Stock Market Analysis
One could hardly describe the past week as “strong” with just about every stock index showing declines, the Nasdaq composite losing less than one percent while the Dow Utilities lost more than four percent. Trading volume was highest Friday, the day of a large decline. While Utility stocks led the way down losses were seen in every major sector. Declines were also seen among the major commodity indexes with heating oil off 5.1%; crude revived a bit after a large decline and was about even for the week.
The dollar strengthened again against almost all other currencies, except only the Chinese Yuan. (Observers spotted many signs of internal weakness in the Chinese economy, especially in construction and manufacturing. This will impact U.S. exporters, China is our #2 trading partner.) The President of the ECB (European Central Bank) announced a “Quantitative Easing” program for March and the Euro obligingly declined 3.1% this week. Euro printing could cheapen the value of the Euro, perhaps benefiting exporters from the region. (Like Chinese trade, this will also negatively impact U.S. exports to the European area, our #1 trading partner.)
The market may have been assessing the major negatives for U.S. manufacturing firms with foreign sales. Profits are likely to be impacted.
Considering a slightly longer time period, stocks returned only 0.49% over the past three months (median return). Stocks with growing earnings displayed much of the return. Larger and mid-cap stocks showed leadership although smaller issues are beginning to revive. Stocks with good relative strength had higher performance, and consumer stocks, durables as well as consumables, did well.
Since the mid-November low, prices have advanced about 16% to mid-February. It was time for a “catchup correction” as signaled by our short term indicators last week.
Recently 61% of S&P 500 stocks were above their 50 day average price, a neutral kind of a figure not suggesting strong moves in either direction. On the other hand, 69% of the stocks were above their 200 day average price implying a heightened potential for a correction.
Bulls of a contrarian bent are encouraged by the 2nd March 2015 Barron’s headline, “Time to Sit on Cash”.
The margin debt position is a negative, after rising to new highs the annual rate of change slipped below zero during the final quarter of 2014. Such trend changes were unfavorable in the past, as chronicled by Dr. Wilson. Observers will note a negative swing after the 2007 peak.
As always, we find pluses and minuses in sentiment. But our long term indicators are favorable, and so are the intermediate leading ones. Our read is a stock correction after such a long rally (the market low occurred six years ago on Monday) is likely as our overseas sales fade (economic slowdowns in China and Europe).
Still, we have not had enough debt build up nor distortion of the economy to generate a lengthy correction with a true recession. At this point our long term indicators suggest a stock market “Crash”, a la 2008, is NOT likely. After all, this is a PRE-ELECTION YEAR. Plenty of liquidity will come from Washington unless they make a mistake in the course of seeking higher taxes for social spending, and more income equalizing. On the other hand, the governors of some states, including Ohio, are promoting flatter taxes and less overall reliance on lofty income taxes. There is always a chance that such movement could extend to the national scene, and trigger higher overall economic growth.
Our leading intermediate term indicators are neutral to somewhat bullish. The Risk Exposure Ratio is a neutral 50%, implying no strong conviction of major trend changes at this point. Accordingly, we would maintain a portfolio with a moderately invested equity position.
F James, Ph.D.
Bond Market Analysis
It was a tough week for bonds as the January employment report was better than economists expected. This likely altered investor’s expectations that the U.S. Federal Reserve may begin increasing interest rates sooner than some expected. Bond yields across the U.S. Treasury curve rose and the yield curve steepened as longer term bond yields rose more than shorter term yields. Even high yield bonds suffered price declines last week.
Holders of U.S. dollars had a great week though. The U.S. Dollar was up over 1% against its major trading partners. The dollar was especially strong against the Euro as the European Union announced the mechanics of their Quantitative Easing program.
Many European bond yields are already very low, most below U.S. bond yields and some even trading at negative yields. We question what positive effect that this will have on the European economy. If yields are already very low, why will this stimulate increased demand for loans and in turn the economy? Indeed, during the United States QE programs we find the Federal Reserve “created” approximately $3.4 trillion but the economy only grew by $1 trillion over the same time.
Most likely, the European Central Bank will be “pushing on a string” and this is not apt to benefit the economy. Indeed, these actions may even hurt the economy as savers are forced to save even more in order to earn the same amount on their savings.
Back in the U.S., with the exception of the employment report, most of our economic reports continue to disappoint expectations. Both Factory Orders and New Orders for Manufacturing were reported to be negative. In fact, the last two times the New Orders data was at this low level, the U.S. economy was later determined to be in recession. We doubt a 2008 type contraction now, but recessions tend to be positive for high quality bond holders.
There are some positive signs in the economy though. Forbes contributor, Louis Woodhill, makes a distinction between someone who works one hour a month and is considered “employed” in the jobs report, and those full time employed. As he reviews the number of actual hours worked in the economy, he concludes the country just made it back to the level of hours worked that we first reached in November 2007.
Although part-time work has increased, full-time jobs and entrepreneurial jobs have suffered and productivity has also suffered as it takes more people to work the same amount of hours. This is troubling for bond holders as productivity gains work to lower inflation and increase the standard of living of a society. Of course, lower inflation is good for bond holders.
Former Federal Reserve Chairman Alan Greenspan appears to have reverted to a libertarian approach on many economic policies now that he is no longer the Chairman of the Federal Open Market Committee. Skeptics wonder if the FED is in fact truly independent of the Administration and Congress no matter which party is in power.
Dr. Greenspan now espouses the belief that America’s entitlement programs may be hindering consumer savings which is where future consumer spending should come from. We could not agree more with the need for greater savings. Many times over the past few years we have noted that consumers have been saving only about 4% of income which is about half of its long term average. Conservatives support entitlement program reforms, finding this likely to “kill two birds with one stone” by making our current debt situation more sustainable while increasing consumer savings.
Presently we find our bond indicators are neutral. While these indicators are not favorable as they were last year when our research called for it to be the “Year of the Bond”, neither are they negative. As measured by GDP growth or full time employment, the economy continues to lag the normal recovery pace. Consensus opinion appears to call for the FED to begin tightening in mid-year, however our indicators suggest such initial restraint would not be the beginning of a long series of FED rate hikes. Accordingly, we favor a neutral duration on bond portfolios as appropriate for client objectives.
Matt Watson, CPA
