What happened in the stock/bond markets last week (3/9-3/13)?

Stock Market Analysis

At first blush, it was a difficult week for stocks. Popular indexes such as the Dow, S&P 500 and the NASDAQ all fell by half a percent or more. Additionally, more stocks declined than advanced. However, there were a few bright spots. Small stocks, like those in the Russell 2000, advanced over 1%. Further, sectors had divergent paths. Healthcare, Utilities and Financials managed gains. Areas posting the biggest losses included Technology and Energy securities which fell over 2.5%.

Perhaps the most surprising data of the week came from retail sales. Consumers make up roughly two-thirds of our nation’s economy. With retail sales we get a glimpse of the rubber meeting the road and see consumers in action. It often answers two basic but important questions. One, are consumers spending and, two, what are they spending their money on. Alas, the results are disquieting. For each of the last three months consumers have cut back on their spending. Also, spending on all the big-ticket items such as Vehicles, Furniture, Building Materials and Electronics are all trending down. If the consumer is holding back it probably will be reflected in sub-par 1st quarter GDP.

Why are consumers resistant to spending more? After all, there should be a positive psychological effect of lower gasoline prices. According to AAA the price at the pump is down over 30% since the end of July. Further, wages are advancing. This too should be good news. Unfortunately the wage growth seems to be limited. Zero Hedge News has acknowledged this point by noting the difference in growth rates between non-supervisory workers (roughly 80% of the workforce) and supervisory workers.

Foreign countries are having their own difficulties. The European Central Bank (ECB) is trying their hand at QE with the hopes it will revive their moribund economy. According to Eurostat data, the Euro Area has yet to have a 2% GDP quarter in 20 years. That is an ugly track record. One can understand their desire for better growth.

Yet if history is a gauge their version of QE is unlikely to fix their economic woes. In our country the Federal Reserve essentially printed $3.4 trillion since the Great Recession. Many economists might predict this would have a multiplicative effect and bring about even higher levels of economic growth. The data, unfortunately, tells a different tale. GDP growth has only risen by approximately $1 trillion. It seems unlikely that a similar approach by the ECB or the Bank of Japan (BOJ) will see success.

What the ECB actions have done has been to create export woes for the United States. By printing money the Europeans are devaluating their currency. Even though the year is still young our Dollar has already risen by 13% versus the Euro. This is on top of the 13% gain the Dollar had for all of 2014. No wonder big multinationals are singing the blues on their international sales. This is one reason we have been shifting equities toward smaller capitalization securities. Small cap stocks generally have a lower reliance on international sales.

Our leading intermediate indicators have deteriorated slightly. Today they are no better than neutral. In this environment we would continue to feature bargain stocks which enjoy good relative value, profitability and stock price strength. We would continue to hold moderate levels of equities in client portfolios.

David W. James, CFA

Bond Market Analysis

Last week interest rates generally fell. Longer dated maturities saw bigger declines in yields than shorter maturities as the yield curve flattened.

Part of the decline in yield may come from the softness of the economy. Commercial retail sales were notably weak, and a weaker economy is often said to be favorable for bond holders. (Part of the weakness reported by retailers was caused by some of the most severe weather of the winter so far.) Wholesale prices were well behaved, not much could be attributed to inflation. Bloomberg News measures a very broad array of indicators, actual versus expectations, and their negative “surprise” index fell to the lowest (least favorable) level since the recession year 2009.

Of course, current economic trends play a role in swings in interest rates. But at this time, we give more credit to changes in currency values and energy prices.

Last week the dollar strengthened again. Compared to a wide array of different currencies our dollar, year-to-date, has seen appreciation on the order of ll.1%. Over the past year, it has gained more than 26%. Losing currencies included the Brazilian Real, down 27%+, the Euro, 24%+, and the Swedish Kroner, off almost 27%. Only the Chinese Yuan and the Mexican Peso have managed to hold their value against the dollar.

The role of petroleum in meeting energy demands for industrial production and transportation is not questioned. For many years, the advanced nations of the world have transferred wealth to a few developing countries that have an abundance of petroleum.

But eventually, the advanced countries developed the technology to generate energy in abundance. According to Citicorp’s Morse, the United States has become a major exporter, and now ships out more in the way of petroleum products than it imports.

This abundance has of course contributed to the adjustment in the world price for petroleum, which is down more than 50% from recent highs. This price decline has been taken by Wall Street to be a negative, unsettling producers and transportation firms.

The U.S. has become so proficient at extracting petroleum that storage space has become a factor of concern. Cushing, Oklahoma tanks are said to hold about 6.6 million barrels of crude, but are fully leased for the remainder of 2015. Cushing is the nation’s largest commercial storage hub. According to the Wall Street Journal, producers are pumping about 1.5 million barrels each day in excess of world needs. Too much supply normally leads to declining prices as producers vie to move their output.

How low could the oil prices go? Our so called “swing producer”, Saudi Arabia, is said to be capable of significant increases in output over current levels and is unhappy with the competition from U.S. frackers. Morse believes the cost of production of the Saudi oil to be less than $5 a barrel.

It may be a surprise to many that lower energy prices could be a concern to economists. Or concern that our currency is rated to be so desirable, and higher valued. Our favorable long term stock and bond indicators give a message of encouragement for the future, with cheaper energy leading to lower production costs for our goods and services, a boon to American consumers.

Lower costs of energy factor into the lower prices we have been experiencing for most products, with recent CPI price changes near zero and in some instances negative.

A stronger currency will make our bonds more attractive to foreign investors. Low inflation will also encourage bond investors. Sure enough, we note foreign investors have recently shown a greater appetite for U.S. Treasury offerings. On the other hand, business firms find export sales become more competitive as prices for U.S. goods (in local currencies) rise. On the whole, however, our favorable long term indicators, for both stocks and bonds, point to a good resolution for investors in the future.

This is not to say that the intermediate term moves will necessarily be positive, and defensive adjustments may be needed from time to time. Today our long term bond indicators are very encouraging while the intermediate picture is less so, however they remain positive overall. We believe opportunities are still present. Investors should continue to hold high quality bonds of moderate durations in this environment.

F James, Ph.D.