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After a scorching 2003 performance, the major market indices have hit an air pocket.
The year started off well with the Dow Jones Industrial Average, Nasdaq Composite Index and S&P 500 posting modest gains in January and enticing reluctant investors off the sidelines. But stocks have been in a sideways trading range since mid-February as investors found things to worry about. The possibility of the Federal Reserve Board hiking short-term interest rates was one concern, a dramatic decline in the dollar yet another. Now investors are turning cautious.
To see if this investor caution is warranted, I sought a "View from the North Country" and the perspective of Steve Leuthold, chairman of the investment firm that bears his surname and a past guest on our program. In his Perception for the Professional, the primary Leuthold publication for professional and institutional clients, he has been calling for a healthy market correction of 7 percent to 10 percent. Historically, markets rarely rally for 12 uninterrupted months.
If you consider the end of the bear market as October 9, 2002, the markets have been in a recovery mode for 17 months. The S&P 500 has posted a 47 percent gain from that date to the end of February. If you take March 11, 2003 levels as your starting point, the S&P is up about 43 percent. Either way, it's a pretty heady move for a market coming off a three year bear mauling.
But Leuthold sees the last six weeks of sideways movement a good thing. It has tempered enthusiasm (a good contrarian sign), eliminating what market technicians describe as an overbought condition. Also, investors also altered their behavior and assumed less risk instead of more. That meant selling more volatile stocks and buying into the so called safe havens, energy, utilities and consumer staples. Clearly investors have taken a more defensive position.
The dollar has also attracted Leuthold's interest. The greenback has had a brutal decline from 2001 through 2003, partly because of the Fed's accommodative stance. The Federal Open Market Committee meet this week and left short tem rates unchanged, but because the move was so widely anticipated, the news was already reflected in the currency market.
But Leuthold believes a significant rally is in the making. The dollar is the leading reserve currency. It is the most widely used and respected form of exchange. With its recent sell off, Leuthold views the dollar as both oversold and undervalued, and is anticipating renewed dollar strength.
And for commodities? A strong dollar would help curb rising prices -- especially for dollar-based products such as oil, gold and industrial metals -- but that doesn't mean they will see a dramatic price decline. All markets still about supply and demand imbalances, and as long as global demand increases and producers are unable to increase production proportionately, commodity plays, especially industrial metals like copper, aluminum and other non-precious metals, may continue to make sense.
What doesn't make sense for Leuthold is the bond market. Because low interest rates attracted so many buyers to high-yield bonds such as corporate securities, prices rose sharply and ended up cutting down the very yields that attracted people in the first place, price and yield always move in the opposite direction. Now the high-yield bonds no longer offer enough of an advantage over drab federal government securities to make it worth Leuthold's while. As an alternative to bonds, he's investing in some high-yield utility stocks.
Leuthold's latest report also touches on exchange-traded funds, which many investors use as proxies for market indices or entire industries. More than 130 ETFs exist -- the best known are the Standard and Poors Depositary Receipts, or SPDRs, which track the S&P 500, and the QQQ, designed to follow the Nasdaq 100 -- and their rising popularity and rapid growth has been remarkable in recent year.
But most exchange-traded funds follow indices for certain sectors, such as technology or real estate, with far fewer traders than S&P SPDRs or the QQQs. While ETFs can play a role in a sizable buy and hold portfolio, lack of ample liquidity can be seen as a disadvantage for many of the lesser known domestic equity ETFs. Even for those with sizable funds to invest, the universe for large, liquid funds is small. Thus, Leuthold cautions that there are few ETFs of sufficient size to be practical for institutional investors, much less individuals.
Still overall Leuthold likes the equity market and views the current atmosphere as a buying opportunity. Find out more on this week's broadcast when Leuthold rejoins us.
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