Daily State of the Markets: It's Complicated

Good morning. By now, you’ve undoubtedly heard that Friday’s jobs report was a big surprise. With the Labor Department reporting that the economy lost the fewest number of jobs since the recession began in December 2007, one might have expected to see the stock market surge. After all, improvement in the jobs picture has been a major source of concern regarding this particular economic recovery. In fact, many economists contend that we will see what is called a “jobless recovery,” which is where the economy recovers while the job market languishes. Therefore, an uptick in the jobs market would seem to be a good thing.

So, although most of the other data on the employment front does not support such a good report, stocks did indeed surge out of the gate on Friday. Before long, all three of the major indices were sitting at fresh new cycle-highs and it appeared that the bulls had found what they needed to finally push through what had become a rather frustrating resistance zone.

But then things got complicated. Although the stock market doesn’t always function in a logical manner, the rally to new 13-month highs certainly made sense. And with the economy clearly starting to show improvement on all fronts, we also saw an increase in interest rates and a rise in the dollar Friday morning. All of which makes perfect sense.

However, it is that last part that became the root of Friday’s problem. If you will recall, we went to annoying lengths recently to detail the extent to which the dollar and the stock market had been inversely linked. In short, while the situation had eased up a bit lately, for the most part, stocks had been moving tick-for-tick with the movements in the dollar as traders worried about the unwinding of the dollar-carry trade.

Since this is likely to be a very big part of our stock-market lives for the foreseeable future, let’s take just a moment to review how this game works. With interest rates at 0% here in the U.S. and the Fed telling everyone around the world that rates would likely stay low for an “extended period,” investors borrowed money in the U.S. at next to nothing and then invested in “risk assets” such as stocks, commodities, and emerging markets stock and bond markets. Thus, traders “carried” the trade with borrowed dollars. But, if either interest rates or the dollar rise, the profitability of the dollar-carry trade is impacted – and not in a good way.

So on Friday, with the dollar rising in response to the better-than-expected economic news and some people starting to talk about the idea that the jobs report would allow the Fed to consider raising rates sooner rather than later, the unwind of the dollar-carry trade came screaming back into focus. In short, this means buying dollars and selling those “risk assets.” And THIS is why the DJIA went from a gain of 155 to a loss of nearly 60 points in less than an hour on Friday morning.

And while the market did manage to finish the day with modestly green screens, the result was anything but positive as traders are left to ponder an apparent conundrum. It would appear that the question of the day is if further positive economic news, which would normally be good for stock prices, will become a catalyst for the unwinding of the dollar-carry trade and therefore become a rather important negative. Hmmm… this might indeed be complicated for a while.

Turning to this morning, we don’t have any economic news on the calendar today. However, we will hear from Fed Chairman Bernanke at noon eastern as he addresses the Economic Club in Washington D.C.

Running through the rest of the pre-game indicators, overseas markets are a mixed bag. Crude futures are lower with the latest quote showing oil trading down by $0.66 to $74.81. On the interest rate front, we’ve got the yield on the 10-yr trading at 3.46%, while the yield on the 3-month T-Bill is currently at 0.04%. In addition, gold is down $24.70 and the dollar is higher against the Yen, Euro, and Pound. Finally, with about 60 minutes before the bell, stock futures in the U.S. are pointing to a slightly lower open. The Dow futures are currently off by about 10 points; the S&P’s are down about a point, while the NASDAQ looks to be about 3 points below fair value at the moment.

Wall Street Research Summary

Upgrades:

Stericycle (SRCL) – BofA/Merrill
FedEx (FDX) – Estimates increased at Barclays
SunPower (SPWRA) – Barclays
Suntech Power (STP) – Barclays
Advanced Micro (AMD) – Bernstein
Starbucks (SBUX) – Deutsche Bank
Manpower (MAN) – Estimates increased at Deutsche Bank
Cigna (CI) – Target increased at Goldman
Health Net (HNT) – Target increased at Goldman
Aetna (AET) – Target increased at Goldman
WellPoint (WLP) – Target increased at Goldman
Coventry Health (CVH) – Target increased at Goldman
Potash (POT) – Goldman, Target increased at UBS
ACE Limited (ACE) – Goldman
Cummins (CMI) – Added to Conviction Buy list at Goldman
Brocade (BRCD) – Oppenheimer
Kohl’s (KSS) – RW Baird
Agrium (AGU) – UBS
Health Management (HMA) – Wells Fargo

Downgrades:

Juniper Networks (JNPR) – AURIGA
Barrick Gold (ABX) – Credit Suisse
DuPont (DD) – Credit Suisse
Advance Auto Parts (AAP) – FBR Capital
TD Ameritrade (AMTD) – Goldman
Nalco Holding (NLC) – Goldman
Bare Escentuals (BARE) – Goldman
Marsh & McLennan (MMC) – Goldman
Illinois Tool (ITW) – Removed from Conviction Buy list at Goldman
Endo Pharmaceuticals (ENDP) – Oppenheimer
Coventry Health (CVH) – Wells Fargo

Long positions in stocks mentioned: CI

Best of luck today and until next time, “may the bulls be with you!”

David Moenning

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The opinions and forecasts expressed are those of David Moenning, President of Heritage Capital Management (HCM) and may not actually come to pass. Mr. Moenning’s opinions and viewpoints regarding the future of the markets should not be construed as recommendations of any specific security or Heritage Capital program. No part of this material is intended as an investment recommendation. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any of HCM’s programs. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that investment objectives outlined will actually come to pass. Investors should consult an Investment Professional before investing in any investment program. Neither Mr. Moenning or Heritage Capital Management nor any of their employees shall have any liability for any loss sustained by anyone who has relied on the information contained herein. Mr. Moenning and employees of HCM may at times have positions in the securities referred to and may make purchases or sales of these securities while this publication is in circulation. The analysis contained is based on both technical and fundamental research. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.

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