Stock Market Analysis
Conclusions: This week’s episode of “As the Bernanke Turns” was an obvious crowd pleaser. The Dow and S&P 500 closed the week at record highs. Small capitalization stocks such as those in the Russell 2000 also joined in and they too set record highs.
The key hero of this week’s tale is the Fed Chairman himself, Ben Bernanke. His speech after the market close on Wednesday was a potent catalyst. What was actually said or meant was not as important as the market’s interpretation of the speech. Their interpretation? QE is alive and well let the good times roll!
In his speech, Mr. Bernanke paid homage to John Maynard Keynes for laying the foundation that excessive governmental spending is an effective tool for promoting real economic activity and employment. Somehow the chairman made these comments without laughing; a difficult skill as the data suggests these conclusions are laughable.
QE has been like mother’s milk to many assets. Despite recent setbacks gold is up nearly 50% since the start of QE in November 2008. Crude oil is up 77% while corn and stocks have almost doubled. However as an economic tool QE is lackluster at best. Under QE our economy, as measured by GDP, has grown at a meager annualized rate of 1.5%; levels that many Americans still feel recessionary. The employment track record under QE is scarcely better. The unemployment rate has averaged an ugly 8.8%
Indeed, the employment situation is much worse than many expect. While the “headline” number showed 195,000 jobs being created last month a deeper investigation reveals a dangerous truth; full time jobs are becoming an endangered species. Last month our great country lost 240,000 jobs. Some statistics now show that less than half of adult Americans have a full time job.
Many blame the new healthcare law for the change in workforce from full time to part time. Unfortunately there is some truth to this. Corporations will eventually be penalized for not providing government approved levels of healthcare to full time employees. One unfortunate consequence is fewer full time workers. This is just another example of good governmental intentions running amok. Perhaps the most alarming point is today we have well over 100,000 pages in our federal code of laws. Taken page-by-page, this is 23 miles of business stifling regulations that, too often, are of dubious benefit.
Earning season is also upon us. Alcoa set the tone with their announcement. Thanks to continually lowering analysts’ expectations the company managed to have a positive surprise. Actual earnings came in at 7 cents a share versus “expectations” of 6 cents a share. Zerohedge did some digging and shows the progression of these expectations. They note a year ago expectations for the current quarter were 30 cents a share. At the start of the year? 17 cents. Even just a month ago the analysts predicted earnings of 10 cents a share. We will not be surprised if many of the earnings “victories” this quarter are of this nature.
We have seen some improvement in our indicators but, regrettably, nothing that suggests the risks have completely subsided. For the first time this year we have seen consumer confidence fall according to the University of Michigan Confidence numbers. Likewise, small business owners are becoming more pessimistic. We continue to suggest a cautious, moderate course which would avoid the exuberance being pushed by the Fed policy Soap Opera.
David W. James, CFA
Bond Market Analysis
Conclusions: After several trying weeks, bond investors got “on the ball” last week and prices moved higher as yields declined. In part, credit could go to somewhat staged speeches by FED members who were alarmed at the sudden fearful reaction of investors to earlier FED statements. In part, credit might go to the somewhat sluggish statistics released during the week, with both mortgage applications and wholesale inventories declining. Weaker demand was shown by monthly declines in the import price index. Initial jobless claims also rose above expectations to 360,000.
But after rising for the better part of the week, bond investors turned cautious toward the end of the week and prices declined a bit, with yields rising slightly on Friday. Gold and oil turned higher also, but the rally was not convincing since volume was so light.
Consumer credit figures were released showing a healthy 5.8% increase year over year, but only 0.7% month over month as activities slowed. Even more interesting were data in the “non-financial business” categories, which reflected -11% year over year, and no change month to month.
Once again, Government, not the economy, is the chief complaint of U.S. small businesses firms, especially areas of regulations and taxes, according to the NFIB. The result: Only 7% plan to hire in the next three months. A slowdown is expected, according to Moody’s analysis.
Gold and commodities in general rose previous week, completely in accord with the week’s big increase in stock prices and the presumption that FED ease will continue along with cheap money.
Bloomberg’s consumer comfort index declined to -27.3, while the University of Michigan confidence index also pulled back. The release that bothered the most was the sharp increase in the producer price index, rising from 1.7% year over year to 2.5%. While some of this was due to energy prices, it contrasts sharply with changes in the consumer price index where increases are much more subdued. We have learned that changes in producer prices must be matched with similar changes in consumer (selling) prices. Otherwise, a “squeeze” on profits is likely to lie ahead.
This “squeeze” is also reflected in other measures. For example, changes in profits must be matched with changes in sales; otherwise, profit gains are apt to be temporary. This situation also exists today.
In stocks, we often reach a temporary top before a pullback when most stocks are above their 50 day moving average, and today we find just under 92% of stocks are so extended. Today 93% of SP500 stocks are above their 200 day moving average. As stocks pull back investors often seek refuge in high quality bonds.
With the Dow and SP500 setting new highs but probably preparing to pull back in a normal correction, our indicators remain bullish for bonds over the intermediate term. Friday’s bond pullback after such a strong week was normal and may be overdone. We like the highest quality bonds as being most liquid, and easy to change duration with only modest cost. At this stage of the business cycle, we do believe it makes sense to control maturities and durations in order to be careful on the volatility we are willing to accept.
F James, Ph.D.
