Weekly markets commentary – June 22, 2009

David Joy — Chief Market Strategist, RiverSource Investments

Stocks Decline as Doubts Arise

The first decline in the S&P 500 Index in more than a month took its toll on what had been among the best-performing sectors in the advance from the March low. Materials, energy, and industrials all declined by more than twice the rate of the broader market. Financials, also among those recent outperformers, fell more than the S&P 500, while technology stocks fell modestly. In contrast, healthcare rose, while utilities and consumer staples suffered small declines.

The same profit-taking pattern could be seen in emerging markets, with Russia leading the way on the downside with a double digit decline. Crude oil declined by $2.49 a barrel and copper fell by five percent.

There has been much speculation recently about if and when these leading sectors would run out of steam and succumb to a round of consolidation. Part of the discussion has even extended to skepticism about the entire rally eventually being completely reversed.

One week of declines is inconclusive, and therefore the presumption is that the advance remains intact. But there are many skeptics, meaning there is a lot of cash still on the sidelines. And, if the market eventually regains some momentum, that cash could become increasingly painful to hold idle.

The obvious candidate to supply a catalyst to restart that momentum is incremental improvement in the economic data. So far, what we have seen in a number of series is mostly a pattern of deceleration in the rate of decline. Of course, that is a necessary prelude to actual growth, but we need to see it.

The index of leading economic indicators (above) has shown marked improvement recently, and is now higher over the most recent six-month period for the first time since July 2007, suggesting that actual growth may not be very far off. Until sustainable economic traction is visible, expect the markets to remain engaged in the present battle between the skeptics and the believers. In the meantime, count us among the believers.

The recent correction in emerging markets provides a window to add to our position. Many of these economies are structurally sounder than those in the developed world. However, their relative outperformance since the fall had caused us some concern that the opportunity had become far less attractive, as their valuation discount had shrunk sharply. In addition, in the U.S., technology, industrials, materials and energy give us the best opportunity for growth in an environment where consumers and financials will struggle to regain their previous strength.

Bond yields were little changed last week, despite the largest 12-month decline in the consumer price index since 1950. The more informative core rate climbed by 1.8 percent. The difference, of course, is largely explained by the price of oil. One year ago it stood near its all time high at $140 a barrel. Six months ago, it was near its present level of about $67 a barrel. It won't be long before the oil price will close the gap between the core and the headline rate.

At the same time, neither should inflation become a real problem any time soon. If so, then bond yields may also meander near their present level for some time as well. The Federal Reserve meets this week, and it seems that concerns about a change in policy are well premature.

The Week Ahead

The economic calendar this week is unlikely to add much clarity to the outlook. New and existing home sales are expected to increase slightly, while durable goods orders are once again expected to decline.