3/31 - 4/4 Market Commentary by James Investment Research
Stock Market Analysis
Conclusions: Last week was generally a positive one for stocks but it was anything but a comfortable ride. The large stocks of the S&P 500 advanced 0.4% while the smaller issues in the Russell 2000 eked out a 0.1% gain. In the current environment, we believe there is relative safety in larger issues.
Other areas that are performing well include defensive-minded sectors like utilities. Last week utilities advanced over 1% as investors sought solace in safer securities as opposed to the “go-go extravaganza” mentality that has gripped much of Wall Street for the year. Indeed, the IPO market, often considered the “frothy” investment, declined for the week and is off over 5% over the last month.
Another sign of changing leadership? The recent resurgence of value investing over growth. Growth investing often focuses on the hope of a better tomorrow at the expense of a solid foundation today (which is more in line with value investing). Wall Street had a love affair with growth stocks. From the end of June 2013 through the end of February 2014 growth investing bested value in 75% of the months. This is a historical anomaly and we now have value outpacing growth in each of the last five weeks.
Part of the market’s troubles may be economic in nature. Back in mid-February Barron’s proud cover story was “the case for four percent growth in 2014.” However, according to economists, a wicked winter “brutal” delayed this fabulous economic growth. Indeed, since last fall economists surveyed by Bloomberg News have lowered their GDP forecast for the 1st quarter six times. However, their projections for the full year remain robust and have changed very little.
Logically, for the economists’ projections to work it means GDP in the subsequent quarters must offer not average growth but rather oversized growth to catch up for the weak first quarter. In this scenario we would expect economic numbers to outpace recent releases and top forecasts. Is this happening? For a number of key indicators, no.
Payroll numbers for March disappointed and even declined slightly from the month before. ISM data for both manufacturing and the service sector were below expectations. Perhaps most troubling is the decline in business investments as measured by changes in capital goods. These are not reassuring signs, especially when coupled with other ancillary data like the 11% drop in copper prices this year and the stunning decline in world-wide bulk shipping prices (the Baltic Dry Index is down 47% in 2014). These are not signs of an economy on the verge of explosive advancement, but of one that is likely to disappoint.
Overall our leading indicators remain in the unfavorable camp. There are areas of relative strength. Auto sales continue to impress and the aforementioned transition from growth to value investing should not be ignored. Still, in this environment, a cautious approach is indicated.
David W. James, CFA
Bond Market Analysis
Conclusions: Bonds had a rather sedate week, until Friday when the news of disappointing employment broke on the optimists. At that point, stocks fell sharply as bond prices rose strongly, and bonds closed the week with the very short treasury yields down 1 or 2 basis points while 10 year bonds and longer settled for a modest increase in yields. Year to date, long bond yields are down nearly 30 basis points or more, producing fine returns for high quality bond investors.
The dollar was just a bit stronger for holders, up about 0.31%, as America continues to be an area of promise for foreigners and, this week, especially the European and Japanese investors. The Dow fell enough Friday to be down for the year to date, and smaller issues such as are found in the Nasdaq Composite index likewise suffered, both of which also contributed to strength among bonds.
A great enemy of bond investors is inflation, so it is good to report the major commodity indexes are showing either little or negative changes for the week, suggesting less demand for the products and thus tending to restrain inflation. Investors fear the big counter to this, monetary expansion by the FED and strong stimulus spending by the Federal Government.
The Federal Reserve has created money said to be about $3.3 trillion since August 2008. Positive economic results are difficult to discern. It is sad to report that one stated objective was to keep bond yields low, yet during some periods of “Quantitative Easing” rates have increased.
It is also interesting that commodity prices have actually fallen over the past 3 years, right in the face of all this inflationary FED and government spending. (But over the last five years, consumer stocks have led the way higher. Inflation could follow later.) We may pay for overspending in the future. Milton Friedman taught that there is no “free lunch.” Year to date, one of the largest decliners among the commodities is copper (down more than 10%), and we have elsewhere discussed the significance of this as an overall indicator of economic strength.
The Purchasing Managers index does not look bad in total, but some of the components are problematic. For example: The 9.3% decline in new orders over the past 3 month, the 5.8% decline in production, and the 4.7% decline in employment. Our Trade balance in goods went negative to the tune of $61.7 billion in February, however, services was positive by $19 billion in February.
Overall we see a picture of an economy rising but too slowly to make the large gains Washington expects and hopes for. Our bond risk indicators continue positive, both for the intermediate and long term, suggesting higher prices ahead. Is this a negative for the economy? As we shortly move into seasonally unfavorable times for stocks, especially in mid-term election years, bonds may continue to offer refuge against domestic economic uncertainties and international conflicts. We would maintain somewhat higher durations where appropriate for accounts.
F James, Ph.D.