Week In Review

The week that was:

The first few weeks of every calendar year are a time for market prognosticators to reveal their predictions for the coming year.  January of 2011 was no different.  I read a handful of columns from some of the most well-respected minds in finance.  However, none of these folks came close to predicting what was to unfold in Egypt in January and February.  Egypt has dominated headlines and the stock and commodities markets have remained fixated on the drama.  The events culminated on Friday with the resignation of President Hosni Mubarak as he handed over power to the Egyptian military.  What happens in Egypt in the following days, weeks, and months will certainly shape the future of the Middle East and maybe even the world.

The Egypt stock market will remain closed until Wednesday at the earliest.  For those of you interested in investing in or speculating on Egypt, the Market Vectors Egypt Index ETF (EGPT) is the way to go.  There has been tremendous volatility in this fund over the last few weeks and I would expect this to continue.  The fund has doubled in size in the last few weeks to $25 million as others seek to profit from the turbulence.  EGPT holds about 27 stocks, with financials making up 47% of the portfolio. 

In news outside of Egypt, China’s central bank raised its key interest rates in an effort to slow inflation.  The one-year lending rate was increased from 5.81% to 6.06% and the one-year deposit rate was increased from 2.75% to 3%.  Economists are predicting that inflation in China could exceed 5% for the first two months of 2011.

Stocks:

The S&P 500 rose 18.28 points this week, or 1.39%, to 1329.15.  The Nasdaq Composite rose 40.14 points, or 1.45%, to 2809.44.  The Dow Industrials rose 181.11 points, or 1.50%, to 12273.26.  The S&P is up 4.14% over the past two weeks.

• Shares of Nokia (NOK) fell almost 14%  on Friday after the company announced a number of changes, including plans to use Microsoft’s mobile operating system in its smartphones.
• A number of analysts downgraded Cisco (CSCO) this week on concerns about higher competition and lower margins.  Shares were down 14.15% on Thursday.

Bonds:

End of week bond yields:

3 Month yield = 0.09%, down 4 bps from last week.

2 Year yield = 0.83%, up 9 bps from last week.

3 Year yield = 1.40%, up 18 bps from last week.

5 Year yield = 2.35%, up 10 bps from last week.

30 Year yield = 4.70%, down 3 bps from last week.

An investment idea for a steep yield curve:

Since 1976, the average yield difference between 10-year and 2-year bonds is 0.83%.  That spread is currently 2.8%, which is near an all-time high.  This elevated state cannot last in the long-term.  An investor looking to take advantage of this situation might purchase the iPath US Treasury Flattener ETN (FLAT).  This fund employs a strategy that profits when the 2-year versus 10-year yield spread declines.  It does this by shorting 2-year Treasuries and going long 10-year Treasuries. 

Going beyond this mean-reversion trade, what does the steep yield curve really mean?  The bullish view is that the two previous similar yield curves (in the early 1990s and 2000s) served as precursors to an improving economy and large gains for stocks.  However, the bearish view is that the long-end of the curve is signaling inflation fears, persistent government debt issuance, or possibly even a future downgrade of US sovereign debt.  I can see merit in both viewpoints but am more inclined to agree with the bearish camp if I had to pick sides as I think inflation is around the corner.

What to look for next week:

7:30 AM          Tuesday           Retail Sales

7:30 AM          Wednesday     Housing Starts

7:30 AM          Wednesday     Producer Price Index

8:15 AM          Wednesday     Industrial Production

7:30 AM          Thursday         Consumer Price Index

7:30 AM          Thursday         Jobless Claims

9:00 AM          Thursday         Philadelphia Fed Survey