Stock Market Analysis
Conclusions: The Dow Jones Industrial Average marched towards the 17,000 mark before falling short. Indeed the S&P 500 and the small-cap Russell 2000 followed suit and declined 0.6% and 0.2%, respectively. For the week more stocks declined than advanced.
Despite this minor hiccup the market participants have almost no fear. Investors Intelligence, which tracks the opinions of professional newsletters, today has the highest levels of “bulls” in many years. Further, the VIX, often referred to as the “fear gauge” is chirping in at a very low 12 reading. No fear here! As a contrarian this is worrisome. In the immortal words of Will Rogers, “It isn’t what we don’t know that gives us trouble, it’s what we know that ain’t so.”
To be sure, the market enjoys solid momentum. The S&P 500 is up 20% (total return) over the last year. Additionally, the last time the index stubbed its’ toe and corrected by more than 10% was 2.5 years ago. Momentum is a powerful friend but it rarely offers clues for turning points.
Another concern is the state of the economy. After the disastrous first quarter our nation’s economy was supposed to rebound with exceptional growth. While the economy should be stronger, we take exception with the idea of rapid growth. After all, Industrial Production showed negative readings in April and the price of copper, which often suggests economic activity, has not budged this quarter. Lastly, exports are down about 1% through the first two months of the quarter.
What about the consumer? It is true they control around two-thirds of our economy. However, retail sales, without the auto and gas components, were flat last month. Indeed, with the growing unease in the Middle East, the consumer’s wallet may get tapped with even higher gas prices at the pump. AAA reports the average price for a gallon of gasoline has not been under the $3 level since December 2010; 1,272 days ago and counting.
Today our leading indicators are in the neutral camp. They still have not signaled a low risk environment ahead for equities. Although momentum has been wonderful, we would suggest tempering future expectations until we get an “all-clear” indication from the data.
David W. James, CFA
Bond Market Analysis
Conclusions: The bond market showed some resiliency last week as the price on long-term U.S. Treasury bonds advanced 0.4% and yields fell. The yield on the 30 year U.S. Treasury bond ended the week at 3.41%. The long end of the yield curve coupled with high quality bonds, such as Treasuries and corporates, continue to be the areas of strength thus far in 2014.
The robust economic forecast suggested by so many economists has not played out according to plan. Just this past week, the World Bank cut growth expectations after a sluggish start to the year. The unfortunate downward revision from 3.2% to 2.8% might suggest reality is finally taking hold. Even Bank of America and Goldman Sachs took part, as they revised their 2nd quarter growth estimates downward. The idea of robust economic growth in 2014 is beginning to fade.
Consider real retail sales and real GDP in the United States. Since 1992 on a quarterly basis retail sales have averaged 2.1% growth year-over-year. When retail sales growth has been less than 2.1% the economy has only grown on average a measly 1.2%. On the other hand, when retail sales growth is above average, U.S. economic growth is much healthier and averages 3.3%. Recently, retail sales numbers, though positive from a year ago, are not strong and suggest sluggish economic growth. This weakness should be good for bond investors.
Concerns remain for bonds and inflation is one of them. So far in 2014 commodity prices have risen as the CRB Commodity Index is up over 10%. There is however, one sector in particular that appears to be the primary cause; energy. This year alone crude oil prices and regular gasoline prices have risen over 10%. This could easily be a reflection of the worries overseas and may pass in the coming months. Nevertheless, this is something we will be monitoring closely.
Weaker global economic growth and geopolitical concerns should bode well for bond investors. Even though historically low, our interest rates are above those in many countries, and investors overseas may find our bonds attractive. Our intermediate bond indicators are still favorable. We would recommend favoring high quality, investment grade bonds and maintain current durations.
Trent Dysert
