital protection.

Another question to ask is deflation or inflation?

We think deflation is the shorter-term risk and inflation, possibly stagflation, is the longer-term risk. In either case gold/gold stocks would be a good investment. Gold's recent weakness is an indication that it was being used as a safe haven along with US Treasuries. As risk appetites have risen, money has flown out of treasuries/gold and into stocks, driving yields higher/gold price lower and stocks prices higher. Quantitative easing should keep treasury yields in check but gold could experience pullbacks on stock rallies. We would view these pullbacks as buying opportunities.

To discuss our outlook and our asset mix, sector, and security recommendations, feel free to give us a call or sign up for the next Friday Morning Coffee on Friday, June 5. This will be the last Friday Morning Coffee before we break for the summer so don't miss it. Let me know if you and a guest would like to attend. We'll try and squeeze a few more bodies in but space is limited.

“Sell in May and go away”

So does this hold true? With may coming upon us and a recent rally in markets since March 9th, 2009 there is a flood of articles that point to this question. Most notably, Brooke Thackray who publishes the Thackray Market Letter monthly has researched this topic and concludes that the best time to be in the market is typically from October 28th to May 5th. The reason he argues May 5th is because typically the markets rally the first few days of May. Most research is reflective of the S&P 500. Two other recent articles I would direct your attention to are John Mauldin’s May 1, 2009 “Thoughts from Frontline Weekly Newsletter” and “Sell in May and go away: fact or fallacy?” in greenlightadvisor.com.

What are the technicals telling us? The current price is above the 50-day and 100 day moving average which is bullish in the short term. We would be looking for the current price to break through the 200 day moving average in order to be longer term bullish. When we look at the volume of trades it appears light to moderate at best. We would want to see rising prices with heavier volume. The moving average convergence divergence (MACD) is bullish when the blue line crosses the red line and there is positive divergence. This appears to be flattening out so it looks like momentum is slowing. When relative strength (RSI) approaches 70 we get concerned that things are over bought. The technicals are flashing caution at this time.

The above writers all agree on one thing. Take this opportunity to reduce equity exposure. There may be some more upside in the short term but seasonality and technical analysis suggest reducing broad market exposure on the S&P 500.