Stock Market Analysis
It was hardly an inspiring week. After some elevation the previous week, we saw a decline of more than 136 Dow points, almost 8/10 of one percent. Big stocks lost ground, but small ones also got hit, fortunately with a smaller loss of 0.2% on the Russell 2000. Consumer Staples revived a bit as did Utilities.
The dollar showed strength with the Dollar Spot Index rising more than 1%. This has led to a continued downtrend in commodities. Indeed, the Goldman Sachs Commodity Index lost more than 2% last week and a decline of over 30% in the past 12 months.
Volume rose on the stock decline, with the heaviest trading toward the end of the week, when prices were slipping. Advances and declines were more balanced, with 17 stocks declining for each 15 advancing.
Margin debt did not decline, rising instead from $453 billion to $471 billion in the latest report, which was October. Customer free credit also rose slightly. Both these figures suggest renewed interest in equities. This has been bullish in the past.
Searching diligently for signs of a market top, we find instead too much pessimism by small investors, as the AAII Indexes showed twice as many bears and neutral investors as bulls (fewer than 24% were bullish against 39% bears and 37% neutral). Closed end funds sold at a 12% discount off net value, another strong sign of pessimism.
Who was buying? Reuter’s insider trading ratio (sales/buys) was a 10, still in the bullish area which is less than 12. These so-called “lucky insiders” are worth following because they tend to buy and sell at the correct times.
Both housing starts and permits increased, offsetting some manufacturing difficulties. Retail sales were said to be softer but I did not notice this on a personal basis. Measures of Industrial Production are down, and the strong dollar remains an impediment. We recently noted only 23% of S&P500 stocks are above their 50 day moving average, an “oversold” indication. Today’s reading marks a potential for a seasonal rally. Emerging markets, which often profit from commodity sales, have become so depressed that a few are becoming attractive for purchase.
We have been projecting increased volatility in the short-term and one might review the past week as a good example. Our risk indicators improved slightly as stocks declined but remain mostly neutral, with our Risk Exposure Ratio at relatively low reading of 34%. We recommend maintaining moderate equity levels at this time.
F James, Ph.D.
Bond Market Analysis
It has been a long time, 4,186 days to be precise, since the Federal Reserve last started a rate hike program. Napoleon Dynamite was hitting the movie theatres and the United States officially handed power over to the interim Iraqi government. In fact, this is the longest period without a rate hike since at least the 1970s.
So, what does it mean for the Fed to raise rates a quarter of one percent? From a practical stand point it means very little. Rates will remain quite low by historical standards. From a symbolic standpoint, the rate hike and potential upcoming rate hikes have quite an impact. They suggest the Fed believes the economy is finally on firm standing.
The problem? The data is suggesting our economy is anything but firm and the prognosis for the future is shaky at best. The Atlanta Fed, for instance, has created a quantitative model which predicts future GDP. While it is certainly not fool-proof, its track record is much better than most economists. The Atlanta Fed’s latest projection for the fourth quarter is for GDP growth of only 1.9%. Barry James, the President of James Investment Research, has an excellent saying. He notes if the economy is growing by two percent or less it often feels like a recession.
There are other important signs of economic turmoil. Manufacturing, as measured by Industrial Production, has fallen over the last 12 months. This may be significant. Starting in 1948 there have been 11 recessions. In each of those recessions there has been at least one occurrence of falling Industrial Production. Overall, our research suggests there is a 90% correlation between 12 month changes in Industrial Production and GDP.
Another important gauge is new manufacturing orders across the country. It has a good track record of predicting future growth in the economy. For this we turn to the regional Federal Reserve reports for New York, Philadelphia, Richmond, Kansas City and Dallas. Starting in 2001, when the average new order growth fell (declining new orders), one saw GDP in the next year averaged a lowly 0.4%. Regrettably these reports have been averaging negative numbers for the last 5 months in a row.
Similarly the links to employment are also disquieting. While some trumpet the monthly employment gains and an unemployment rate of 5%, the actual picture is less sanguine. For example, even though more than 200,000 jobs were created last month, a closer examination finds there were 67 low paying jobs (in areas like hospitality and temp-workers) for every 1 high paying job (in fields such as information, finance and manufacturing). This is an abysmal ratio. Given the decline in the entrepreneur class, it may be quite some time before a healthy labor market returns.
What is a bond investor to do? Currently our leading indicators are favorable for bonds. Given the fallout over high-yield (or “junk” bonds) we would stick to higher quality investments. Further, while the Fed can raise rates, this will generally be limited to bonds with the shortest maturities. Longer bonds will instead focus on how the economy is actually doing as opposed to Fed actions. Given this environment, it makes sense to extend durations (maturities) slightly where appropriate.
David W. James, CFA
Economy 2016: Click below and view President/CEO, Barry James as he presents the first of a short video series supplementing our analysis and Economic Forecast for 2016.
