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The big paradox out there right now is that the stellar rise in North American stocks this year has coincided with the biggest recession since the Second World War.
A smaller, but related, paradox hit Friday, when upbeat data on the job market left markets battered or confused, depending on which market you were watching and where you were invested.
For example, any investor who had decided ahead of all that data to seek some safety in bullion and bought shares of Barrick Gold on Thursday, shares in the largest and one of the most respected gold producers, suffered a 9 per cent loss the next day when the good news hit on the economic front.
And diversity didn't help protect you if you were a Canadian investor - strong employment gains here were overshadowed by the relatively mild job cuts in the U.S. and a subsequent surge in the value of the U.S. dollar. That pulled the relative value of commodities and the loonie down, pressuring Canada's benchmark index while U.S. markets struggled to find direction.
How should investors make sense of this market? One theory is that what we have been seeing over the last 18 months may not be paradoxical at all, but simply grander and faster than what we have become accustomed to in previous cycles.
Vincent Delisle, strategist for Scotia Capital Inc., said the confusing thing here is the "off-the-charts magnitude" of the markets' moves. By the time most investors are reading about events in a newspaper, or even on a financial blog, the information is already lagging.
"The average investor reading about positive job numbers and a 1 per cent drop on Bay Street is going to feel lost," he says. But take out the dramatic scale and speed of recent events, and you see that they are being resolved in a classic text book manner that mirrors patterns going back 100 years.
Accepting this rationale makes it a bit easier to plan a strategy. It says that job growth in the U.S. will be the most important theme next year and that the market has already priced in most of the recovery.
The latest information on jobs "signals the very late innings of the U.S. dollar bashing," Mr. Delisle says. "The fact that we are not seeing stocks rise is a reminder of what's likely to happen when the real U.S. economy is growing again."
The market is looking beyond a turnaround in jobs and already weighing interest rate hikes next year. The first indications were the jump Friday in yields on U.S. government bonds, which were up 10 basis points or more for short-term bonds and 8 basis points for long-term bonds.
"[Friday's]moderate reaction in the U.S., and decline in Canada, is simply the fact that the market is seeing increasing probabilities of getting rate hikes next year," he says. "Rate hikes are getting priced in to the bond market. The prospect of higher interest rates is signalling that the [stock market]leadership in the recovery we've seen since March is very close to an end."
Today, U.S. Federal Reserve chairman Ben Bernanke is scheduled to give a speech to the Economic Club of Washington, D.C. Tomorrow, the Bank of Canada will detail its monetary policy with regard to interest rates. The Bank of England will follow with its own report on Thursday. None is expected to change its rate, but the language from the central banks will likely fit with economists' expectations of rate hikes beginning by the middle of next year.
It is just a matter of time before the U.S. Federal Reserve Board begins to raise interest rates resulting in a narrowing of the wide yield gap between short-term and long-term U.S. Treasuries.
"Rarely has a single trade been so widely anticipated," said Eric Lascelles, chief economics and rate strategist with TD Securities Inc. But due to financing costs, timing is everything and bond traders should be patient, he said. Data from previous recessions - 1973-75, 1990-91 and 2001 - suggests a significant narrowing of the spread does not happen until over 20 months after the recession's end. Assuming the current recession ended in May, the yield curve - the difference between 10-year and 2-year U.S. Treasuries - may not begin to "flatten" notably until late 2010 or early 2011.
But, he cautions, the peak in the U.S. unemployment rate has tended to precede curve flattening by just two to four months. Use that as an indicator and spread narrowing may start earlier than other economic indicators - jobless claims, non-farm payrolls, leading economic indicators and ISM manufacturing - suggests Mr. Lascelles. The initial flattening stage begins eight to nine months before a Fed rate hike.
Weak U.S. dollar = Strong stock market. Now that's a simple equation.
"The impressive recent inverse link between dollar weakness and stock price strength is unsettling as the correlation has now reached its strongest level in at least 30 years," said Myles Zyblock, chief institutional strategist and director of capital markets research for RBC Dominion Securities Inc.
And it seems currency traders are betting the U.S. dollar will remain weak, as dollar short-positions have become elevated at a time when the greenback has fallen into oversold domain, he said. The primary risk to higher stock markets "over the next few months is a countertrend move higher in the U.S. dollar," he said.
Investors need to keep an eye on the dollar. Both energy and financials should appreciate strongly in 2010, said David Bianco, chief U.S. equity strategist for Merrill Lynch & Co. Inc. However, energy is likely to outperform with a significantly weaker greenback, while moderate appreciation of the currency and subsiding inflation fears would boost financials, he said.
A cold snap and better employment data combined to ignite the depressed natural gas market late last week, but the long-term outlook remains murky.
Natural gas futures prices rose 3.7 per cent or 16.4 cents (U.S.) on Friday to $4.62 per million British thermal units, according to Bloomberg. That was the first gain during the week as inventories climbed higher.
The consensus seems to be that the "worst part of the downturn is over and market conditions are improving," said analysts with Canaccord Capital Inc. in their Weekly Energy Review. However, it is uncertain when production declines resulting from reduced drilling activity will bring supply and demand back into balance.
This commodity cycle is also unique from a long-term perspective because technological "innovations in horizontal drilling and completion techniques have resulted in a gradual, but profound" increase in productivity and aggregate supply from shale gas plays, they said.