Stock Market Analysis (7/1-7/5)
Stocks were strong last week, rising about 1 ½% (Dow) and small cap stocks about 3% (S&P 600) while utilities lagged. For a change, many commodity indexes also rose. The dollar was strong against almost every currency, excepting only the Chinese Yuan. The remarkable thing about price movements is the strength of the smaller stocks. Investors apparently are weighing the odds of a new bull market starting. Still, rallies in stocks have been on lower volume, not the best sign. Although the Dow rose about 1.5% last week, almost as many stocks declined as rose, the ratio being 16/15.
After peaking on the 22nd of May, stocks fell for a month, losing about 7.5%, and are now working to regain former heights but so far have only retraced half of their losses. It has been a weak rally, with only 57% of stocks above their 200 day moving average; well down from 93% in May. Prices remain in the overbought section of the 40 day Bollinger Band, suggesting a further correction would not be out of the question. The stochastic technical indicator is on a sell signal at 65.88, as is the popular technical indicator, MACD.
Sentiment figures suggest a peak in bullishness is past, however sentiment is still positive and rising among investment advisers and small investors. The VIX fear gage is only 16. The CAPE long term price earnings ratio today is 23. At that high ratio, stocks tend to return 1 to -4 percent annually. The median price to book ratio on the SP500 is over four, very extended. Ratios of one were briefly seen in the early 1980s, when the giant bull began.
We continue to be concerned about the prospects for corporate earnings increases, Reuters estimates this to be down sharply with only half of the 5.4% rise in in the first quarter, and sales are estimated to grow at half the rate of profit growth. This does not appear to be sustainable; growth is not possible without sales.
Economic news this past week was encouraging, with 195,000 more employed. Nearly enough jobs were created to meet the numbers of new entrants into the field. This however does not speak to full or part time work, nor to the level and salaries of employment. In preparing for new government health programs, some firms are restricting the hours of workers, which would mean they might hire more people but give each fewer work hours. Since January 2008, IBD reports a decrease of 5.4 million full time workers and additions of 3.4 million more involuntary part time workers, a number which is rising rapidly.
The market has been reacting to talk of the end of Quantitative Easing (Printing money, buying bonds.) As often happens, events can move in a direction opposite to popular beliefs. Based on the past two episodes of QE ending, after the program ended stock prices declined along with bond yields, while commodity prices, including gold, rose.
We welcome the increase in stock prices, but wish for a more sustainable base to launch from. What base conditions? Should prices have been declining for three to six months, should pessimism be rife, should investors be discouraged, should our Risk Exposure Ratio be low and should our indictors be strongly positive, we would look for a sustained uptrend. As it is, we have yet to get an all clear and expect some further troubles for stocks. We would maintain a conservative posture toward equities for the time being.
F James, Ph.D.
Bond Market Analysis
Treasury yields generally stayed quiet for the week as they awaited Friday’s employment data. When the payrolls came in at a surprising 195,000 the few traders left in their offices quickly hit the sell button repeatedly and yields rose in dramatic fashion on Friday.
Part of the concern is an improving economy will bring on the tapering effect from the Federal Reserve regarding their latest Quantitative Easing (QE) program. With QE currently buying $85 billion of bonds each month the concern by bond traders is natural.
However a deeper look at the employment data suggests Friday’s action may have been overdone. Our nation’s job situation is anything but robust. Data provided from the St. Louis Fed shows part time jobs in America are at record levels. Likewise, temp jobs are also at record levels. Full time jobs? Sadly, we are still 6 million below our old levels. Most ominous is the decline in entrepreneurs. Last month we lost 54,000 entrepreneurs. These are the people who typically provide our nation’s job growth engine.
Wages are hardly enticing either. The OECD suggests 1 in 4 American jobs are low wage jobs. This is the worst rate among the G-7 nations. Further, according to the Center for Economic and Policy Research fewer than 1 in 4 jobs created in our recovery are “good jobs” that offer decent wages, have access to health insurance and have a retirement plan.
We note economists tend to have a herd mentality. This often leads them to make poor initial conclusions. However as economists make “revisions” to their initial conclusions their accuracy improves. This it is noteworthy as the International Monetary Fund (IMF) are changing their economic forecasts. Their GDP forecasts for global, Chinese and American growth have all been lowered. IMF chief Christine Lagarde admits their latest projections are still likely too optimistic.
Our bond indicators are currently favorable and Friday’s sell-off may be well overdone. Still, while we like bonds, it does make sense to control maturities and duration in order to be careful on the volatility we are willing to accept.
David W. James, CFA
