Apr 22, 2014 - Here's what happened in the stock/bond markets last week

Stock Market Analysis

Conclusions: Stocks rallied last week, with 2,394 advancing and 812 declining on the NYSE. Daily trading volume decreased on the shorter week, from about 774 million shares in the previous week to approximately 747 million shares. But new highs advanced sharply and ended the week at a ratio better than 2:1 over new lows. It was a win for the bulls as the Dow rose 2.38%. Utilities, thought by some to be a bond substitute, continued to rise. Margin debt continued to rise, which is normal for an advancing market. Inflation indications worried some and all three leading commodity indices rose. Industrial metals prices were irregular, however, as cash spot copper declined along with aluminum. Inflationists would wonder why most precious metals, including gold, platinum and silver fell lower. And, why the U.S. Dollar strengthened against most currencies including the Brazilian Real, the Canadian Dollar, the Chinese Yuan, the S. African Rand, the Korean Won, and the currencies of Sweden and Switzerland.

The bulls are trying to resume an advance which began near SP500 1,737 and moved higher to 1,897 before falling back. In this advance of the projected move are advance decline statistics, and the A-D line set a new high this week. The MACD, a popular indicator, built on moving averages, just moved into a “Sell” configuration.

Sentiment as shown by Investor’s Intelligence Bulls – Bears has shifted, now at 29.3 after peaking above 39 two weeks ago. This is a negative. Trader sentiment has been rising from 57% to 58%, according to Barron’s, which is normal for a minor rally advance. Closed-end fund discount was very large and bullish, now less so.

Export sales are lagging, ahead in February only 0.28%, hardly enough to keep some factories open.

The sharp decline has improved our Risk Exposure Ratio (RER) as well as the indicator picture. In spite of this, we find good evidence that upside movement for stocks will be limited at this point, perhaps for some time. Why?

• Valuations are extreme, stocks recently sold for more than the value of U.S. GDP, a region of previous tops. The SP 500 PE tracks at 23.9, its stocks yield only 1.8%. Stocks sell for $4.50 per $1.00 book value
• The FED is being shamed into curtailing money print operations such as Quantitative Easing, the slow economy marks the program as ineffective.
• The administration attitude continues to be perceived as anti-business, according to many who object to higher taxes and more regulations.

Our leading stock indicators and risk exposure ratio do not necessarily signal an early crash, and they have improved a bit while remaining basically neutral. The best news: long term indicators remain strong, suggesting good buying opportunities can be expected after a pullback.

F James, Ph.D.

Bond Market Analysis

Conclusions: Bond yields headed higher for the week with the 10-Year Treasury touching 2.73%. This rise in yields coincided with rising stock prices. Indeed, for the last seven weeks bond prices and stock returns have been the perfect dancing partners with one stepping back as the other advanced and then reversing course and leadership as well.

Of course one key area for our Treasury market is its perceived as a safe harbor in times of unrest. The sad news of individuals dying in eastern Ukraine suggests tensions there are mounting, despite international promises to make the situation de-escalate. As tensions rise it is likely investors will want to keep at least a comfortable level of higher quality bonds in their portfolio.

On the economic front it is true that, so far, most companies have earnings surpassing analysts’ expectations. However, what is generally not receiving headlines is the revenue shortfall. Most companies’ revenues are simply not doing as well as projected.

This could be the economic pattern for the second quarter where results may exceed the harsh winter’s first quarter results but overall lack the growth needed to make the entire year as robust as some project.

For example the Philadelphia Fed Manufacturing report and retail sales numbers (especially automobiles) were signs of economic optimism. Counterbalancing this is the disappointments in manufacturing in New York and the lackluster housing starts and building permits data. Other signs of concern include the nearly 10% decline in copper prices this year coupled with over a 50% drop in bulk shipping prices (as measured by the Baltic Dry Index).

Presently our intermediate indicators remain favorably aligned. We would expect the diversification benefits between bonds and stocks to continue and would suggest most investors hold a healthy level of high-quality bonds in their portfolio.

David W. James, CFA