Stock Market Analysis
The S&P 500 Index rebounded this past week after four weeks of falling stock prices. The index gained 4.1% on the week; the largest weekly gain thus far in 2014. Small cap stocks continue to rally for a second week; advancing 3.4%. Oil fell for the week.
Volume has been relatively light compared to the previous couple weeks when stock prices declined. Since the market peak in mid-September, volume on the days the market rises is about 10% lighter than the days the market declines. This might be a possible sign the rally lacks conviction.
The FED regional activity reports we specially monitor (New York, Richmond, Chicago, and Philadelphia) suggest the economy is doing well and this could continue over the coming months. In fact all four regions are positive and our Four Horseman of the Economic Apocalypse Indicator is favorable. We should note, however, a couple of the FED reports indicate new orders, which tend to be more forward looking, are falling and in some cases have turned negative. This is something to watch closely in the coming months; especially if a downward trend emerges.
Over the past several weeks an interesting situation has developed as a divergence in sentiment has arisen among individual investors and professional advisors. The sentiment readings for individual investors (AAII) show the bulls actually increasing, and at the highest levels in nearly two months. Unfortunately, advisors (Investors Intelligence) have a different view as the number of bulls has declined to a new low in 2014. Readings such as this suggest the retail investor may be buying from the pros at the top setting the stage for tougher times ahead.
Stock returns have been highly correlated with the expansion of the FED’s balance sheet and with QE projected to be ending, higher volatility is expected in the stock market. While the long term indicators remain favorable, short term indicators are neutral after prices have recovered most of the recent sharp losses. Our intermediate indicators remain unfavorable and point to higher risk levels for stocks over the intermediate term, the recent rally represents an opportune time to reduce equities in overinvested accounts.
Trent Dysert
Portfolio Manager
Bond Market Analysis
U.S. Treasury bonds took a breather last week as yields across the curve rose and prices declined. The U.S. Dollar rose in value compared to a basket of 6 other major currencies. Oil dropped again and closed the week below $81 per barrel.
CPI was reported this past week and it came in largely as expected. Year-over-year inflation was reported to be 1.7%. Increases in food prices, specifically dairy and fruits and vegetables, last month were offset by a 1% decline in the price of gasoline. The segment of CPI related to housing did not increase as much as it has recently but was still up 6.4% over the past 3 years while gasoline is down 6.1%.
Existing home sales rose 2.4% in September; however, year-over-year sales are down 1.7%. Housing inventory fell to 5.3 months vs 5.5 months in August. Home prices have been rising over the past year, up 5.6% and the most recent report show the median home price to be $209,700.
Mortgage Applications released Wednesday was in one aspect one of the best reports in recent memory. Mortgage holders decided that it was time to refinance with mortgage rates dropping to 4%. Refinancing was up 23%; however, first time home buyer mortgage applications were down 5%.
Former Federal Reserve Chairman Ben Bernanke recently spoke at a conference in Washington DC where he gave his opinion regarding future inflation and interest rates. He stated that he believed in the “benefits of slow and late tightening” and letting inflation “initially overshoot” the Fed’s 2% inflation target. He also stated that a “3%” inflation target might be better for the Federal Reserve to adopt in the future as this would decrease the possibility of having negative inflation.
The Federal Reserve has stated that they would “tolerate” inflation above their 2% target for a time in order to reduce the chances that inflation would drop below their 2% target after QE and their low interest rate policy has been removed. This reinforces our strategy of not “buying and holding” bonds until maturity and remaining nimble in case inflation does increase faster than investors expect.
Stock market volatility has increased in the past few weeks and bonds have provided a welcome respite. While we are not as positive on bonds as we have been in the past, we are not negative and we do not abandon their important place in portfolios. Our bond indicators continue in the neutral camp. They represent an excellent defense against stock market volatility. We recently took profits, lowered durations and became more defensive after the strong returns long term U.S. Treasury bonds have enjoyed in 2014.
Matt Watson
Portfolio Manager
