Stock Market Analysis
The President spoke, but Congress is not listening. Ideas for higher taxes are a non-starter and neither is a lot more economic stimulus. The markets seemed to like the standoff, the Dow rose 0.94% while the small cap Russell 2000 added 1.05%. Twice as many stocks advanced as fell and over 500 stocks set new 52 week highs. This was a solid rebound from the weak start to the year and, in fact, was the first weekly advance for the S&P 500 in 2015.
The biggest news of the week was the huge stimulus package the European Central Bank (ECB) decided to implement. They saw the impact of Quantitative Easing (QE) here in the States and thought they would do the same over there. In truth, our results here have been questionable – $3.4 Trillion in QE but only $1 Trillion in economic expansion. The big winner from QE? The stock market, which rose over 20% on an annualized basis during QE.
While no panacea, the first readings are interesting. The Euro fell 3.14% against the dollar but stocks in Europe rallied strongly. This has a historical basis; our research shows that stock markets rally strongly the first year after their currency is devalued.
I recently returned from a trip to Costa Rica. I was doing some coaching, teaching and seminars. At one point I even taught from my book, Seven Timeless Principles of Investing. I learned valuable lessons about different cultures and their approach to investing. I met one man who had been hired to build up the stock market in Costa Rica, but the market remained too thin and Costa Ricans (Ticos) showed little interest. I did find that Ticos are very entrepreneurial and they diversify by starting multiple additional businesses. Unfortunately, they seem to be infected with the same political hurdles as here, growing taxes and regulations. Still, no one will complain about the weather in January.
As opposed to 2007 and 2008, our long term indicators are very positive. In addition, macroeconomic conditions and even the election year cycle favor stocks. However elevated valuation levels and over enthusiasm, leave the market vulnerable to corrections along the way. We believe we are in a transition period for stocks and this will lead to greater volatility. Our intermediate term indicators remain in neutral territory and we would maintain neutral levels for equities.
Barry R. James, CFA, CIC
Bond Market Analysis
A panoply of factors helped longer term bonds continue on their recent rally. Deflation, not of the football variety, became an increasing concern of investors. At one point the 30-Year Treasury bond hit an all-time low in yield. However, intermediate term bonds lost a little ground.
The Swiss Franc broke ranks with the Euro, leading to a surge in its value. The dollar continued to rally and may be putting a number of companies into an earning’s growth crunch. They face stiffer competition overseas and are reporting shrunken dollar sales. Recently reported sales and earnings growth are anemic.
Bonds overseas lost ground with the announcement of their Euro 60 Billion a month Quantitative Easing (QE) program. This should not be a surprise given our own experience with QE. During QE our long term bonds lost over 20% of their value, but rallied over 75% when it ended or was in periods of tapering. European leaders may want this, as a number of countries have some of their rates in negative territory – for instance, Switzerland, Germany and Denmark. Zero Hedge estimates 20% of all sovereign debt in Europe has a negative interest rate. This totals over $1 trillion worth.
Rather than create a swell of inflation fears, it appears to have had the exact opposite effect. Commodity prices tumbled with oil leading the pace. It had a drop of over 7% last week. While I was able to fill up at Costco for $1.71 a gallon, this rapid drop will not likely continue at this pace. (One footnote – I filled up recently in Costa Rica and gas was over $8 a gallon.) On the other hand, such drastic measures have caused some concern over currency wars and both gold and silver rallied nicely last week.
As strange as it may sound, risks in the bond market are decidedly low. Our risk indicators have improved dramatically and we are shifting to somewhat longer maturities. We do not think this is permanent, but right now, the year of the bond has continued into 2015, with bonds once again outperforming stocks. This window is open and we will try to take a prudent approach to taking advantage of it.
Barry R. James, CFA, CIC
