Dec 17, 2013 - Recent Market Commentary by James Investment Research

Stock Market Analysis

Conclusions: With small advances three days on light volume, and two days of heavier volume declines, stocks struggled and ended the week with a 264 point decline on the Dow Industrials. For the week as a whole, 875 stocks rose and 2,324 declined while 269 set new highs against 401 new lows. Not inspiring, is it? Utilities and smaller stocks took it on the chin with heavier declines as almost every sector fell. Among the sectors, Material stocks did the best. We monitor three commodity indexes. One showed a decline last week, the other two were neutral.

After many weeks of neutral readings, we have become concerned about the intermediate picture for stocks. Why? First, bullish sentiment is soaring and we know it is wisest to move against the crowd.

1) We classify Investors Intelligence advisers as excessively bullish when the Investors Intelligence % bulls less the % bears approaches or exceeds 40%. Periods of excesses were found in 1987, 1991 and certain other years in the early 1990s. Earlier in December, the plurality was as high as 42.8%.
2) This week Barron’s featured articles “Bullish Prediction s for 2014.” Their experts predict an improving economy and higher corporate profits.

3) Even with the week’s decline, the VIX reading closed the week signifying confidence for the future. In spite of the market pullback, bearish sentiment among small AAIII investors is only 25, the lowest in three weeks.

Another reason for caution is the apparent FED desire to terminate their so-called “Quantitative Easing” QE program. This has been soundly criticized as distorting the markets, favoring the wealthy who own stocks and housing, as they print money to buy bonds, increasing their own reserves up to nearly $4 trillion through purchases of about $85 billion per month. QE is said to be criticized for actions that destabilize foreign currencies and bring about social unrest. Whatever the findings, there can be little doubt it is ineffective as U.S. and Global unemployment continue at high levels. Last week we reported our findings that QE Expansion periods appear to coincide with rising U.S. stock markets, and Curtailment coincided with declines in U.S. stocks.

A final reason for caution: Our leading intermediate term stock indicators have shifted and are now moving in an unfavorable direction. Long term indicators remain bullish, suggesting a stronger economy and improved financial markets after a pullback. Our annual economic research forecast, which may be viewed on our website: www.jir-inc.com (James News: December 10, 2013, Economic Outlook 2014), also comes to this conclusion for fundamental considerations. We note that significant improvements in our economy are unlikely in the near term, but we sport economic advantages such as technology and cheap energy in the U.S. which are apt to prevail over the much longer term. For now, we suggest a modest reduction in equities and a more conservative posture, favoring deep value bargain stocks in sectors such as finance and energy, remaining lightly invested in utilities and international.

F James, Ph.D.

Bond Market Analysis

Conclusions: The yield curve for Treasuries flattened on the week. The two and five year Treasuries sported higher yields while the ten year remained flat and the thirty year yield eked out a small decline.

High quality bonds have always been a peculiar creature in that they usually perform best when economic news is poor. This trait is probably even more acute now with growing rumors of the Federal Reserve potentially tapering their bond buying program in the future.

In that sense it is curious that bonds did not have a more disappointing week. The National Federation of Independent Businesses (NFIB) latest survey show small business owners have growing optimism. Retail sales are surprisingly strong with much of the effect coming from big ticket items like electronics and building materials.

Even the bi-partisan budget deal was met with a ho-hum response by bonds. Of course a deal which encourages spending now with promises to cut future spending should be viewed with suspicion if one is looking for America to get its budget in working order. The current sequestration did not eliminate excessive spending in Washington, but it did curtail it. The new deal will grant more creative “freedom” in deficit spending.

Of course news on the inflation front remains solid and this is a positive for bonds. The Producer Price Index (PPI) measures inflation on the wholesale level. For the third consecutive month this measure is showing deflation, not inflation. This coming Tuesday we will find out whether inflation remains muted on the retail level as well.

Other bond indicators remain favorable. Hourly earnings remain at reasonable levels and the global and United States overall economic data still favor lower yields in the future. Rumors of tapering can have a chilling effect on bonds. However, once a plan is actually announced it could prove to be another example of investors selling on the rumor and buying on the facts.

David W. James, CFA