Thursday, January 01, 2009

Hints of Risk Appetite in the Stock Market

As 2008 came to a close, many of the headlines recapped how bad a year it was for the stock market. Several market indicators, however, were showing interesting improvement. At Wednesday's close, we had 256 NYSE, ASE, and NASDAQ stocks registering fresh 65-day highs against 144 lows, the strongest reading since September. On a shorter-term trending basis, we had 4 stocks from my basket in uptrends, 11 neutral, and 25 in downtrends at Monday's close. By Wednesday that had improved to 25 stocks in uptrends, 6 neutral, and 9 in downtrends.

When reviewing data from the Decision Point site, I was particularly interested to see that the advance-decline line specific to midcap stocks (top chart) had bested its November peak, moving to a multi-month high. We're also seeing an increasing proportion of stocks--nearly half across the NYSE--trading above their 50-day moving averages (bottom chart).

The low 900 area remains important resistance for the S&P 500 Index, but small cap and midcap stocks are already breaching their equivalent levels to the upside. That suggests a healthy degree of risk appetite among equity investors. That same appetite has been driving prices up for intermediate-term corporate and municipal bonds, as investors seek greater returns in a zero interest rate world. With a weak U.S. dollar and continued overseas conflict, we're also starting to see increasing signs of life in the commodity markets. Short-term Treasury prices, meanwhile, are hovering near several-week lows.

I will be following these themes closely as we start the New Year, because they will give us important clues as to whether deflation themes will morph into inflationary ones in the wake of unprecedented fiscal and monetary stimulus. Should that occur, we could see quite a shift out of safe assets (Treasuries) and into riskier ones (stocks, bonds, commodities).