Stock & Bond Market Update (4/13-4/17)

Stock Market Analysis

Following a positive prior week, stocks had a “sinking spell” last week when the Dow declined 1.8%. This brings its year to date return to a miniscule 0.02%. The broader S&P 500 Index has done only slightly better gaining slightly less than 1.1%. There is some evidence smaller and mid cap sized companies are doing somewhat better, with year to date returns of 2.80% for the S&P 600 Small Cap Index and approximately 4.4% for the S&P 400 Mid Cap Index.

Reviewing sentiment figures and reports, it appears smaller investors are somewhat anxious to invest for appreciation, and are reasonably optimistic. Large institutions continue to exhibit caution and do not display a strong desire to increase allocations to equities. Looking at the data from Investor’s Intelligence we note the Bulls-Bears figures peaked in March with a reading above 40%. The latest reading is only 36.6%; not as much confidence.

With a Risk Exposure Ratio of only 55, stocks do not appear “over-extended” for the intermediate term. Only 42% of S&P 500 issues are above their 50-day moving average and fewer than 67% are above their 200-day moving average.

Having said that, currently the value of all stocks on NYSE is equal to 111% of GDP. Only twice before have stocks sold at this level (June 07, June 99.) Shiller’s CAPE (Cyclically Adjusted Price Earnings) ratio is around 27, clearly extended but not near 44, which it reached at the December 99 top.

Money stock continues to grow, perhaps not at a heady rate above 10%, as it did in 2011, but at a respectable 6%+ rate. Even with all this liquidity, money market funds are growing at a rate above 20% with corporate liquidity said to be near $2 trillion here in the U.S. and nearly as much overseas. So there is plenty of money to sustain stock advances and we see few signs of tightening.

Our long term indicators remain favorable while leading intermediate and short term indicators suggest a neutral outlook, neutral but not negative at this time. Careful stock selection is always important, especially so when the investor cannot count on a major bullish tide sweeping prices higher. At times such as this there is usually safety in selecting undervalued bargain stocks which rise when investors discover their real value, while they tend to resist major declines. Our monthly market analysis reminds us, once again, how important market capitalization can be in security selection. As a firm, we remain diversified in capitalization, neutral to slightly overweight in large and mid-cap stocks, but with a rising appetite for smaller issues.

F James, Ph.D.

Bond Market Analysis

It was a profitable week for owners of Treasury bonds. Yields fell for Treasuries with maturities from 1 year out to the 30-Year Treasury Bond. From a return perspective we find long-term Treasuries, long-term corporates and TIPS (Treasury Inflation-Protected Securities) all enjoyed gains of 1% or more on a total-return basis.

Inflation continues to remain hemmed in. In fact, on a year-over-year basis, both CPI and PPI (which measure inflation on the retail and wholesale levels, respectively) are negative and indicate deflation instead of inflation. This is a condition that often rewards high quality bonds.

Another advantage of U.S. debt is how attractive our yields seem to the international investor. Presently our 10-Year Treasury yield is around 1.9%. This may appear low to some. However, Bank of America notes that over half (53%) all global government bonds are yielding less than 1% today. In Germany their 10-year government bond yields a shockingly low 0.07%. Switzerland is even more extreme. Their 10-year government bond actually has a negative yield.

Further, we remember the generally inverse relationship between the economy and bonds. Namely, in times of tough economic tidings it is the bond market that shines. Of concern for the economy are the reports from the different regions of the Federal Reserve. Presently there are negative readings from New York, Virginia, Dallas, Kansas City and Chicago (which is a national activity reading). The only favorable reading comes from Philadelphia.

Further, it is important to examine the predictions of economists regarding the economy. Historically these initial projections are simply wrong and many times spectacularly so. However, where their accuracy improves is in their projection revisions. Thus it is worth noting the economists’ (as surveyed by Bloomberg News) 1st quarter GDP projections five months ago was for a relatively robust 3% growth. As reality has set in, the projections have been revised downward in drastic fashion. New expectations for the quarter are now for tepid growth of only 1.4%. This new number will invariably be closer to the truth than the original projection.

Still, there are some positive numbers on the economic front. After three consecutive months of declining retail sales we finally are seeing growth. Even more impressive is the growth that has occurred in “big ticket” items like vehicles, furniture and building materials. Housing traffic, as measured by the National Association of Home Builders, recovered nicely in its latest reading. Finally, even the Federal Reserve’s end of Quantitative Easing has not stopped their efforts at money growth. M2, a popular gauge on money supply, is still growing over 6% a year.

In all we have seen some deterioration in our leading intermediate bond indicators. However, they have yet to turn unfavorable. In this environment we continue to recommend investors maintain moderate durations in high quality bonds.

David W. James, CFA

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