Stock Market Analysis
Conclusions: Happy days are here again. The Dow hit a new record high and advanced 1.2% for the week. In even better news, the small cap Russell 2000 jumped 2.7% and finally climbed out of the cellar into positive territory for the year. About twice as many stocks rose as fell in the week and 574 stocks hit new yearly highs. The icing on the cake was the rise in volume compared to the week before. This is good news because volume is down almost 30% from a year ago and was making the rally worrisome.
One recent change has been encouraging. The stock market seems to be shifting its focus from growth to value. Using our proprietary measures of growth and value, we saw the top growth stocks lose over 5% in the last 3 months, while value stocks held even. We know the S&P 500 was up in that three month period, but the typical stock in our 8,500 stock universe actually fell almost 1%. Nonetheless, value factors have started to return to their usual place of dominance, a healthy sign.
The market got a lot of assurance from economic reports this last week. An example would be the employment results reported Friday. We now seem to be adding over 200,000 new jobs a month and supposedly we have finally recovered all the jobs lost during and shortly after the recession. Unfortunately, the steady unemployment rate comes on the back of very low participation in the labor force, and still high underemployment results. I was speaking to a man today who had lost his home and had been living in his car. He finally got a job and was so incredibly thankful that his life is now back on track. Job creation is not just a statistic, it affects real people.
Risk levels remain somewhat elevated, with our Risk Exposure Ratio indicating a 68% chance of a significant correction. Put call premiums and a number of sentiment readings, like the VIX, also point to potential problems for the market. However, momentum and internal indicators point to continued strength. We wish we could say the market is low risk, but it would not be the truth. Stocks may continue to edge higher, but a heavy exposure doesn’t seem prudent at this moment. We would continue to maintain a cautious approach to stocks.
Barry R. James, CFA, CIC
Bond Market Analysis
Conclusions: Bonds had a typical reversal after a big rally. All sectors of the bond market, except high yield bonds, showed losses. Hardest hit were longer term bonds, with long term treasuries seeing losses of 2% on the week. In the recent selloff, the ten year treasury has bounced up from about 2.4% to 2.6%. Of course, the question we all have is whether we’ve seen the end of this bond rally or if rates will head lower again?
We like to look around at the economy as well as sentiment. When it comes to the economy, last week we saw some reasons folks may not like holding bonds. Manufacturing reports early in the week gave indications of strength. Both the PMI Manufacturing Index and the ISM manufacturing index improved over the previous month. In addition, they both showed new orders improving, an excellent predictor for the future. A friend of mine runs a manufacturing firm and he reports sales are strong, raw material costs aren’t rising that quickly and margins have actually expanded. However, he is still reticent about making large expenditures to expand production.
In the area of sentiment, we find folks aren’t very happy owning bonds. Low yields on bonds and money market accounts have prompted people to look for alternative investments, often called alts. I’ve been coming across more and more articles about this. In fact, investment in these increased 43% last year. This area contains a wide spectrum of investment approaches, from market neutral and long/short to arbitrage and other hedge fund approaches. The key to these seems to be the fact that they aren’t fixed income. Not surprising, many of these are now available to the average investor, not just accredited investors. The loathing of bonds, and increasing interest in alts makes this contrarian wonder if bonds won’t have another good rally yet this year.
Both our short and intermediate term bond indicators have improved with the selloff, hopefully a good sign that this is likely to lead to another rally rather than a collapse in the bond market. Not everything is rosy in the economy, and even some economists are starting to cut their high expectations for the second quarter. Worries about deflation even have the European Central Bank cutting rates to a negative yield. In other words, you are getting back less money than you lend. This is serious medicine and indicates a lack of economic strength around the globe. Our bonds didn’t rally on this news, but the recent pullback looks more like an opportunity to add bonds rather than sell them.
Barry R. James, CFA, CIC
