What happened in the stock/bond markets: Dow advances and commodity stocks decline

Stock Market Analysis

Conclusion: Last week the Dow advanced while many other indices declined. Industrials and health care stocks led the way, while commodity stocks declined. Gold lost about 1% for the week. According to Barron’s, large value stocks beat smaller issues. Our research shows this to be unusual. Overall, declining stocks outpaced advancers last week yet more than 475 stocks set new highs against only 60 new lows. Volume on the decline was moderate, actually a bit less than the preceding week when prices were clearly rising.

For those who follow economic developments closely, it was a confusing week. Business investment and new orders for certain capital goods were projected to rise, however they were actually down more than one percent. Likewise retail sales disappointed with “Flat to lower” readings while increases were anticipated.

Interestingly, year-over-year growth in the Consumer prices measure (CPI) was higher than the wholesale measure (PPI). In the past this has been favorable for profits as businesses can generally pass on all their cost increases plus a little extra to their customers.

Unfortunately, consumer confidence declined from 80.2 to 71.3, a substantial drop. In fact, the Michigan consumer sentiment index closed at 73.2, said to be the lowest reading of the year. Our source among trades-people suggests business fell off considerably in the face of concern about employment and government deadlock. Home sales lost a bit of momentum but home prices continued to press ahead, advancing at the rate of nearly 1% for the month and 12% over the past year. Of all the releases, the report on declines in business equipment orders and shipping were most disturbing. Why? In the past it has closely tracked new employment. New equipment requires operators. Still, there is some hope as business activity was reported as improving in both Kansas City and Dallas.

This is the time of the year which favors smaller stocks, especially value issues. Over the past 5 years, returns on the small-cap Russell 2000 have been more than 3% a year higher than the larger issues of the Dow Industrials. Over a 90 day period beginning in October, for each of the past three years, our smaller bargain value stocks were found to outperform larger bargain value stocks. Note: this was not true in the ’08-’09 bear market when large issues better resisted the declines, even as almost all stocks (large or small) lost ground.

Sentiment is too bullish right now for a long term bottom area, Investors Intelligence shows among advisors bulls are near 53%, bears near 16%. Since mid-October the spread has widened. Typically, most tops occur when there is a wide spread that is just beginning to narrow.

Even with a slight headwind of the previous week many of the market technicals are fairly moderate. The 10 day moving average of advances to decliners is showing no unusual stress and is near the 52% neutral region. Likewise the percent of S&P 500 stocks above their 50 day moving average is at a neutral 59% area. We would criticize the market only on the very short term basis where prices are near the upper Bollinger band; this has in the past often been a reversal signal suggesting prices are rising too swiftly over the near term.

After giving good warning of the recent rally, our leading stock indicators are now pulling back a bit, and are overall neutral. Well invested portfolios should be enjoying the rally and maintain a steady course. The flap over government shutdown and now Washington’s takeover of the country’s medical care has been unsettling for stock investors. Long term, we continue to have concerns for the equity market due to extended prices and a sluggish economy. It is not only individuals who fear unexpected or substandard medical treatment. Some business firms also suffer from neglect and poor treatment by Washington.

F James, Ph.D.

Bond Market Analysis

Conclusions: U.S. Treasury yields held steady for most of the week until Friday when bond prices declined after the ISM Manufacturing index posted a strong report. The U.S. Dollar was up about 2% against other major currencies after declining about 7% since the early part of July. Crude oil has declined 14% to $94.61 after reaching a 12 month high in early September around $110 per barrel.

The Fed statement on Wednesday didn’t provide much new information regarding the economy except that they mentioned that the housing market sector has “slowed somewhat.” Overall, the Fed is still looking for a stronger economic data before it begins to reduce the amount of monetary accommodation. This is noble, but we doubt that the Fed has better data than the millions of American’s who are making their own decisions each day about what is best for their own economic future.

Speaking of Americans and their financial future, the NORC Center for Public Affairs Research reports that the 55 and older labor market segment is the fastest growing segment. On top of that, 82% of working Americans over 50 say that it is somewhat likely that they will work for pay in retirement. It’s not surprising then that 47% of American’s expect to retire later than previously thought. The definition of retirement has changed for most Americans.

Kimberly-Clark announced that they would be reducing the diaper counts in the majority of their diaper packages due to “product innovation.” We doubt that this “innovation” will really reduce the number of diapers used but it is a way to possibly improve profit margins while not increasing price. That is quite the “innovation” indeed.

Our bond indicators are slightly better this week however, they are still not overwhelmingly positive. We would continue to move portfolios into a position of lower volatility while maintaining modest duration in high quality bonds and cash.