Market Update

Allrighty,

So last night Torina texted me about the recent run-up in stocks. Yep, the machine that is the stock market seems to add 40 points to the Dow each day. The consensus on the street is both bulls and bears want the stock market to correct back down to earth, therefore it probably won't happen. Everyone's also waiting for this unknown external event that gives the market a reason to sell off for a bit, but the riots in Egypt were nothing but a head fake.

My theory: You're starting to see inflation across the globe, especially in emerging economies, mainly driven by the rise in food prices (that plus high unemployment in the middle east). We've seen emerging markets slowly, but surely correct over the past couple of months and they've fallen like a row of dominos. First it was the faster growing emerging economies such as Thailand, Indonesia, India, and Turkey. Then you saw Brazil and China roll over. Now you're seeing weakness in Hong Kong, Singapore, Malaysia, S. Korea, and Russia. It's nothing but a healthy correction, and you're already seeing increased buying back into the first tier that fell, but non-the-less, where does that leave the developed markets? Are we the next domino to take a breather?

So what's the catalyst for a healthy correction? Inflation is the central theme in the emerging economies and it may provide a glimpse into the future for the US, although less extreme. Our CPI came out at a seasonally adjusted 0.4% rise. But, the food index rose 0.7%, it's largest increase since 2008, and energy and fuel rose 2.1%. So prices are starting to creep higher. When QE2 began, the order of ops was: commodities will rise, then after 6 months, stores would begin to pass on their costs to consumers...we're starting to see that.

So since the market is forward reflecting (about 6 months), you would have expected to see energy and risk stocks that rise in bull commodity markets lead, and stocks whose costs are tied to food production and energy underperform. This obviously happened. Now, you haven't seen weakness in energy names yet, but just this past week many of the food names and consumer staples are starting to break out. Check out the charts for K, and DF. This is a bit worrisome to me, since these are defensive names who generally outperform in defensive markets. What this may be telling us is that the US will be the last domino to correct, and the 2nd half of the year may be contributed to a more defensive approach of weighing the consequences of QE2, along with the rise in longer-dated interest rates.

Suggestions: Look to scale back positions in energy and risk names that have had huge runs, and reposition into stocks that have been beaten down ( food/consumer staples). The gold and silver trades are officially back on (Torina mentioned SLV in a previous post and it looks to be headed to the atmosphere again).

Stocks I like for this play: DF, MO, NKE, PBR, SLW, MCD