Stock Market Analysis
Better... Stocks may be down over 6% on the Dow year-to-date, however on a total return basis they rose 2.13% last week. Tech, health care and consumer stocks led the way as gaining stocks outstripped losers; in spite of this, five stocks set new lows for each new high. But the longer threat from industrial recession was apparent in the continued reduction in many commodity prices, especially energy. Gold and silver have also had large declines.
A chartist might observe the S&P 500 Index lost more 12% after the 20 July 2015 top, and has made a modest rally, climbing a little over 5% from the low. The moving average of advances (advances and declines) fell sharply in the downtrend, dropping below the significant 35% BUY signal. Now it is running at 48%, an average reading, which gives no signal for future moves. However, at 18%, the percent of S&P 500 stocks above their 50 day moving average remains well below 30%, typically a strong buy indication. Stochastics and Bollinger band readings are additional technical indicators and they too are bullish. These seem to say, “Prices went down too fast.”
One of the sentiment indicators we review weekly is the AAII survey, a report on individual investors and their forecasts. Recent readings were almost exactly neutral. Professionals, as reported by Investors Intelligence, just switched from a net positive to a net negative reading, which in the past has sometimes marked the beginning of a positive reversal in prices. Not too long ago, bulls outweighed bears by 40% or more, but this has dropped to the point where bears are just starting to take the lead. Historically, it usually takes weeks before this turns into a “buy” signal.
We try look at the market from the standpoint of multiple time frames. Nearer term, more volatility and some price advance is likely. The technical factors we outlined above point in this direction, along with our strong intermediate term leading indicators. But more fundamental considerations such as slowing growth in consumer credit, especially revolving credit, are not as promising. Also, our long term indicators are no longer favorable.
Here are some of those longer term negatives. 1) Stocks are extended price wise, for example as Professor Shiller reports in the NY Times: “The average CAPE ratio between 1881 and 2015 in the United States is 17; in July, it reached 27. Levels higher than that have occurred very few times... [Afterwards] the stock market eventually collapsed.” 2) The FED is no longer pumping out money which especially benefits real estate and stock investors. Quantitative easing ended a year ago and now they are threatening to end easy money. Higher interest rates will not help corporations. 3) No relief is in sight for the chief negatives for business in the U.S.: high taxes and excessive regulations. 4) Unfavorable currency exchange rates are impacting corporate sales and profits, especially larger companies. Corporate earnings growth slowed over the past year. Earnings momentum among 8,000 stocks we follow is now negative; a year ago it was low, but still positive. 5) The emergence of China as a major trading nation and one of our chief competitors. They are just behind us in total trade activity (imports + exports) and gaining. [$5.2 Trillion US, $4.3 Trillion China.] This and the many American investments in China mean we are linked and we will feel the impact of sudden changes in their policy.
Our risk indicators remain positive and we would maintain our position in undervalued domestic equity positions.
F James, Ph.D.
Bond Market Analysis
It was a tough week for the U.S. Treasury bond market as investors looked to riskier assets, such as equities and high yield bonds as market volatility subsided. Yields on both the U.S. 30-year Treasury and the 10-year Treasury note rose on the week to 2.98% and 2.20% respectively. Returns for intermediate Treasury notes lost 0.1%, while long-term Treasury bonds took the brunt of the decline; falling 0.8%.
Prices in the Treasury market would have fallen more if it were not for the University of Michigan Consumer Sentiment Index’s disappointing report on Friday. It fell much more than expected and it helped send bond yields lower and prices higher. The index fell to 85.7; the lowest in eleven months. This is sign the recent volatility is weighing on the minds of consumers.
The big event later this week will take place on Thursday the 17th. All eyes will be on the FED to see if they decide for the first time since 2004 to begin raising interest rates. Currently, the futures market indicates only a 30% chance of a hike in September. The FED has indicated in the past they will be data dependent. So what exactly does the data show at this point?
The FED Labor Market Conditions Index has shown improvements in the past few months. This is encouraging after negative readings in March and April. Unfortunately, the improvement has been lackluster and the readings for the last six months are more indicative of times when the Fed looked to cut rates, not raise them.
Additionally, the outlook for inflation remains low. Recently, the Consumer Price Index suggests inflation is running at just 0.2% year-over-year; 12 months ago it was 2%. Even Core CPI (ex: Food and Energy) has yet to break higher. It remains in the 1.5 - 2.0% range it has been in over the past three years. These numbers point to a hike that might be later rather than sooner.
Whether they begin to raise rates now, in October, or by the end of the year, we are not likely to see the FED aggressively raise rates once they begin. The more likely scenario would be a very gradual move higher over an extended period of time.
Our bond indicators are no better than neutral. We would continue to focus on high quality fixed income securities and lower durations to neutral levels where appropriate for portfolios.
Trent Dysert, Portfolio Manager
