Market Update for February 27, 2014

The Russell 2000 broke out to a new all-time high yesterday, a positive for the bulls as small-caps tend to lead during bull markets. It will be interesting to see over the next few days if other indexes keep pace. While the NASDAQ has done well this year and the S&P 500 Index is right near its all-time highs, the Dow Jones Industrial Average and the Dow Transports are still below their highs. The Dow Industrials needs a 2.5 percent rally to reach new high this year, while Transports need about a 4.5 percent rally.

On Monday, we mentioned that investors shrugged off bad data in the home building sector and that’s usually a sign of underlying strength. Yesterday, we saw that strength validated with upside surprise in new home sales, which sent the home builders sharply higher.

The Chinese markets stabilized over the past few days and the yuan stopped its brief devaluation for the time being. There was a moment of panic in China with their currency sliding, and the news of one bank halting loans to the real estate sector has the highest level of government asking questions. Although the yuan only fell a bit over 1 percent in the past month, it is the biggest decline in years for the currency.

Furthermore, until there is official confirmation or denial, the widespread belief is the central bank of China was responsible for the devaluation of the yuan. Prior devaluations in the past few years were the act of market participants, not the central bank, which is why the move drew so much attention. If China has decided to let the yuan weaken, there are billions of dollars, yen, yuan and euros positioned on the wrong side of this move.

With the National People’s Congress coming up next week, there is the chance that reforms or policy steps will be announced. Until those meetings end, investors are less likely to take bold positions, either bullish or bearish. The past three quarter end periods have seen cash crunches in the banking system though, and given current events, March 2014 is shaping up to be worse than the prior three quarters. If there are no policy moves, early spring could prove rocky for investors.

The commodity sector gapped higher last week and will likely fall in the coming days. The rallies in oil and gold appear to have run out of steam for now. Copper continues to weigh on the sector, a powerful counterweight to the rally. Until copper turns higher (something most likely dependent on China), the rally in commodities is in doubt, although gold could trend differently due to its monetary characteristics.

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