Stock Market Analysis
Investors were thankful for a prosperous Thanksgiving week in the stock market. Stocks reacted positively to the major economic data releases during the week. The large stock S&P 500 index was up 0.1% and the small cap Russell 2000 index advanced an impressive 1.6%.
Overall, there were 7 economic data reports that were better than economists expected such as Housing Starts, Case-Shiller Home Price Index, Richmond Fed Manufacturing Index, Jobless Claims, Chicago Purchasing Managers Index, Consumer Sentiment, and Leading Indicators. One area we highlighted last year was housing and Year-To-Date the S&P Homebuilders Index is up over 20%.
There were 6 reports that were less than economists expected including Pending Home Sales, Mortgage Applications, Durable Goods, Consumer Confidence, Dallas Fed Manufacturing Survey, and the Chicago Fed National Activity Index. Of course as Mark Twain quipped, “An economist’s guess is liable to be as good as anybody else’s.”
You might be wondering, about the difference between the Consumer Sentiment and Consumer Confidence reports, especially as sentiment came out better than expected while confidence disappointed. Consumer Sentiment is measured by the Conference Board while Consumer Confidence is measured by the University of Michigan. Both reports have sub-indexes that report on current conditions vs. future expectations. With consumers making up the largest portion of GDP, it is important to follow them for clues as to the direction of the economy and the stock market.
With the S&P 500 up over 29% year to date, Zero Hedge reports that over 75% of the advance in the S&P 500 this year is due to multiple expansion (a rise in stock price without a corresponding gain in earnings). Investors are willing to pay over 20% more per dollar of earnings than they were at the end of 2012. Are businesses really worth that much more now than they were last year? Have long term cash flows increased as much as the rise in the stock market? With profit margins near all-time highs, investors should probably be reducing the amount they are willing to pay per dollar of earnings to make up for profit margins and valuations that are likely to decline to their long term averages over time.
Howard Marks wrote in his most recent note to clients that in his opinion the tenor of investor bullishness is not at excessively high levels. Bullishness may not be at excessively high levels, but a lack of bearishness can be just as ominous to contrarians. The Investors Intelligence survey reported the lowest number of bears ever in its survey. This is a contrarian bearish signal because “If there aren’t any bears, who is left to sell too?”
Our leading stock risk indicators are presently in the neutral camp; however for accounts with excessive equities, we would use the recent run-up in prices to reduce positions in these overinvested accounts.
Matt Watson, CPA
Bond Market Analysis
In quiet fashion the Thanksgiving holiday week saw a slight drop in yields for both the 10 and 30 year Treasury. Indeed, it appears maturities all the way down to a 3 month T-Bill participated with lower yield levels.
The big question on investors’ minds is; Is this the time to give up on bonds? Typically high quality bonds move the opposite direction of the economy and there are a few bright economic spots.
We often turn to the regional Fed reports for insights into the manufacturing sector. Of particular note are the regions of New York, Philadelphia, Virginia, Kansas City and Dallas. As a group they are showing robust levels of new orders. Typically growing new orders are associated with positive economic trends for the future.
Still, there are many positives. Inflation, despite the massive printing of money, has remained subdued. The Consumer Price Index (CPI) shows inflation, on a year-over-year basis, growing at a relatively benign 1%. This is the lowest level since 2009. With all of the money growth why isn’t inflation running at higher rates? As our Assistant Vice President, Brian Shepardson notes, “Because it isn’t chasing anything.” A look at our nation’s dismal velocity of money (measuring how often our dollars exchange hands) illustrates his point. Today the velocity on M2 (a popular measure of the money in circulation in our country) is at its lowest point in recorded history.
Further there is another factor which may help contain inflation. Oil prices are on the decline. Back in September oil was topping $110 for a barrel. Presently oil is down to under $93 a barrel with lower prices possible. Why? Because America’s production levels are growing in earnest. Already, thanks to fracking and directional drilling technologies pioneered here in the United States our energy production levels are back to levels last seen in 1985. Further, the International Energy Agency (IEA) suggests that by 2015 our country will be the number one oil producer in the world.
Lower energy costs help keep a check on prices in general. AAA reports that gasoline prices at the pump are down by over 50 cents a gallon from their February top. Again, lower energy prices make the transportation of goods across our nation’s fruited plains much more affordable and should be felt in many categories that make up the CPI.
Presently our indicators suggest this may be an opportune time for high quality bonds. The indicators have strengthened over the last several weeks and now suggest extending durations where appropriate. We do not expect this to be a permanent move but do believe this represents a tactical opportunity for active management.
David W. James, CFA
