Market Commentary by: James Investment Research - March 7-March 11

Stock Market Analysis

Once again, stocks moved higher during the week, with the Dow Industrials up about 1.3%, slightly more than the S&P 500 Index. Small capitalization securities generally lagged for the week. It has been a difficult year. The Dow remains slightly down year-to-date.

The trade-weighted dollar weakened by a small extent, even as U.S. investors displayed indecision. In this, they might be reacting to the European Central Banks (ECB) newly announced stimulus efforts. Apparently Europeans are joining the Chinese in depreciating their currency, lowering interest rates, and even encouraging banks to expand loans. The great economist, Fisher, once remarked “All fiat money loses its value.” So far, Central bank and government stimulus have not worked well for certain South American countries and their economies. Nevertheless, it would appear that Europe may embark on a similar process.

Many professionals believe the economy is growing adequately. But a strong dollar over the last few years continues to create trade problems. It seems S&P 500 stocks are reporting lagging earnings and unfortunately sales are following suit.

Some signs are favorable for stocks. For example, the net difference between daily new highs and new lows has shrunk and even turned slightly negative a couple days this past week. In the past, this revealed indecision by stock investors and has been a bullish indication.

Indecision amongst our smallest investors has been a positive sign in the past. This is true today as the American Association of Individual Investors (AAII) is reporting more neutral market projections than either bullish or bearish. The Investors Intelligence survey is also showing indecision with about 39% bulls and 35% bears.

Another sentiment figure we watch closely is the discount/premium priced into net asset values for closed-end mutual funds. While this figure has improved some as the stock rally moved forward, it is still in “too cheap” territory today, showing excessive negative sentiment. Thompson’s index of insider buying and selling continues to show heavy buying by the insiders, bullish.

Additionally, excessive negative sentiment has recently been displayed among option purchasers. While this configuration is a short-term positive, such desire for protection among option buyers is worthy of note. Investors have been favoring buying at the end to the day, as shown in the Smart Money Flow Index. This has been going on for eight weeks and this is usually bullish.

Our leading risk indicators remain favorable. The strong rally of recent weeks served to improve optimism among investors, but not to the extent of suggesting lowering equity levels. The pattern of American stocks following China’s markets remains a concern. Still, the lack of bullish sentiment suggests the rally may have legs. We would allow equity positions to grow and may do some limited buying where appropriate. We do note our most accurate indicators continue to suggest no new bull market. We will keep a cautious eye on risk levels. We favor value securities with strong earnings which have displayed favorable relative strength and leadership in 2016.

F James, Ph.D.

Bond Market Analysis

The U.S. Treasury bond market gave back some of the strong gains made since the start of the year. Long-term, 30-Year U.S. Treasury bond yields have risen to 2.75%, after falling to 2.5% a month earlier. This increase in yield has caused prices to fall as 30-Year Treasury bonds are down 4% over the past month. The recent strength in stocks prices and improving economic reports has caused certain investors to abandon the safety of the U.S. Treasury market.

Japanese 30 year bond yields dropped to an all-time-record low of 47 basis points. Investors could lend to the U.S. Government for only 2 years and earn 93 basis points. Higher yields and lower duration risks are among the reasons why we find U.S. bonds still attractive especially compared to foreign bonds.

The National Federation of Independent Business (NFIB) small business optimism report was not very optimistic. The report showed the lowest amount of optimism among small business owners in 2 years. Each individual category was either flat or down for the month. Given the importance of small firms, this pessimism does not portend well for the future of the U.S. economy.

“Mind the Gap” is typically used to alert passengers to the space between the train car and the platform. Investors today should pay attention to the “gap” between wholesale inventories and sales. This “gap” has elevated to new business cycle highs and is approaching levels last seen in 2008-2009. Inventory recessions (for example, 2001) can be relatively mild if the liquidations do not cause a large disruption in consumption. However, the most recent “gap” just surpassed the peak reached in 2001.

Bond investors looking for signs of inflation may find some in recent wage data. However, according to the Fed’s own labor market indicators, recent developments have been weak overall. This may be a reason why the Fed is apt to hold off on increasing interest rates this week as the Fed Futures market predicts. Currently, the Fed Futures market anticipates only two interest rate increases in 2016.

The bond market provided strong returns earlier in the year and prices for bonds have become elevated. Our intermediate indicators are slightly unfavorable at this time. We recommend investors trim durations that are excessive, while remaining in high quality bonds of moderate durations.

Matt Watson, CFA
Trent Dysert

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