5/19 - 5/23 Market Commentary by James Investment Research

Stock Market Analysis

Conclusions: When does a record high in the S&P 500 not seem like a record high? When the gains in a mid-May week make up about one third of the gains for the year. Still, it was a solid week for stocks, with all major indices advancing and prices rising every day. There were about twice as many stocks advancing as falling and plenty of stocks hit new 52 week highs. Lastly, every sector but Utilities rose.

All of the gains came with very little input from economic reports. Perhaps no news is good news. We did have a number of Fed members speak and the minutes from their April meeting also came out. They gave a good deal of consideration to normalizing policy. This means they are not only looking at removing quantitative easing but also reducing the balance sheet that has been building for years. They also said they expect the economy to improve after weather affected the first quarter. The only problem, Industrial Production fell in April, a month that was not affected by winter. In addition, the Chicago national activity index fell unexpectedly.

It was good to see slumping areas rebound. Small stocks did very well as did technology and other growth oriented stocks. Bargain stocks did not fare nearly as well, but still advanced. Mergers are still making news, with AT&T making a run at DirecTV. This has all been part of a trend where shares have taken off of the market at a solid pace. Companies have been buying back shares and many have been bought out. It is amazing but the Wilshire 5000 has less than 4,000 stocks in the index now.

The market’s next move is likely to be the result of excessive sentiment. Right now, we do not have excessive sentiment in either direction. Sentiment surveys have shifted to being less sanguine, and even put/call premiums point to less optimism. However, we do find trading patterns during the day pointing to excess enthusiasm by speculators. Like I said, mixed signals, which usually means no major move is at hand. It still feels like a market that will experience lots of little moves but no clearly discernible trend.

After improving somewhat in mid-April, our indicators are now shifting back into negative territory. This is not unusual after the market rallies. We have not made any changes in our equity levels since lowering equity levels at the end of March. We would remain cautious, as it would take perfect economic conditions to overcome the effects of Fed tapering.

Barry R. James, CFA, CIC

Bond Market Analysis

Conclusions: As expected, bonds took a breather last week. Yields had been dropping since the Federal Reserve decided to taper Quantitative Easing. After the huge rally in bonds, it is normal for them to pull back some. Recently, two major inflation indicators (PPI, CPI) have revealed slightly higher inflation. We have all seen prices at the pump and at the grocery store bound higher. Interestingly, medical care has taken a major upturn in prices, and those increased costs actually helped the economy avoid negative growth in the first quarter. Of course, that is not good news for consumers.

Speaking of consumers, retail sales have had a difficult time moving ahead. While certain areas of the job market are picking up, recent graduates are still having a hard time finding work. I am lucky to meet many top executives and I am hearing that jobs are available in big data and in construction, but it is hard to find qualified applicants. Locally, Navistar has been looking for employees to work for $15 an hour but they have had difficulty finding individuals who can pass the drug screening. It is an odd mixture to say the least. There are job opportunities, but the percentage of working age adults with jobs is at historic lows.

Manufacturing seems to be taking a breather, as industrial production and the Chicago National Activity Index have turned lower. Housing, a key bell-weather of the recovery, is showing some signs of a rebound. Existing home sales picked up a little in April, but are still down compared to a year ago. On the other hand, new home sales picked up more than expected, a good sign. Mortgage rates remain below 4.5 percent and I am hearing that home ownership has become cheaper than renting. However, millions are still upside down on their home value to mortgage owed and many fear they could get burned again on a house.

The Federal Reserve is talking about stronger economic growth and it seems pleased that inflation is closer to 2%. They have feared deflation and the malaise it might bring. In addition, folks had been abandoning bonds and even money market accounts because they paid so little interest. We face and interesting conundrum now, higher rates are bad for the economy, but they can help retirees and others dependent on fixed income payments. This kind of transition is likely to spell greater volatility for bonds.

Our leading bond indicators remain neutral. As we said last week, “The best time to purchase long-dated bonds is probably behind us.” While we own some longer term, high quality bonds, we do not see this as a buy-and-hold environment, and we will reach a point where we need to shorten maturities. However, this has been the Year of the Bond so far and we would continue holding a good position in high quality bonds.

Barry R. James, CFA, CIC