Stock Market Analysis
Last week stocks took a bad tumble toward the end of the week, when the last hour or two saw near-panic trading. Among common stocks, nearly five times as many stocks declined as advanced. Daily volume rose to the highest in the week. New lows outnumbered new highs by a 5 to 1 ratio. Declining prices near the close, on higher volume, is a strong warning feature which suggests that demand for stocks is at least temporarily filled. Almost every domestic index declined last week, with utility stocks leading the decline for a 3.4% weekly plunge. Telecommunication and consumer staple stocks were also hard hit—they had previously led advances and might have been considered to be over stretched.
As stock prices fell, so did commodities, popular indexes were down 4 to 5 percent for the week, along with commodity futures. Copper and Nickel were down 7 to 12 percent, but losses in precious metals doubled this decline.
Technical internals are weakening now. Our advance decline line peaked two weeks ago in spite of higher stock prices, and so has the percent of stocks above moving averages. Stochastics turned negative.
Bullish sentiment is near an extreme, Investors’ Intelligence polling on bulls-bear spread is now 32 and at the same level as March 2011, before the May peak which preceded a 22% decline.
On a fundamental basis, it is hard to show economic improvement when looking at reported data. On the other hand, consumer surveys and personal observation finds stores and restaurants filling up, more shopping traffic, and good sales among automobiles and homes.
In a sharp twist of logic, good economic news is taken to mean less FED stimulus and therefore higher interest rates and lower stock prices. To this line of reasoning, strong growth would be bad for stocks. The end of QE1 saw SP 500 stocks decline about 21%, QE2 heralded a decline of some 21%, and QE3 a setback of only 9% but this was soon overtaken by Operation Twist stimulus.
Since the uptrend began in October 2011 the market has experienced three earlier corrections, each amounting to 9 to 11 percent. With the weak Friday close and deteriorating coincident indicator array this week, it would not be surprising if the present 3% decline from the top heralded the start of a setback, with stock prices falling well below the 22 May all-time high. Where appropriate, we suggest reducing equity levels in balanced accounts.
F James, Ph.D.
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Bond Market Analysis
It was another week of rising yields for the longer dated Treasury market. For both, the 10 and 30 year Treasury bonds, yields have headed higher for five weeks in a row.
Much of the back-up in yields is attributed to potential actions by the Federal Reserve. The popular thinking goes that the economy is improving and as it does so there is less need for the Fed to perform extraordinary actions like buying $85 billion of debt every month. The thought process goes on that the Fed will begin to wean the market off of these actions by “tapering” their buying in future months.
This whole theorem, however, is predicated on an improving economy that is on stable legs. Regrettably this is not the case. The American economy relies heavily on the consumer and their spending. One of the better data sets dealing with the consumer is disposable income, personal spending and the savings rate. These follow what we call “The Rule of Seven” where historically disposable income and spending grow about 7% a year and the savings rate is around 7%.
Where do we stand today? Disposable income is growing at a tepid 1.7%. Spending is stuck at 2.8% and the savings rate is a lackluster 2.5%. None of these numbers are even close to our nation’s historical norm and taken together suggest a consumer who remains cautious.
Likewise, key sectors like manufacturing face ominous clouds ahead. Many of the regional Fed branches report on the state of manufacturing in their domain. The insights from these are illuminating and, unfortunately, disappointing. Among the reports from New York, Philadelphia, Virginia, Dallas and Kansas City there are variations, but the general message is the same; trouble ahead.
On average, these regions are reporting lower, not higher, new orders. New orders, of course, are the life blood of many corporations. Employees are not immune either as most areas are reporting fewer jobs. The one statistic in which all areas were uniform was pointing out that the workweek is getting shorter. Companies are looking to have workers perform fewer hours. None of these are items suggesting a robust economy ahead.
Today our indicators remain favorable for the bond market. Our economy remains troubled which typically benefits bond holders. Likewise, the U.S. Dollar remains strong. It is up over 5.5% on a trade-weighted basis and this typically attracts foreign investors. Despite headlines to the contrary, opportunities remain in the high quality bond market.
David W. James, CFA
