Stock Market Analysis
It was another profitable week for many of the popular indices. The large cap S&P 500 advanced 0.4% and the small cap Russell 2000 did even better and gained 0.8%. However, it should be noted that more stocks declined on the week than advanced. Indeed, looking at the equal weighted (as opposed to market-size weighted) results of the stocks of the NYSE suggests the market actually fell.
From a sector perspective the week was led by Financial, Healthcare and (surprise!) Energy stocks. Each of these gained over 1%. Meanwhile, Cyclical, Non-Cyclical, Utility and Technology stocks generally declined.
Technology stocks may continue to face headwinds. Our research has identified this as the number one sector affected by movements of the US Dollar. Presently the Dollar Index (compared to a basket of our major foreign partners) is up over 11.5% in 2014. This will make export growth more difficult in the future. Further concern comes from the latest cover of Barron’s, a popular weekly financial magazine. In bold type, their headline claims, “Crash [in tech stocks]? This time it’s different”. History often shows the “this time is different” mindset, while heartfelt, rarely is true for investors.
Energy has been another hot topic. Light Sweet Crude enjoyed its lowest weekly close in over five years. How can investors benefit? We recommend considering industries that can take advantage of lower oil prices. Transportation is one candidate. After all, everything from airlines to trains to trucking can possibly benefit from lower fuel costs. Chemical makers should also benefit.
Another beneficiary of lower oil prices may come as a surprise: refiners. After all, refiners have to buy crude oil before they can turn it into other products (like gasoline). Consider, since the end of July crude oil prices are down almost 33%. Stock prices for explorers, who benefit from higher oil prices, are down by a similar amount. Refiners, however, are actually trading at a gain over this time.
There is growing concern over the holiday season’s sales numbers. The National Retail Federation (NRF) found the “Black Friday” weekend had sales about 11% lower than the previous year. Another troubling sign of the times come from consumer revolving debt which is often associated with credit card purchases. Starting in 1970 this has typically grown at a 13% annualized rate. The last three months have been anything but robust as annualized growth has been less than 1%. While it is good, long-term, for Americans to avoid excessive revolving debt it is unlikely to bring any joy to retailers over the holidays.
This may be even more important to the economy over the next quarter or so than many analysts suspect. Over the past year inventory buildup has represented 73% of the growth to GDP. This is fine so long as there are actual sales to justify the growth in inventories. However if sales are disappointing there can be a rather disquieting adjustment to continued buildups.
The labor situation does offer some good news. Over 300,000 jobs were created according to the Non-Farm Payroll survey. We have now seen 10 months in a row where job gains have topped 200,000 and this is the longest such streak since the summer of 1994. Unfortunately, there is the small matter of pay to consider. Over this 10 month period of job gains many have been regulated to lower wage industries like temp workers. In fact our data suggests there have been over 3 low-wage jobs created for every 1 high-wage job.
Presently our leading indicators have deteriorated slightly but still remain in the neutral camp. Looking to the future we note presidential pre-election years (like 2015) have an excellent track record. The last time the stock market declined in a pre-election year was 1939. However this does not guarantee a smooth path. With a number of valuation measures at elevated levels the market could easily see increased volatility. With this in mind, we recommend investors avoid the “buy-and-hold” approach and take a more active strategy that features bargain investing.
David W. James, CFA
Bond Market Analysis
It was not a good week for the US bond market. The Barclays US Aggregate Index (generally accepted as the US Bond Market) was down about 0.85%. We recommended reducing risk in bonds where appropriate for our client portfolios a few weeks ago and short term bonds were generally down much less than long term bonds this past week.
A review of the major bond sectors show that intermediate term 7-10 year US Treasury Bonds were down about 1.0% although short term US Treasury Bonds were down only 0.3%. Corporate bonds declined roughly 1.4%, High yield bonds were down about 0.9%, Mortgage bonds fell nearly 0.5%, US agency bonds were down approximately 0.9%, and TIPS fell around 1.0%.
The US Dollar strengthened by about 1% again this past week. Oil prices continued their decline and were down about 2.5% on the week. This was the 9th week out of the last 10 that oil prices have declined. Oil closed the week at levels last seen in July 2009.
It was a busy week for economic data releases. Most reports were better than expected and not surprisingly, the bond market reacted negatively to better economic prospects. The possibility that the Fed would start raising interest rates earlier than expected due to the strong economic reports could also be a reason for the increase in bond yields last week.
ISM Manufacturing Index was better than expected however it was also lower than the prior month. ISM Non-Manufacturing Index, which is often considered a barometer for the service sector, was better than expected and higher than the previous month.
The MBA Purchase Applications report includes two indexes that give investors information on the housing sector. The overall report was disappointing due to a decline in the refinancing index however the purchase index did show an increase.
The Productivity and Costs report showed that productivity growth was 2.3% and Unit Labor costs declined 1.0%. This report was a positive for bonds in the short term as higher productivity and lower unit labor costs should help keep inflation lower than normal.
The Employment report was much stronger than expected with actual job growth reported to be 321,000 and expectations were for 230,000. The Unemployment rate held steady at 5.8% and private payrolls corroborated the ADP Employment report earlier in the week with growth of 314,000. The participation rate was steady at 62.8% which unfortunately is still very low historically and continues to point toward structural unemployment issues rather than cyclical issues.
Our long-term indicators are still favorable by a 2:1 margin while our intermediate indicators remain neutral to slightly positive. We are no longer as positive on bonds as we were earlier in the year; however, neither are we unfavorable at this time. Even with a more conservative posture, bonds continue to offer investors diversification and defense against stock volatility.
Matt Watson, Portfolio Manager
