Stock Market Analysis
Conclusions: Stocks moved lower last week, as almost every index fell and all sectors except for materials lost ground. Transportation averages declined the most. Commodity prices were mixed but mostly neutral to lower. The dollar weakened slightly but is still ahead for the year. The Euro and Kroner strengthened the most.
A condition we call the “Fosback HiLo Logic” effect appears today, related to the “Hindenberg Effect” or the “Bollinger squeeze”, such names derived from observations that short term volatility has narrowed after a strong upswing and such action often precedes a sharp move in prices.
What can we count on to reliably foretell market direction? It is unfortunate, but when the public has become absolutely convinced on a course of action, it is frequently the wrong thing to do. We can sometimes (not always) get a strong sense of conviction in reviewing mutual fund purchases. Recently, for example, we find that cumulative year to date domestic figures for stocks are running more than $85 billion higher than a year ago, and are now the first positive since the 2009 crash (leuthold data). The public has regained a measure of confidence in stocks. ETFs are often used by professional advisers, who have also been buying domestic equities to the tune of about $66 billion year-to-date. It seems advisers have also developed an appetite for domestic equities.
Foreign mutual funds continue to be even more popular with a total equity fund inflow of $248 billion year to date, more than any previous record. Incidentally, the previous August year to date inflow record was set in calendar year 2000, when a recovering market was just making a top and rolling into a two year bear market. Market historians will note S&P stocks topped out on the 1st of September 2000 near 1,700, then fell to 768 on the 10th of October 2002 two years later.
Director of Research David James, also points to a possible peaking of margin debt. These funds are used by brokerage customers to borrow money to buy stocks. The previous peak in this time series also occurred near the 2000 top. New stock issues (IPOs) are coming out at a near-record pace now, with 64 new issues since May, the most in any three month period since the top in 2007. But knowledgeable investors? Reuters calculates differently than we do, but their figures show insiders are sporting a sell /buy ratio near 45, extremely bearish (ratios above 20 are bearish.)
The current bull leg of the SP Composite has extended to 230 weeks off the ’09 bottom; prices are ahead about 156%. These are very much on the high side of bull markets since 1932, where the median advance of 107% has typically been achieved in 155 weeks. According to Chartstore, this is the third most extensive advance of the past 81 year period, perhaps caused by the FED’s unprecedented action to improve the economy, which unfortunately has been unsuccessful.
Our leading indicators are shifting in an unfavorable direction. While market tops usually take an extended period to complete, our Risk Exposure Ratio (at 69) points to elevated risks in excess equity positions. The data, and especially the shift to more speculative investing, suggests following a cautious path today, as outlined in our June “Topping Market” warning.
F James, Ph.D.
Bond Market Analysis
Conclusions: The bond market gained ground last week even as the U.S. Treasury issued $72 billion of new bonds. The yield on the 10 year Treasury bond fell 5 basis points to 2.57%; Treasury notes in the 7-10 year range advanced 0.28%. The long end of the curve performed even better as the 30 year Treasury bond yield fell to 3.63%; long bonds gained nearly 0.5% on the week.
While we wait for the retail sales numbers to be released later this week, we can look back to analyze the consumer based on gains in their disposable income and spending. We often talk about the “Rule of 7” which shows that going back to the 1960’s we have typically seen disposable income and spending rise about 7% per year. Even the savings rate has averaged about 7% during this time. So where are we now? One finds we are still well below the averages of the past as disposable income is running below 2% and spending is 3.3%. Both numbers are some of the lowest seen in several years. For the economy to truly heal it will need the help of the consumer as they make up nearly 70% of the economy. But lethargic economic conditions generally favor bond investment.
Consumer Credit expanded in the month of June by $13.8 billion but was lower than expected. The breakdown of the data pointed to the revolving debt (credit cards) declining for the month while nonrevolving debt (student loans and auto loans) increased $16.5 billion. The increase in auto loans has definitely aided the auto industry as vehicle sales have increased to over 15.5 million cars. Even the increase in student loans could be considered a benefit to the economy as students look to increase their skills. Unfortunately, this is becoming a frightening situation as job opportunities for graduates remains poor. Many of these graduates have loans to repay after college and as Zero Hedge reports there has been a dramatic increase in delinquencies over the past year. They find that over 1 in every 10 student loans are now more than 90 days late in payment. This is an obvious sign the economy has more healing to do and needs to add more jobs. This would also be a better sign for the overall economy as it would help to lower the unemployment rate. Recent apparent employment progress relies on discouraged workers leaving the labor force.
Our stock market study this week discussed guidance investors can receive from a contrarian view of public mutual fund shareholder actions. In this respect, it is worth noting that June recorded an all-time record of net cash outflows of bond mutual funds. In spite of a record of on-time payment of income, and relative safety from extreme volatility, the public has become so discouraged with prospects of bond returns that they are stirred to action.
The bankruptcy of Detroit and subsequent investor concern has depressed prices even among higher quality muni bonds, creating opportunities for sophisticated buyers. High quality bonds such as state obligations or unlimited tax general obligation bonds are recommended.
Our bond risk indicators remain favorable and continue to suggest advantages in bond positions in the intermediate term. Inflation has yet to take off as inflation expectations over the next five years are running just under 2%. We recommend a position in high quality bonds with modest durations where this is appropriate for client objectives.
Trent Dysert
