Sept 22, 2015 - Here's what happened in the stock/bond markets last week

Stock Market Analysis

The stock market continued its zig-zag pattern. For the past 10 weeks the stock market has alternated between a week of advances followed by a week of declines. This week was no different as the S&P 500 fell 0.1%. Hidden within this has been the better performance of small stocks such as those in the Russell 2000. The Russell actually gained 0.5% and has become the leader over the last month. Among the major sectors Utilities, with their defensive nature, enjoyed solid returns while Basic Material and Financial issues led the decline.

Although the market has been alternating in an up-and-down fashion for some time, the market internals have been a concern. The last 10 weeks have seen volume 13% heavier on the down days suggesting more conviction by the sellers. Similarly the number of declining stocks has outpaced advancing issues. Additionally there have been nearly 4 stocks setting new 52-week lows for every 1 stock setting a new high.

Much is being made of the Federal Reserve’s choice to do nothing. One of the Fed’s concerns has been the state of the world economy. This is understandable. Two commodities that help us understand the global economy are copper and oil. When both are in demand it often suggests a robust worldwide economy. Unfortunately over the last year copper and oil prices are down 22% and 52% respectively.

What about in the United States? Pundits proclaim, “Surely our economy is in better shape.” Perhaps, however, “better” does not mean robust. Industrial Production displays a strong correlation with GDP. So far in 2015 Industrial Production has been falling, not rising. The Atlanta Fed provides a statistical analysis based on relevant factors for Third Quarter GDP. Their current forecast is for meager, 1.5% growth, a full one percent lower than Wall Street prognosticators.

Still, some feel there is encouraging news on the labor front and this should have propelled action by the Fed. It is true our nation has enjoyed 59 straight months of job gains, the best streak on record. Also, the unemployment rate has declined to a relatively low 5.1%.

Regrettably these encouraging labor facts may not be offering us the most accurate labor picture. The percentage of adults actively in the work force (participation rate) has fallen precipitously even after the end of the Great Recession. Additionally, the number of Americans on Food Stamps skyrocketed to all-time high levels. Finally there is the matter of wages. One might have a job but how well is it paying? Based on the declining median family income there is reason for concern.

Today there are a number of positive indicators in our array. But as we examine our most accurate indicators, we note they are mostly in the negative camp. With the market decline in late August we should have enjoyed a sizeable rally in stocks. We did recover about half of the decline, but it has not been as robust as one might expect from a healthy market. Given this and the disquieting nature of market internals, we would suggest investors gradually lower equity levels for overinvested accounts.

David W. James, CFA

On a personal note, I will be having surgery in a few days and will likely be off for a few weeks to recover. I look forward to returning and getting back into the swing of things. I thank everyone for their kind thoughts and prayers. They are always appreciated.

Bond Market Analysis

A bond rally toward the end of the week helped as it reversed bond losses of the previous week. Yields on distant Treasury issues declined 2 to 7 basis points, with 5 and 10 year bonds providing the best returns. Prices on shorter bonds also moved higher.

If we look for bond direction, it is appropriate to look at economic projections. We find the ECRI Weekly Leading Index fell again, still in negative territory now, from -2.1% and going to -2.2%. All too often, severe downturns in this index are associated with recessions. We are not yet at that point, but the negative direction of index is worrisome.

Currently, a wide variety of indicators suggest caution. For example, the Coincident / Lagging Index fell again, for the fourth month in a row. Stock prices over the last three months are negative. Last month, business equipment orders fell 0.03%, not what one would like if anticipating a strong revival.

We do note a number of bullish analysts are joining with Federal Reserve officials in forecasting business and economic improvement, often pointing to gains in some of the employment statistics. Unfortunately the pundits and Fed’s track record on economic forecasting leaves something to be desired.

If the economy were to turn strong, one would normally notice prices for commodities firming up as manufacturers anticipate more orders ahead. Instead, commodity indexes are weak, with Goldman’s index down 1.6% for the week, and off 14.4% year to date. Over the last year it has lost almost 39%! Industrial metals have been especially weak.

The big news of the week is the Fed decision to hold rates steady, close to zero interest rates. As the Wall Street Journal [WSJ] opined, “the accommodative tone the central bank took in its policy statement [amounted to]...a sign...of deeper official concern about the global economic slowdown centered in China.”

In fact, the Fed voiced a concern about world trade, and the World Trade Organization [WTO] reports trade growth is proceeding at only half of the normal expansion rate. Sure enough, inside the U.S., business capital spending is decreasing.

The problem is that these trends are not easily reversed. The WSJ reports $8 trillion has gone into stimulus by central banks around the world, and it has had little positive results. Earlier, we estimated U.S. stimulus (FED plus government direct spending) amounted to about $3.5 trillion, however U.S. GDP increased only $1 trillion. Wise heads conclude that government stimulus by central banks can raise hopes but generally lacks effectiveness. Even so, at this point Central Banks are likely to continue to pump out money because they are not aware of other options.

Declining stock prices, declining commodities, lower industrial production are harbingers of less demand for business investment capital and is usually favorable for bond buyers. Our long term bond indicators are mostly favorable, suggesting low rates will persist over the very long term. The intermediate term is more of a mixed picture, with future Fed action likely to try to push short rates higher. A modest position in fixed income securities is indicated for most investors as a defensive strategy. We would continue to focus on high quality securities and durations at neutral levels where this is appropriate for portfolios.

F James, Ph.D.

 

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