Commodities Outshine Stocks in 2010

December 2010
Stock Market Commentary:

The major averages surged in December and enjoyed double digit gains in 2010. Furthermore, the 18-week rally which was confirmed on the September 1, 2010 follow-through day (FTD) remains intact which is a healthy sign for 2011.


Before we address the current market outlook, it is important to step back and put the recent action in proper context. Since the March 2009 bottom, the major averages have experienced explosive gains on the simple premise that the global economic recovery will be robust. That notion helped the benchmark S&P 500 Index vault an impressive +88% as of December 31, 2010’s close. The major averages pulled back from April-August as fear spread that the robust recovery may begin to wane due to the ominous debt levels in several European nations coupled with a high rate of unemployment. The summer sell off sent the major averages down –11% to -18% from their 2010 highs before bottoming in early July. The euro, which has also enjoyed healthy gains since March 2009, topped out in December 2009 and has steadily fallen during the first half of 2010, then rallied smartly off its multi year lows in July and pulled back after in November after Ireland needed to be bailed out. Looking ahead, it is imperative to monitor the direction the euro is heading in order to better gauge investors’ world-wide collective appetite for risk.

Bullish Case: Stocks Are Strong!

History shows us that most bull markets last between 18-36 months before they fail. Therefore, the fact that we are only beginning our 23rd month bodes well for this bull market. It is also very encouraging to see nearly every government across the globe step up and unanimously infuse an unprecedented amount of capital into the global economy and more recently, reiterate their stance in recent months to infuse more capital if needed (which are now known as quantitative easing 1 and 2). This unified action saved the global economy from entering a deeper recession and laid the foundation for this massive bull run. On average, central banks around the world are still keeping rates near historic lows to help spur economic growth, while a few have begun raising rates. As of this writing, the major averages continue racing higher and managed to negate a massive head and shoulders topping pattern, breakout of a smaller inverse head and shoulders pattern, trade back above their 50 and 200 DMA lines, and take out April’s highs. As long as these levels hold, the intermediate and longer term picture remain positive. It is also healthy to see a slew of commodities surge to fresh multi year and record highs. Gold, silver, cotton, and coffee are a few well known commodities that have enjoyed robust moves recently.

It is also very encouraging to see the bulls show up and continuously defend support. Since the April 2010 highs, the major averages have pulled back a handful of times, each somewhat mild, not exceeding the -20% level which technically defines a bear market. Therefore, until the major averages pullback over -20% from their recent highs this could be interpreted as a temporary correction, albeit steep, before the bulls again return and resume this powerful uptrend that began in March 2009. A characteristic of this bull market and others is that every time the market pulls back the bulls promptly show up to quell the bearish pressure and defend support. That said, until support is breached, the bulls deserve the bullish benefit of the doubt.

Bearish Case: EU Debt & High Unemployment Rates Are Still A Concern

Sovereign debt woes and high unemployment rates continue to be the bane of this rally. Since the April 2010 highs, several popular rating agencies have downgraded a slew of European nations and financial institutions’ debt. Not surprisingly, this corresponded with a steep sell-off in the euro which sent it down to fresh 4-year low earlier this summer.  Italy, Hungary, Portugal, Greece, Iceland, and Spain are some of the European nations which analysts believe are dealing with onerous debt levels. All of this helped gold and bonds race higher as the so-called “safe haven” trade. Gold prices surged to all-time highs last month as the US dollar fell.

The bears believe that the effects of the massive worldwide stimulus packages from 2008-2009 are beginning to wane and the future of the global economic recovery may not be as robust as initially expected. The bears also claim that technically this rally is done and overdue for a serious intermediate-term correction. Since the March ‘09 lows, the major averages have retraced (rallied back) a little over +60% of their 2007-2009 bear market decline, which is a fairly typical bounce before a new down leg ensues. Only time will tell exactly how this plays out.

Market Action:  Price & Volume A-

As we know, the major averages topped out in October 2007 and then proceeded to precipitously plunge until they put in a near-term bottom in early March 2009. Since then, the market snapped back and enjoyed hefty gains which helped send the major averages to one of their strongest 23-month rallies in history. The small cap Russell 2000 Index was the standout winner, surging a whopping +128% and a very impressive +25% in 2010. The tech-heavy Nasdaq Composite is second, vaulting +110% since the March 2009 low and jumped 17% in 2010. The benchmark S&P 500 Index raced+88% since the March 2009 low and 13% in 2010. Meanwhile, the Dow Jones Industrial Average soared +79% and +11% in 2010. Despite these impressive gains, several commodity markets soared in 2010. Gold rose nearly 30%, Coffee and Sugar both enjoyed tremendous gains and a host of other commodities hit fresh recovery highs.

Looking forward, as long as the major averages stay above their 50 DMA line the bulls remain in control. However, if the 2010 lows are further breached, then odds will favor even lower prices will follow. Allow us to be clear: the action since the July low has been robust, very healthy, and suggests the bulls are now back in control of this market. Trade accordingly. Never argue with the tape, and always keep your losses small.

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