Stock Market Analysis
It was another profitable week for stock investors. Large stocks (S&P 500) gained 1.3% and smaller issues (Russell 2000) did even better and advanced 1.8%. The breadth of the advance was strong with nearly three stocks advancing for every two that declined.
So far our special study, “Opportunities from Brexit” has been spot on. In the study we noted, “The volatility created by the Brexit outcome should be considered a buying opportunity for U.S. investors.” We wrote this on a day when the Dow lost 600 points and pundits were clamoring for investors to run away. Instead of the start of a major sell off, in two short weeks the Dow Jones Industrial Average and the S&P 500 set new 52-week highs.
Of course, much of the week’s gain came on Friday, with the release of a very encouraging payroll report. Officially, June saw the creation of 265,000 jobs. This is almost 30,000 more than Bloomberg’s most optimistic analyst had expected. Job creation is always welcome news. However, we do note a few concerns. First, the data suggests 1.8 lower wage jobs were created for every one higher wage job. Second, and perhaps more important, job growth over the last 1, 5 and 10-year periods has not kept up with the growth of our country’s adult population.
Another concern lies with corporate profits as S&P 500 earnings per share (EPS) peaked in December 2014. This comes despite a backdrop of low interest rates and share buybacks which typically elevate EPS numbers. Share buybacks help to concentrate earnings and it is disquieting to find that 66% of the S&P 500 companies have bought back shares but it did not elevate EPS.
However we did find some encouraging signs for the prudent investor. One is the return of bargain investing. For much of 2016 we have seen expensive stocks leading the market. June saw a change and those securities with better relative value, profitability and price appreciation started to lead once again. Over the decades, we have seen this as a more normal condition and usually favors stock pickers.
Another promising sign remains an accommodative Federal Reserve. Presently, the futures market suggests a less than 1-in-5 chance of the Fed raising rates by December. Another sign of accommodation, in 69 of the last 79 months we have had a lower Fed Funds rate than year-over-year CPI. This can be referred to as negative real interest rates which can push investors into stocks. Finally, although there is no longer a formal Quantitative Easing program, it does not mean the Fed has been idle. The supply of money (M2) has grown 6.9% over the last 52-weeks which is about a full percent higher than the norm starting in 1980.
Overall our intermediate indicators remain in a favorable configuration. While it would not be surprising to see a small correction from the recent robust rally, we would continue to use those corrections as an opportunity to add equities to underinvested accounts.
David W. James, CFA
Bond Market Analysis
U.S. Treasury bonds continued to advance in price last week as the 10-Year and 30-year U.S. Treasury bonds reached all-time low yields. Bonds usually perform relatively better when stocks do not; however the prospect of continued monetary accommodation has helped both recently. The yield curve continues to flatten and shift lower, signaling lower expectations for interest rates.
The U.S. dollar moved slightly higher last week while crude oil and natural gas declined. Gold and silver rallied strongly. Previously, we thought silver was relatively cheaper based on the ratio of the price of gold to the price of silver. We expected the ratio to move back to average levels and it has over the past few months. While silver is still somewhat cheaper than gold the case for silver is not as strong as it was.
Friday’s Employment report was the highlight of the economic calendar this past week. 265,000 jobs were created in the month of June; however the unemployment rate rose to 4.9% as the participation rate rose to 62.7%. The average work week remained steady at 34.4 hours.
The lackluster May report was actually revised lower and combining the last two months only an average of about 150,000 jobs per month. Further concerns include our adult population is growing at a faster rate than jobs over the last year. One bright spot was in the manufacturing area where 14,000 jobs were created, a rare occurrence lately.
The Federal Open Market Committee (FOMC) released the minutes of their June meeting on Wednesday. The “wait and see” approach Janet Yellen has mentioned in the past seems to be the current course of action. After raising interest rates in December for the first time since July 2006, the FOMC has kept the Federal Funds Target rate unchanged in 2016.
Mortgage rates have fallen and homeowners have been taking advantage. Refinancing activity rose sharply last week as the 30 year fixed mortgage rate fell to 3.66%. Some homeowners are also taking advantage of the opportunity to reduce the maturity of their mortgages while not increasing their monthly payment very much. Prepayment speeds on mortgages may increase here for a time and mortgage prices may reflect this in a negative way. It has been a lagging sector all year.
Our intermediate and longer term bond indicators are still slightly unfavorable and we would use the continued rally to trim durations where appropriate. Eventually we may see another opportunity to buy bonds but it will likely take place at better prices.
Matt Watson, CFA, CPA
