8/10 - 8/14 Market Commentary by James Investment Research

Stock Market Analysis

Last week we said, “Ron Paul, Stansberry and others have come out with reasons why we are getting ready for a crisis that will wipe out a lot of wealth. In our 40 years in business, we find these proclamations are usually better times to buy than to sell. Fear gives the chance to buy low.” I love it when the markets cooperate and make us look like we know what we are talking about. The Dow rose 0.67% and the small cap Russell 2000 rose 0.52% for the week. More stocks hit new lows than new highs, but advancing stocks outnumbered declining ones. Energy stocks led the advance while Utility and Industrial stocks also rebounded after lagging this year.

Every month we review what has been working and what hasn’t. While you can’t draw a straight line from the past three months, we do try to glean what we can for making better decisions. In the last three months, large cap stocks continued to outperform smaller cap stocks, an indication it is too early to move out of large cap stocks. In addition, we saw low strength stocks vastly underperform higher strength stocks. Lastly, even though the typical stock lost about 3% in the last three months, our method of evaluating stocks showed good discrimination between high and low ratings. This confirms our desire to stay with our discipline and is a welcome change.

The Chinese devaluation brought turmoil to the market, but turmoil is just another word for opportunity. Their economy has been slowing, their market vulnerable and their exports weakening. They are pulling out the stops to try and reinvigorate trade and growth. The devaluation will hurt our exporters, as they compete against cheaper Chinese goods. This could be a boon to importers and to companies with a domestic focus. In fact, this could be the catalyst for a significant shift in how the market perceives opportunity, perhaps a final push to help smaller cap stocks. To this point it has been the search for Eldorado and we’ve been the gaily bedight, gallant knight.

Edgar Allen Poe didn’t know it, but he wrote about the stock market. The shadow suggested looking “Over the Mountains of the Moon and down the Valley of the Shadow.” These are the watch words for contrarians. Go where others won’t go and seek opportunity when everyone sees darkness. Our indicators remain favorable and we suggest following the poem’s advice to “Ride, boldly ride...If you seek for Eldorado.” This is a better time to buy stocks than to sell them, but we are prepared to shift if conditions warrant. Ignored, bargain type domestic stocks are especially attractive.

Barry R. James, CFA, CIC

Bond Market Analysis

The bond market lost a little ground this week as long-term U.S. Treasury bonds fell 0.3% on the week. However, the third quarter remains strong for bonds, long term Treasuries have gained just over 5%. The yield on the 30 Year U.S. Treasury bond ended the week at 2.86%; down 25 basis points over the past month. The 10 Year Treasury note finished at 2.19%.

The big event of the week was the announcement that China had devalued their currency. This worried many investors and “flight to quality” took hold as bond investors looked to the safety of the U.S. Treasury bond market. At one point, Treasury bond yields fell to levels last seen nearly two months ago, however, they didn’t stay that way.

Retail sales for the month of July rose 0.6%, excluding automobiles they rose 0.4%. This was good news since consumers make up nearly 70% of the economy. Bond investors worried the continued growth in retail sales might trigger a FED hike as early as September. Retail sales and the consumer might be growing moderately but other areas of the economy are not as healthy.

The FED Labor Market Conditions Index is one of those areas of the economy that gives us concern. The index is a fairly new indicator made from a basket of 19 employment related indicators and the reading from this past week continues to show weakness in the labor markets. The trend over the past 6 months also deserves some concern as it remains weak.

In fact we were able to analyze historical data back to 1976 and found some interesting results regarding the overall labor market and the FED Funds Rate. Our research showed that when broad labor market conditions were weak, as they are today, rates were more likely to fall than rise in the next six months. This may be one of the factors some believe will delay FED rate hikes.

We continue to find our intermediate term indicators are favorable as are our long term bond indicators. We are not expecting a significant move in bonds like years past, but would maintain our position in moderate duration, high quality bonds.

Trent Dysert, Portfolio Manager