WEEK IN REVIEW "The Taper Tempest"

WEEK IN REVIEW

Good economic news was plentiful this week: The US had fewer initial jobless benefits claims than in any week since the first week of October 2007. The eurozone economy grew for the first time in seven quarters. Portugal had an unexpectedly strong second quarter, emerging from its two-and-a-half-year recession. Greece posted a surplus. Japan's economy grew by 2.6% in the second quarter, after a 3.8% expansion in the first.

However, the surge of positive economic news led many investors to focus on the downside: The US Federal Reserve is that much more likely to begin tapering its stimulus activity soon. A Bloomberg survey found that 65% of economists expect the Fed to begin reducing its stimulus in September, tapering its $85-billion-a-month bond purchases, possibly by $10 billion initially.  Bill Gross recently said that he thinks the Fed is 80% likely to taper in September (video in sidebar). Others have called for a "tapered taper" suggestive of a slower retreat from current stimulus. So perhaps, a paring of $10B from the monthly stimulus and not $20-25B.

On the economic front, housing starts rebounded from a 7.9% drop in June with a 5.9% increase last month to an annualized rate of 896,000. Building permits also bounced back, rising by 2.7% in July to 943,000. A separate report showed consumer confidence unexpectedly dropped from a six-year high. The preliminary reading on the University of Michigan index of consumer sentiment fell to 80 in August from 85.1 in July.

For the week, US stocks fell broadly, but European and Asian benchmarks had mixed results. The yield on the 10-year US Treasury note brushed up against 2.8% for the first time in two years. Yields on the German and UK 10-year government bonds also rose, as nervous bond investors sought protection from rising rates. Commodities prices climbed, including silver futures, which jumped into bull market territory, rising 24% from their June low. Gold prices also rose. Both precious metals are seen by some as safe havens for investors concerned about violence in Egypt and stock market losses.

BEHIND THE NUMBERS

Before we get to the numbers specific, it is important to remember three things at the outset:

1.) Despite this being the worst week for the market this year, this was a healthy retrenching that is not unexpected and is necessary for an extended secular bull rally to continue.

2.) This is an Options Expiration week and much of the excessive volatility can be attributed to that.

3.) Broadly, just about every sector suffered this week.  But cyclicals like financials and materials outperformed.  These will be important catalysts if we are to weather this Fed "taper" tempest.

U.S. stocks declined on Friday, handing the Dow Jones Industrial Average its worst week this year, with investors on uncertain footing as longer-term Treasury yields rose to two-year highs.

The Dow slid 30.72 points, or 0.2%, to finish at 15,081.47, while the S&P 500 index fell 5.49 points, or 0.3%, to close at 1,655.83. The Nasdaq Composite shed 3.34 points, or 0.1%, to end at 3,602.78.  All three main stock indexes lost ground for the second week in a row.

For the week, the Dow lost 344 points, or 2.2%, suffering its biggest weekly percentage drop and point loss of 2013. It was the blue-chip index's worst weekly percentage slide since May 2012, and its largest point decline since June 2012.

The S&P 500 slumped nearly 36 points, or 2.10%, for the week, suffering its biggest weekly point drop of the year, but not its biggest percentage decline. The tech-heavy Nasdaq was down just 1.6% for the week, as Apple's 10.5% weekly gain provided a boost.

Eight of the 10 S&P 500 sectors were down. Telecommunications and Utilities gave up the most ground as Verizon fell 1.5% to $47.80 and PG&E Corp declined 1.6% to $42.65. Technology helped limit losses thanks to Applied Materials' 2.4% rally to $15.69 after the company's announcement of its new CEO encouraged investors. Industrials also managed to gain ground as Boeing advanced 0.9% to $103.65.

Stocks are taking their lead from the bond market. Higher yields are not usually good news for stocks, but if higher yields come because the economy is getting stronger, the latter would be positive for equities.