Dec 29, 2015 - Here's what happened in the stock/bond markets last week

Stock Market Analysis

Last week Santa brought a gift for investors, a rally. The large cap S&P 500 rose 2.8% and the smaller cap Russell 2000 gained over 3%. Much of the rally was focused on areas hardest hit this year, such as Energy and Basic Materials.

Despite the welcome gain, the S&P 500 is still trading at levels below the day the Fed announced a hike in rates. In fact, for much of the last year, many stocks have actually been in a bear market. Currently, over 1/3rd of stocks in the S&P 500 are down 20% or more from their 52-week high. For smaller stocks it has been even worse, as 55% of the stocks in the Russell 2000 have fallen 20% or more. Put simply, the market has been on shaky ground.

What to make of the future? We got an encouraging manufacturing report from the Richmond Fed, a welcome reprieve. However, new orders reports from the rest of the country are sorrowful. GDP for the 3rd quarter was revised downward to a lackluster 2.0%. As Barry James, President of James Investment Research, likes to remark, “If GDP is growing 2% or less it’s going to feel like a recession.” Indeed, according to the Associated Press, twice as many people thought 2015 was a bad year for the United States rather than a good one.

Real consumer spending increased by 0.3% in November. While this seems encouraging against the meager numbers of 2015, it is just average looking at the last 20 years.

Businesses appear to be worse off. When businesses are excited about their prospects, they often like to expand. Looking at Capital Goods (excluding air and defense) offers us clues about this. The latest number is a disquieting decline of 0.4% and it has fallen over the last 12 months. Additionally, corporate profit margins (profits / GNP) are also falling.

Taken together, the picture is waning for the bull market. Still, bull markets are difficult to derail and often enjoy a final run-up before the markets reset. Our leading stock indicators are deteriorating slightly, but not enough to engage major action. However, this bears watching and we are considering the best approach to take if they turn negative. Retooling one’s portfolio to include companies with good buyback programs or dividends will make sense. Further, our research notes value investing typically asserts leadership in periods following declining profit margins.

David W. James, CFA

Bond Market Analysis

This was the week where both stocks and commodities showed signs of revival. The Dow Jones Industrial Average rose 2.5% while the CRB Commodity Index gained 1.8%. Even crude oil rose 8.0%. Precious metals advanced, including Silver which rose more than 1.4%, over a full percentage point better than Gold.

In the face of these currents, bond prices fell as the yield on U.S. Treasury Bonds rose. The DX Dollar index fell slightly, a little more than half of one percent. While the Dow rose, an internal measure of advancing and declining stocks shows it was a weak rally. If they market turns lower it could be a boost for bonds.

The economic picture is mixed for the shorter term. Orders for capital goods weakened but personal income picked up a bit. New and existing home sales waned, but there were fewer jobless claims. The monthly personal consumption deflator was unchanged, but was up 0.4% over the past year. Prices are barely creeping higher. GDP for the recent quarter was revised downward to +2.0%.

Over the intermediate and longer term, the movement of bond prices will be determined by multiple factors, among them the flow of stimulus from government coffers, the level of inflation, the pace of economic activity, and the trend of stock prices. We expect heavy U.S. stimulus has come to an end, at least for now. Economic activity was increasing, but the U.S. has shown signs of deceleration from global factors including the Chinese slowdown. Inflation is starting to creep into the wage arena and may increase across the board, but not until U.S. economic activity begins to rise more swiftly.

A few weeks ago we suggested a small reaction, not a major one, when the FED began to push rates higher. So far, that projection appears on target. Our focus on the highest quality bonds has been helpful. According to Bloomberg, “Treasuries are proving their worth as the haven of choice...”

Today our leading bond indicators are in a neutral to slightly favorable configuration. We recommend investors focus their bond investments in higher quality, moderate maturity bonds.

F James, Ph.D.

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