Stock Market Analysis
Stocks completed a rough week but the downdraft did not seem to bother business analysts or investors. Moody’s reported, “The third quarter is looking better for U.S. GDP, but at the potential expense of growth in the final three months of the year. New data on retail sales and inventories suggest that stockpiles subtracted only 0.7 percentage point from third quarter GDP growth rather than the 1.4 percentage points previously thought.” They further opined the quarter was tracking at a 2.1% annual rate.
A very significant event was lightly reported. This was a report that General Motors Buicks are now being shipped from China to the United States as well as elsewhere. This and the news China is now producing modern passenger jet aircraft reveals the extent of their sophistication and their competitive nature.
While the major stock averages recovered earlier from their August-September setback, this is not true for the Transportation or Utility indexes. Year to date, utilities are down about 7.5% and the Dow Transportation Index more than 10%. Some observers look to them for clues about the future, thus not encouraging news for the bulls.
Gold shares remain in a downtrend, and lost almost 0.6% for the week. Copper touched another new low on Friday.
Reuter’s ratio of insider sales to buys is now 9 and ratios below 12 are often rated Bullish by Barron’s (more buying among the insiders on a relative basis). Herzfeld’s closed end fund shows a bullish discount of nearly 12% below asset values. Investment advisers and small investors are normally bullish but many “fence sitters” currently exist, those not committed to either the bull or bear camp.
What of the future? The news from China is not good. Authorities continue to follow the Chinese style of bad examples we set here at home: Cash for Clunkers, Home Affordability Mortgage relief, Troubled Asset Purchases. The Chinese have, for a time, even censured executives against selling stock, and persuaded Exchange authorities to limit trading in certain issues.
Perhaps this will persuade U.S. investors to reduce risk and we will embark on a bear market. On the other hand long bull markets are difficult to untrack and this is one of the longest and strongest in history, beginning in 2009 and continuing irregularly since then. Our Risk Exposure ratio is only 36 and our indicator picture continues reasonably strong, perhaps less positive but still on balance favorable. We are entering into one of the seasonal periods where equities in general, and especially small-cap value stocks, the type we often purchase, tend to do well. While we would not increase risks here by adding to equities, neither would we completely abandon stocks at this point. Somewhere in the year ahead (as the outgoing President prepares to turn over responsibilities) it is likely that stocks will make their final rally of the Bull Run before a decline which will correct many of the distortions of present markets. We would not give up just yet.
We do anticipate volatility over the short term, especially among lower quality securities that have risen dramatically. The prudent investor would maintain moderate equity levels, timing additions to periods of pullback, sales to rallies.
F James, Ph.D.
Bond Market Analysis
High quality bonds spent most of the week meandering before rallying on Friday. On a total-return basis Long-Term U.S. Treasuries advanced 0.5%. The other end of the quality spectrum, High-Yield (sometimes referred to as “Junk”) Bonds lost 1.4%.
Much of Friday’s rally can be explained by some of the economic data releases that day. Prognosticators firmly believe that inflation is finally ready to begin. For example, economists predicted the Producer Price Index (PPI) which measures inflation on the wholesale level would rise by 0.2% for the month of October. Alas, reality was a decline of 0.4%, more of an indication of deflation rather than inflation.
The Retail Sales report was also released on Friday. This is often important as it gives us a look at the actions of consumers and their impact on the economy. Typically bond performance responds inversely to the economy so a strong Retail Sales report could put pressure on bond holders. However, the actual numbers were sub-par and showed one the consumer was not in a rush to depart with their hard earned cash.
Earlier in the week we received the latest update on small businesses from the National Federation of Independent Businesses (NFIB). As about half of all jobs in the United States come from small businesses this is data worth following. Overall, optimism didn’t improve. However, other parts of the report reveal significant factors that rarely make the headlines. Most business owners, for example, believe the economy in general and their company’s profits in particular are trending the wrong way.
Another hot topic is the Federal Reserve and the debate on potential rate hikes. Supposedly, job growth has accelerated and a rate hike must happen. Unfortunately the labor market is probably not as strong as many believe. Over the last twelve months we have added more adults than new jobs. Furthermore, the Fed’s Labor Market Conditions Index, which examines 19 separate labor factors, is weak. It’s readings in the last six months are historically more indicative of weakness leading to rate cuts rather than rate hikes.
Finally, we note the horrific terrorist attack on Paris over the weekend. Certainly our thoughts and prayers are with the French people. What will investors do? Often in the face of crises, either domestic or abroad, investors seek refuge in safer investments and the U.S. Treasury market is frequently considered a safe harbor. It would not be surprising to see our Treasury market rally in the very short term. Examining our leading bond indicators, we note they are slightly favorable today. We would continue holding higher quality bonds of moderate duration at this time.
David W. James, CFA
