Stock Market Analysis
Conclusions: With the tapering came market jubilation. For the week large stocks like those of the S&P 500 gained 2.4% and smaller issues such as those of the Russell 2000 sprinted to a 3.6% advance. Both represent record highs. It seems a Santa Clause Rally is firmly in place.
The week was filled with many important economic releases and stories but perhaps there were none bigger than the tapering of the Federal Reserve’s Quantitative Easing program. In what may likely be his last press conference as Fed Chair, Ben Bernanke explained how our economy is showing enough positive signals for the Fed to lower their extraordinary program of buying bonds out of thin air. The previous total had the Fed purchasing $85 billion of our country’s debt every month. Now, the monthly purchasing total will be lower, but remain a robust $75 billion. Details on the complete elimination of the QE program were lacking.
The market, which had previously had a two week losing streak on the rumors of tapering, decided to “buy” on the fact. Indeed, there are encouraging signs on the economic front. The final revision to 3rd quarter GDP shows growth of over 4%. Further we find growth in Industrial Production, which is arguably the best monthly gauge of economic movement, to have advanced over 1.1% in November. This is the strongest advance in over 12 months.
While this is encouraging it is important to remember that no market goes straight up or straight down. In 2013 the stock market may have delivered a false sense of security for investors. The biggest decline for the year has been less than 6%; a very low number. Since 1930 there has never been back-to-back years where volatility has remained that low. Put simply, a bigger correction in 2014 awaits.
Likewise the overall level of bullishness by Wall Street advisors is troubling. Surveys by Investors Intelligence show there are currently over 4 bullish advisors for every bear advisor. We have not seen this level of enthusiasm in well over 10 years. Further, analysts are also on the bandwagon. Today they are offering over 10 “buy” recommendations for every 1 “sell” recommendation. Too many bulls!
Presently our leading intermediate indicators are slightly unfavorable. Given the disquietingly high level of Wall Street optimism we noted in last week’s analysis, “For now, we suggest a modest reduction in equities and a more conservative posture...” While our long term indicators suggest we will see opportunities in the year ahead, a bit of caution now may be warranted.
David W. James, CFA
Bond Market Analysis
Conclusions: Last week the Chairman of the FED gave what may be his final meeting summary as Chairman, as he is to be replaced near the end of the year by a new, liberal College Professor, Janet Yellin. She has been a strong supporter of his extraordinary efforts at the FED to print and spend money and directly use FED powers to stimulate the US economy. Under his supervision the FED has created buying power and expanded their reserves to nearly $4 trillion, creating inflation overseas but not yet in the United States (in spite of their best efforts.) It seems clear that liberals on the Board wish for a higher rate of inflation here at home, believing it will motivate consumers to buy (before the price rises further) and therefore stimulate the economy. Under its new premier, Japan is following such a policy, we will see how it turns out.
Last week nearly all stock averages rose and so did the yield on the 10 year bond, up about 1 basis point. This bond has, however, risen more than 100 basis points year to date. Much longer bond [20 and 30 year] yields declined and prices rose, to the surprise of many analysts. Very short maturity bond yields rose but to a moderate extent. Progressive economists looked upon a cessation of activity by the FED with great concern, so far such concern appears to be unwarranted. Is it possible that a lower level of intervention by the central bankers would be helpful?
The Wall Street Journal did well to urge caution at the President’s glee over signs of improvement in the economy, such as last week’s third quarter GDP revisions up to the 4.1% annual rate, consumer spending up from 1.4% to 2% annual growth, and signs of improvements in commercial credit. The facts are, most retailers complain at the year-over-year sales lethargy, said by some to be well below the desired 6% mark, and much of the increase in industrial production has gone into building inventory.
A purpose of the Quantitative Easing money printing program has been said to lower yields on longer term bonds, thereby encouraging capital investment spending. Yet it is clear that such yields frequently rise for a time, then decline after QE programs ends. No such stated objective is linked to the impact on equity prices; however they frequently rise during the program.
Good intentions by big government are everywhere, but recent FED actions favor wealth creation by real estate and stock investors, who are already affluent, and do less for the poorer among us who most benefit from strong business firms with stable conditions and predictable job demand.
Our socialist friends overseas continue to suffer from recession level unemployment and our exports are hampered. The US lead in technology and now cheap abundant energy permit us to remain attractive as a supplier for their industrial and grain crop needs. Consumers are cautious, now more than ever with health program uncertainties, and moderate income spenders shop cautiously even while the wealthy are heavy spenders. There are however, many more moderate income citizens than wealthy. We report continued improvement in our intermediate term bond risk indicators, which suggest a lethargic future economy will reveal excess funds for investment and continued downward pressure on interest rates. The spread between Moody’s AAA long bond and long US Treasury yields has fallen from 77 to 65 basis points, a sign of confidence among bond investors.
James, Ph.D.
