Market Week: May 10, 2010

The Markets

Investors who were waiting for a correction finally got it–in spades. The equities markets’ wild rides on Thursday and Friday left the Nasdaq down 10.5% from its April 23 high–official correction territory. Thursday’s nearly 1,000-point intraday plunge in the Dow and Friday’s whiplash volatility wiped out all 2010 gains for the three major domestic indexes. Only the small-cap Russell 2000 was left in positive territory year-to-date despite taking the week’s biggest hit and being down almost 12% from its late-April high. The Dow industrials have suffered the least from the carnage of the last two weeks (down 7.4%), while the S&P has dropped 8.7% in the same time.

Strong profit reports and an unexpectedly high nonfarm payrolls number (see below) were virtually ignored in the face of heavy selling triggered by concerns about another potential global credit crisis. And that doesn’t even count Thursday’s psychotic break, when something–human error? high-frequency automated selling? computer glitch? some combination?–sent even the most stable stocks plummeting during minutes that brought back queasy memories of the fall of 2008. Trades placed between 2:40 p.m. and 3 p.m. Thursday that were more than 60% up or down from the last price at or before 2:40 were cancelled by the Nasdaq and New York Stock Exchange, and the Securities and Exchange Commission and stock exchanges are investigating the cause of the chaos.

The waves of global fear sent investors to seek the comfort of Treasuries; prices rose as the yield on the 10-year note dropped sharply, and the euro hit its lowest level against the dollar in 14 months. Oil also fell below $75 on concerns that European banks might stop lending, thus slowing global economic recovery. However, eurozone finance ministers agreed in an emergency weekend session to a massive $955 billion bailout package of loans and loan guarantees designed to be a firewall against the need to restructure sovereign debt across the European Union (EU).

Despite last week’s tumultuous markets, we continue to remain bullish in the near term. Markets clearly favor the European Union’s bailout of Greece; however, a significant amount of market strength is likely due to short covering. The strength and duration of the current rally will set the stage for the remainder of the year. Longer term, we are cautious and cognizant the market may have seen the high for the year and there remains the risk of a more significant correction. As far as specific industry groups, we remain bullish on Precious Metals (Gold and Palladium), Banks, Casinos & Gaming, Homebuilding, and Retail.

Market/Index	2009 Close	Prior Week	As of 5/7	Week Change	YTD Change
DJIA	10428.05	11008.61	10380.43	-5.71%	-.46%
NASDAQ	2269.15	2461.19	2265.64	-7.95%	-.15%
S&P 500	1115.10	1186.68	1110.88	-6.39%	-.38%
Russell 2000	625.39	716.60	653.00	-8.88%	4.41%
Global Dow	1984.48	1992.64	1823.64	-8.48%	-8.10%
Fed. Funds	.25%	.25%	.25%	0 bps	0 bps
10-year Treasuries	3.85%	3.69%	3.45%	-24 bps	-40 bps

Last Week’s Headlines

• Nonfarm payrolls saw their biggest increase in four years; 290,000 jobs were created in April, and only 66,000 were temporary census workers. However, the new hiring wasn’t strong enough to absorb the 805,000 job seekers entering or re-entering the labor market on signs of recovery, according to the Bureau of Labor Statistics. As a result, the unemployment rate went from 9.7% to 9.9%.
• In addition to the EU bailout agreement, the European Central Bank reversed a decision earlier in the week and announced it will buy government and private bonds. The program, intended to backstop European banks and bond markets, is similar to moves adopted by the Federal Reserve in 2008 to combat the credit crisis here.
• American incomes as a whole rose in March, but American spending rose almost twice as fast. According to the Bureau of Labor Statistics, incomes were up 0.3%, while spending increased by 0.6%. And saving? Down 0.8%, to an annual rate of 2.7% of income.
• April was the U.S. manufacturing sector’s best month since June 2004, expanding for the ninth straight month. The Department of Commerce said construction spending in March also was up by 0.2%, mostly on nonresidential public projects such as roads.
• Productivity rose during the first three months of 2010, though the 3.6% productivity gain was less than the previous quarter’s 6.3%. The productivity gain more than offset a 1.9% increase in hourly compensation, according to the Bureau of Labor Statistics. As a result, unit labor costs for nonfarm businesses–one indicator of whether inflation is heating up–declined 1.6%.

Eye on the Week Ahead

Investors will be digesting the global ramifications of the EU bailout program, and anything definitive on the exact cause of last week’s dysfunctional trading could move markets.

Key data releases: International trade (5/12); retail sales, industrial production (5/14).

Recommendations are not suitable for all clients. Please contact us to discuss specific investments mentioned in this report.