Wall Street Week Ahead: Look for signs in the rally’s break

Posted May 27, 2013, at 6:30 p.m.

NEW YORK — The U.S. stock market’s break in its recent rally left investors wondering last week if they’re seeing a turning point or just a blip in the upward path.

This week could make it harder to figure out, considering that the long Memorial Day weekend typically signals the start of the summer. The U.S. stock market was closed on Monday for the holiday.

The three major U.S. stock indexes posted a decline for the week on Friday, their first weekly loss since mid-April, raising some fresh worries that this year’s rally may be weakening.

Among investors’ biggest concerns right now is how soon the Federal Reserve may be ending its stimulus program. The minutes released this week from the Federal Reserve’s latest meeting showed some officials were open to tapering large-scale asset purchases as early as at the June meeting.

Volume picked up sharply in the last two days following the release of the Fed’s minutes on Wednesday.

“We should have already been prepared for” the Fed’s eventual tapering of stimulus measures, said Bryant Evans, investment adviser and portfolio manager at Cozad Asset Management, in Champaign, Illinois.

“The market is perhaps just looking for an excuse to sell off some gains. And then you throw in the ‘sell in May and go away’ philosophy, well, here we are (at) Memorial Day weekend.”

The pickup in volume suggested to some a shift in sentiment, though activity has been below average throughout the rally, which has taken the Dow and the S&P 500 to record highs.

Much of that rally has been driven by the Fed’s continued economic stimulus.

Brief pullbacks

The rally’s duration and scope have surprised even veteran market watchers, many of whom have been expecting a reversal in the trend for several weeks.

The market has managed to avoid any significant pullback since November, and dips have been used as buying opportunities. Even with the week’s 1.1 percent loss, the S&P 500 remains up 15.7 percent for the year.

Volatility has also not been a problem.

That’s why Wednesday’s reversal — where the Dow and the S&P 500 both rose more than 1 percent during the morning, but fell more than 1 percent in the afternoon — caused many investors to take notice.

“That’s a change. Historically, when you get that kind of a reversal day, it kind of stalls things out for a while,” said Frank Gretz, market analyst and technician for brokerage Shields & Co. in New York.

But he said the market’s up trend has mostly been orderly, with little divergent action.

Other analysts see some of the market’s strong momentum finally waning. Last week’s decline caused the S&P 500 to trade below its 14-day moving average, but the index managed to close above that level.

More volatility ahead?

In another possible sign of weakening sentiment: Two massive blocks of puts were bought on Friday on the iShares MSCI Emerging Markets Fund and the Vanguard FTSE Emerging Markets Fund, according to options strategists.

The move suggests investors are hedging against a possible decline in emerging markets in the weeks and months ahead.

“Buyers can only take stocks so far. There’s certainly a little bit of buyers’ fatigue setting in, and with the market being as extended as it is, it’s certainly not unrealistic to think sellers will start to come in and take advantage of the strength we’ve had,” said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles.

That’s not to say the up trend is over, James said.

Enis Taner, global macro editor at RiskReversal.com, an options research firm in New York, wrote in a note to clients that he expects “equity volatility will be higher in the next couple months than it has been for the past six months, particularly when looking at signals from the commodity and currency market.

“Call option buying was the dominant theme” at the beginning of last week “as the market kept making new highs,” he added. “Wednesday’s sell-off from the highs though, after Bernanke’s comments and the FOMC minutes, and then Japan’s mini-crash” last Thursday “have completely changed the bias of the market.

“The CBOE put/call ratio is near its highs of the year today — a sign that investors are quickly reaching for protection to protect gains after months of complacency,” Taner wrote.

Bond yields vs. stocks’ gains

Some of the recent rally has reflected a push out of bonds and into stocks.

Equity valuations tend to be lower when real 10-year U.S. Treasury note yields are above 4 percent or below 2 percent, Goldman Sachs analysts wrote in a recent research note.

“We expect both real and nominal bond yields to gradually rise from current low levels,” the analysts wrote.

On Friday, the benchmark 10-year U.S. Treasury note’s yield rose slightly above the key 2 percent level — the highest in two months. Treasury yields rose after the Fed added to bond investors’ fears that the U.S. central bank might slow its bond purchases later this year if the economy improves further.

Investors are trying to determine if yields are likely to climb on stronger growth and a more hawkish stance by the Fed.

Economic data has remained mixed, adding further uncertainty to market projections.

This week brings May consumer confidence data on Tuesday and preliminary data for first-quarter gross domestic product on Thursday. On Friday, personal income and consumption data for April is set for release, along with the final reading on consumer sentiment for May from Thomson Reuters/University of Michigan, and the ISM-Chicago business survey, also known as the Chicago Purchasing Managers Index, for May.

 

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