Rates and the Dollar Will Set the Pace

06/08/2009 10:30 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Jim Farrish, editor of SectorExchange.com, looks at the impact of the recent rise in yields and a newly rising dollar on the current market rally.

The Standard & Poor's 500 index has moved from a low of 676 on March 9 to 940 on Friday, a gain of 39%. And 11 of those 13 weeks have ended positive, with the most meaningful pullback during this period at 5%.

There is growing concern among investors that the market is overpriced and due for a correction. But although this analysis seems sound both technically and fundamentally, emotionally the market can continue at "overpriced" levels for long periods.

The major indices all ended last week to the upside-from the S&P 500's 2.2% gain to the S&P Small Cap 600's 5.7% surge. And nine out of the ten major Dow Jones sectors had positive returns last week, too; only utilities/telecom declined. 

Last week was focused primarily on economic data, which continue to improve but remain at recessionary levels. The jobless report showed a loss of only 345,000 jobs, far less than the 525,000 expected. However, the 9.4% unemployment rate raised plenty of concern. The Institute for Supply Management's (ISM) manufacturing and services data showed the same slight improvement, but remain recessionary, with both well below the 50 level.

The economy, of course, is the cloud hanging over the financial markets. The fundamentals haven't improved enough to support current stock prices. In my view, that will have to be resolved—economic growth will have to rise or stock prices will have to fall.

Interest rates on the ten-year Treasury note spiked to 3.86%, while the spread between the yield on two- and ten-year Treasuries gapped to 280 basis points—the biggest in history. This will be a problem for the Federal Reserve, which will have to address the imbalance or risk the credit markets freezing up again. Fed chairman Ben Bernanke stated last week that he wasn't concerned about the rise in the long end of the yield curve. I think he may be if rates continue to rise. This is something to watch in the coming weeks.

The dollar ended its freefall on the jobs report Friday, when the dollar index bounced back above support at 80. A stronger dollar would likely hurt commodities, which have been one of the leaders over the last month, and a pullback in that sector would affect the overall markets. It could also, however, present some buying opportunities as prices pull back.

The table below has changed to reflect where I think the opportunities are in the weeks ahead. They are all exchange traded funds that allow us to capitalize on the moves in each sector, be they up or down.

It promises to be in an interesting week as the winners will be determined by moves in interest rates, the dollar, and the price of commodities. This is a light week for economic data, so stocks are on their own.

Here are some specific things to watch.

Interest rates: Look for the rise in yields to ease, with a test of short-term support near the 3.6% mark on the ten-year Treasury.
Dollar: Look for a rise towards resistance at the 83-83.7 mark on the dollar index.

Commodities: Look for a pullback if the dollar gains strength in the short run.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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