May 16, 2015 - Stock & Bond Market Analyses

Stock Market Analysis

Ennui seems to be settling in as the markets appear to be treading water. The Dow was basically flat for the week although the small cap Russell 2000 rose 0.92 percent. For the year the Dow is only up 1.6 percent while the Russell 2000 has fallen 1.5 percent. Falling stocks were nearly matched by rising stocks and the number of stocks hitting new highs has fallen considerably in the last few weeks. Energy stocks enjoyed the rebound in oil prices while defensive stocks, like Non-Cyclical and Utility stocks declined.

Commodities and bonds have had the returns this year as domestic and especially foreign stock markets have been a drag. Of course commodities and bonds were punished last year and a rebound is somewhat normal. Gold is up 18.5 percent this year and oil us up over 30 percent. According to our calculations, every major foreign equity market, except the U.K., is down this year. The markets are extremely difficult to figure out at the moment, which is one reason investors seem so antsy.

This is especially true among stock investors. Our research shows 53 percent of the 8000+ stocks we follow are in a bear market. That is, at the end of April, they were down 20 percent or more from their recent high. We track the markets closely and in the last three months found a disturbing trend. Those which had been performing the worst did better than those that had been doing well. In addition, we noticed the stocks we would rate as the most expensive had twice the return of the best bargain securities. Logic is not working well, usually the sign of a market in transition.

I had an interview with the Wall Street Transcript this last week and pointed out the market is a bit like a sailboat and the end of Quantitative Easing took the wind out of the sails. Right now the market is depending on the oars and they are valuation and earnings. Valuation measures are extended and first quarter earnings were lackluster. What is a stock investor to do?

We would start by taking a good look at sentiment readings. Our sentiment indicators are pretty much evenly divided, half bullish and half bearish. When we try to gauge sentiment in a more heuristic manner, we find individuals worried to death about the future as well as those wanting to get more aggressive to try and get higher returns. Again, we do not find a prevailing pattern.

Fortunately, we have the benefit of all of our other indicators as well. Looking across the spectrum of Fundamental, Monetary, Sentiment and Technical indicators, we would say the risks are almost evenly divided but not nearly as positive as in February. After a strong run in stocks, it is not unusual for the market to digest those gains and then try to figure out the next phase. The election is the wild card which will also leave stocks in limbo. It is wise to have reduced equity levels while still keeping a healthy portion of the portfolio in stocks. We expect the market to work through these uncertainties and return to a more usual status, one that rewards common sense investing.

Barry R. James CFA, CIC

Bond Market Analysis

Bonds lost ground last week as Long-Term Treasuries fell 1.5 percent in price. Yields jumped across the yield curve as the Two-Year Treasury rose 0.13 percent in yield and the Ten-Year rose 0.10 percent. Yields rose among all sectors except High Yield bonds. This seems to be the breather we had spoken about in last week’s analysis.

Still, long Treasuries have trounced stocks this year with a return of 8.2 percent in 2016. Only long term high quality corporate bonds (+9.0 percent) have done better. We are glad to see this since we said in our 2016 Economic Outlook we found high quality corporate bonds attractive.

Last week saw a mixed bag of economic reports, but they may have triggered some of the sell-off in bonds. Supporting bonds were weak Fed reports in New York, Chicago and Philadelphia. Offsetting this were stronger reports on Industrial Production, Capacity Utilization and Housing Starts. We also saw an uptick in the CPI the Leading Economic Indicators. All together this has been leading to an uptick in the Atlanta Fed’s GDPNow economic estimate. It is currently at 2.5% for the second quarter.

After the big drop in rates early in the year, bond yields look a bit like ripples on a pond. Each ripple is a bit smaller than the one before. We have seen yields trade in a 20 - 30 basis point band after the first big downturn and rebound this year. Each subsequent spike and fall has been less than the one before. This is due in part to moves in the stock market and in part due to changes in commodities. The low in yields coincided with the low in stocks on 11 February. This happened to be the same day as the low in oil prices for the year.

In spite of the uptick in oil and gold, bonds have held fairly stable. This may be because corporate earnings remain in a funk and business sales have fallen in the last year. Historically this would point to trouble in the labor market. In at least one area this is coming true. Announced layoffs were at their highest quarterly level in the last five years. In addition, the Fed’s own Labor Index is posting negative results. While we have heard some jawboning from a few Fed governors about rate hikes, it would go against their track record to do so. Nonetheless, the futures market gives a June rate hike about a 28% chance of happening.

Overall our leading bond indicators are essentially neutral. Investor sentiment on bonds had grown fairly skeptical but is beginning to turn more favorable, often a positive sign. Presently, we would maintain a portfolio of higher quality bonds and a moderate duration. We remain in a trading range and would adjust portfolios accordingly.

Barry R. James, CFA, CIC

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