Stock Market Analysis
Stocks continued their winning ways as the Dow rose 1.85 percent while the small cap Russell 2000 jumped 3.08 percent last week. The advance was confirmed with about four stocks advancing for every one that fell in price. In addition, new highs swamped new lows.
In a world where interest rates have gone negative in many countries, investors are being faced with a conundrum. Even though the stock market is closing in on previous highs, investors are interpreting recent movements in a variety of ways. One very conservative client is interested in becoming more aggressive while another conservative client desires to eliminate almost all risk. Of course, when the stock market has been locked in a trading range since the end of 2014, it is not unusual for investors to become a bit antsy.
The end of Quantitative Easing is forcing investors to return to their roots when it comes to stocks. Those roots are valuations and earnings. Valuation levels are somewhat extended when looking at Shiller’s CAPE or when comparing the value of the stock market to the value of our economy. In addition, it looks like we will have four quarters in a row of falling earnings. I had a discussion with a Bloomberg reporter this week about the fact that earnings estimates are off 10% while revenue estimates are only off 1%. While I did not have a definitive reason on this, it would appear that companies had done the easy cost cutting previously, and margins may be facing contraction.
We have previously seen a lot of share buybacks going on as companies were trying to get more money back into the hands of their shareholders. Harvard Business Review found that from 2003 – 2012 S&P 500 companies spent 54% of their profits buying back shares. They spent another 37% paying dividends, which have not left much for trying to grow their business. Much of this can be attributed to the financial crisis and poor economic policies which discourage business risk. We cannot expect the same level of share support in the future, so stocks will remain in limbo a bit longer. However, this should be good for a return of common sense investing in smaller and more value oriented stocks.
Our indicators continue to become less favorable and risks are rising. It would be prudent to try and lower them where appropriate. We would recommend lowering equity levels for overinvested accounts.
Barry R James, CFA, CIC
Bond Market Analysis
Treasuries took a breather last week as other types of bonds did better. TIPS, intermediate and long term treasuries saw their yields rise and prices fall. Both high quality and low quality corporate bonds gained. High quality corporate bond yields have been historically low and do not offer a great bargain. On the other hand, the lowest quality bonds have been through a major downturn and they are getting a little relief. It does not hurt that their yields are so high.
Taxes are due on Monday, April 18th and maybe some of the selling of Treasuries had to do with the need to pay them. It looks like we have had record collections for 2015; over $3.1 Trillion in Federal taxes and some estimate $1.5 trillion in state and local taxes.
While there were some good economic reports, it seems there were more negative than positive. Consumer confidence slipped and Industrial Production took a big hit. It fell by 0.6% for the month, the sixth time it has fallen in the last seven months. In our economic outlook we said “Manufacturing slowdown to continue” due to the strong dollar and weak economic growth overseas. It appears these have kept our manufacturing sector from rebounding.
Inflation is muted, especially at the wholesale level, as the PPI fell last month and remains negative for the last year. Broad measures of inflation at the consumer level are also muted, but higher gas prices did give the CPI a slight boost last month. We are also starting to see some increases in wages, but the job market is not strong enough to indicate a significant likelihood of wage inflation becoming an issue.
After the big rally in bonds, we are seeing some resistance. Our risk indicators are pointing to more risk, so we would work at keeping durations at or below recent target levels. We do not think it is time to abandon bonds, but we would not expect a big jump in bond prices for a while.
Barry R. James, CFA, CIC
