Market Summary
The Market got what it wanted to hear from Federal Reserve Chairman Janet Yellen as she signaled stocks are due for more gains. Listening to Ms. Yellen speak is like getting lectured by your grandmother, but nonetheless she is following former chair Ben Bernanke’s philosophy in that whatever is good for the stock market is good for America. Look, you can find 100 or 1,000 analysts who will proffer conflicting opinions on why the market should’ve or shouldn’t have performed as it has since the recession started. But I don’t care who you talk to, no knowledgeable market watcher can seriously deny that the Federal Reserve’s various iterations of Quantitative Easing (QE) is the steroid that has juiced the stock market to stratospheric levels.
We can talk about and debate numerous theories on how to price stocks and what factors will influence whether shares will go up or down. However, at its most basic core, what drives the price of any investment is straight-forward, simple supply and demand. If there are more buyers (demand) than there are sellers (supply) the price has to go up and will continue to rise until there is equilibrium with demand equaling supply. Conversely, if there is more supply (sellers) than there are buyers (demand) the price will always drop until there is equilibrium. You can do quantitative analysis and apply all the advanced economic theory you want, but in the end it is the basic demand = supply equation that will drive the price. The reason all the ‘expert’ financial prognosticators keep getting it wrong about a market correction, crash, etc. is because they ignore that fact the Federal Reserve is supplying unlimited demand ‘QE’ to keep stock prices afloat. Company earnings, U.S. political system dysfunction, global political and economic unrest, chronically poor labor markets, etc., none of it have really mattered. Ben Bernanke started the free money train and Janet Yellen is committed to keeping it rolling, and until it comes to a complete stop, betting against this market is a very risky bet indeed.
Investor Analysis
Recent articles mentioned “…the past few weeks ‘risk on’ categories have been the best performing sectors as small caps, energy and financials are leading the market higher…” The updated performance graph below reflects the two major themes of the past few weeks. Oil and gas prices have gone higher as chaos in the Middle East and Ukraine brings into question whether the world-wide energy supply is at risk. The other theme relates to the discussion above about the Federal Reserve’s continued easy money policy. Janet Yellen’s comments indicate the Fed is not concerned about fighting inflation any time soon. Gold has surged the past few weeks as investors are buying it as the traditional inflation hedge. Conversely, higher inflation expectations are a negative for treasury bonds as prices have dropped in response to higher yields demanded by buyers.
We recently opined “…gold prices appear to have bottomed out a support line that has been in place since the beginning of the year. Now is probably an opportune time to look at setting up trades that will profit if gold does bounce off its support level…Gold appears to be bouncing off a support level that has held up the price all year… your bullish trades to take advantage of the bounce off support should already be profitable with gains continuing to run…” The current gold rush has probably made most of its move and now is the time to takes some profits and/or tightens stops to lock in gains. If the price stalls out at resistance, a price neutral gold trade is probably a low-risk opportunity.
As you can see in the chart below, gold and treasury bonds continue to maintain an inversely correlated relationship. Depending on how your investment portfolio is set up, gold and treasury bonds can be used to hedge against each other and the equity market. For example if you took our suggestion to bet on higher gold prices a few weeks ago you should be showing a nice profit. Long bullish gold trades are now more risky since the price has surged and shorting gold is also a risky move at this point. But a long bullish Treasury bond trade is inexpensive and low-risk right now, and if/when gold drops you can expect bond prices to then move higher. Also, you can expect bond prices to rise if equity prices drop significantly.
By Gregory Clay
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