Stock Market Analysis
What a great week for stocks! The S&P 500 hit an all-time high as it jumped 1.75%. Even small cap stocks joined the rally as the Russell 2000 jumped 1.65%. We saw more than twice as many stocks rise as fall and more than 8 times as many stocks hit new highs as new lows. As a result, a renewed sense of optimism has come over investors. The AAII survey shows an amazing rebound in bullishness from very depressed levels. In fact, it has hit a new high for the year.
This last week, I saw the following chart of projections for worldwide economic growth. While expectations were very high earlier in the year, they have taken a steady and alarming downturn. We certainly can see this coming true as it appears much of Europe is heading toward a triple dip recession. In harmony with this perceived slow down, key indicators like oil and copper prices have been falling. At the same time, longer term interest rates have been hitting yearly lows. The only major indicator that doesn’t reflect this slowdown is the stock market. Can it continue to defy gravity?
Source: ZeroHedge, Bloomberg
As we’ve pointed out previously, the stock market has done very well during periods of quantitative easing. However, it has taken some significant tumbles when QE has been halted. Perhaps that is why the Federal Reserve has taken a “go slow” tapering approach this time around. We are being led to believe that the program of QE will actually end in October. The stock market will then have to completely rely on its own merits for attracting investors. Right now, low interest rates and solid earnings are enough to overcome investor hesitation.
As the recent pause in the market advance showed, folks turned bearish fairly quickly and even pulled money out of the market to try and protect gains. Fortunately, this operated as a pressure relief valve and indeed, investor skepticism rose enough to allow the market to rebound, albeit, on lower volume than we’d like to see.
We are in a transition period for the market as the smallest stocks have been mired in a downturn. Our research showed 6 out of ten of the smallest companies were down 20% or more from recent highs. On the other hand, large cap stocks, as represented by the S&P 500, have hit new highs. This has been masked by the indices, which weight results by market capitalization. That said, our indicators don’t give us an all clear yet and we think stocks will still experience some aftershocks of this transition. We would maintain a conservative weighting in high quality, bargain securities.
Barry R. James, CFA,CIC
Bond Market Analysis
As stocks rallied last week, bonds took a breather. Except for high yield bonds, all sectors of the bond market fell. Of course, long term treasuries have had a great run this year, with returns of almost 16 percent. This is associated with a nice drop in long term rates. One item of interest though, has been the rise in rates in the two to five year area the last couple of months. This leads to a flattening of the yield curve. Of course, with short rates so low and the Fed tapering, it shouldn’t be a surprise that shorter rates would start anticipating the eventual rise in shorter rates.
The economy and inflation are the biggest contributors to changes in longer term rates. As pointed out in the stock section, worldwide growth expectations have been falling. Growth in Europe has stalled and rates in Germany are now below those in the United States. Economic growth here in the U.S. seems to lack a long term catalyst. We have seen improvements in employment, but wages have barely moved in the last 5 years. At the same time, households have experienced a squeeze as gas and food prices have risen. On the other hand, inflation has been held in check as home prices and commodities haven’t gotten out of hand.
Housing is crucial to our economy and no long term expansion has been generated without housing giving a clear path. Currently, lower rates have helped existing home sales and we have seen housing traffic numbers pick up. As we have said in the past, this is a good indicator of future sales and prices. However, we have also seen a pick-up in supply, which might mitigate some of the benefits. Many homeowners who had been underwater are now seeking to get out from under their mountain of debt, which might lead to added problems with supply.
Our indicators show low risk for bonds and further international problems (i.e. Argentina, Venezuela, Ukraine and Iraq) lead many investors back to our bonds. In addition, further swoons in our stock market or in Europe would also help keep rates heading the right direction. Our indicators are very positive, as they have been all year. We would maintain a portfolio with moderate to long durations and high quality.
Barry R James, CFA, CIC
