Sep 17, 2013 - Stock & Bond Market Update

Stock Market Analysis

Conclusions: What a week, and I’m not talking about Syria or flooding in Colorado. The stock market soared with the Dow gaining a loft 3 percent and the small cap Russell 2000 climbing 2.4 percent. Sabre rattling gave way to celebrating in Damascus and on Wall Street. All the major sectors rose with Consumer Services and Industrials leading the way. Rising stocks led declining stocks by a 19 to 12 margin and we have finally seen new highs topping new lows for the first time in four weeks. Volume was up from last week, further adding to the good news.

However, as Barron’s points out, Time magazine just featured a bull in full party mode. Their sources reviewing this type of phenomenon point to an 80 percent chance the market will top in next month and be lower a year from now. This bullish sentiment is understandable. The market has moved up 175% from the low set on 9 March 2009, an annualized rate of 25%. Why wouldn’t everyone join that bandwagon? It seems like everyone was on the opposite bandwagon in 2009. On the day before the market low, our 8 March 2009 report stated, “Like a stubborn mule, our intermediate term indicators remain very positive. While we know neither the exact date nor the catalyst, we expect an explosive rally in stocks will develop.” It pays to not jump on bandwagons.

The market has risen eight of the last nine days and it seems risk has left the building. We sent out a Topping Markets study on 10 June 2013 and prices are still below the 2 August peak. Currently our Risk Exposure Ratio reflects a 65% chance of a correction in stocks, but risk levels could easily rise more before this indicator would give a definitive sell signal. In spite of the recent advance, our intermediate term risk picture has improved.

We are over bought in the short term and we wouldn’t be surprised to see stocks settle a little. However, people are still abandoning bonds and they are ignoring Fed rumblings about changing Quantitative Easing. We will get additional insights into Industrial Production and Capacity Utilization and housing this week. But the elephant in the room will be the Fed announcement on Wednesday. It could have far reaching repercussions which no amount of research can properly anticipate. Still, we are encouraged to see our indicators improving and we should take advantage of our previous cash buildup to do a little buying. It may only be an intermediate term move, but improving indicators are a good reminder that upcoming opportunities will eventually emerge.

Barry R. James CFA, CIC

Bond Market Analysis

Conclusions: Last week was good for bond investors as all major sectors of the bond market advanced in price. Yields dropped across the U.S. Treasury yield curve. The 5 year note dropped the most with a six basis point decline. Crude oil dropped 1.5% and gold dropped 4.7% on the week even though the U.S. dollar also slightly fell in value compared to other major currencies.

Economic reports this past week included the Producer Price Index (PPI), Retail Sales, and Consumer Sentiment. The YOY PPI reading was unchanged when food and energy prices were removed. Retail Sales and Consumer Sentiment reports on Friday were disappointing. Retail Sales excluding automobiles and gasoline were only up 0.1%. Consumer Sentiment had its largest miss to expectations on record and back to March 2013 levels.

The NFIB small business optimism index dropped from 94.1 in July to 90 in August. Five subcomponents improved while 4 subcomponents worsened and one was unchanged. The biggest changes came in small business earnings trends (-13), sales (+8), employment (+7), job openings (-4), and expectations for the economy (-4). Obviously, there are some contradictions in the subcomponents such as the expectations for increased employment but lower job openings. This survey continues to reflect the uncertainty of the current economic situation.

The U.S. Federal Reserve was established in December of 1913 and since then annual inflation has averaged 3.25%. Prior to the establishment of the Fed, Deutsche Bank reports that inflation was 0.4% annually. As Will Rogers said “It isn’t what we don’t know that gives us trouble, it’s what we know that ain’t so.”

One of the major factors in economic growth is productivity. A positive ongoing development in education is the notion of “flipping the classroom.” This requires students to watch video lectures at home and then do “homework” at school with the aide of teachers and even other students. Stanford University is teaming up with the Khan Academy (a pioneer in the industry) to reinvent medical education and help students progress faster and gain experience in the profession sooner. With a possible shortage of doctors in the future, this is a welcome development.

Another important business component is wages. Minimum wages vary across the globe. Mexico’s minimum wage of $0.55 pales in comparison to Australia’s $16.00 per hour. However, real minimum wages, adjusted for differences in purchasing power, range from $0.80 in Mexico to $10.37 in Luxembourg. The U.S. minimum wage is 10th among 26 countries surveyed by the International Business Times with a minimum wage of $7.25.

Our indicators remain neutral on bonds and we continue to maintain a moderate position of high quality bonds as well as cash. We look to the bond portion of our portfolios to reduce volatility and preserve capital. We have modestly reduced our portfolio exposure to bonds while retaining the ability to participate in lower yields.

Matt Watson, CPA