Jun 11, 2013 - Here's what happened in the stock/bond markets last week

Stock Market Analysis

Conclusions: TGIF or it would have been an unpleasant week for stocks. As it was, the Dow moved ahead 0.88% while small cap stocks advanced 0.35%. Nevertheless, more stocks fell in price than rose, and for the first time in recent memory, more stocks hit new yearly lows than new highs. Could this be the proverbial correction we have been talking about over the last month?

Only time will tell, but let’s consider a few facts. The Dow is up 21.5% in the last twelve months and at this week’s low it was only down 3% from the high. Most agree a correction is a 10% decline from a recent high. By that measure, we aren’t even close. Price Earnings ratios remain elevated, still well above a year ago. Dividend yields and Price to Book levels are more expensive than last year as well. Corrections usually lower these valuation measures considerably. Clearly, this also doesn’t tell us much about a correction. However, the market has been showing internal signs that may be pointing to a further decline in stocks.

Multiple sentiment measures have started to shift away from extreme bullishness. This is often a necessary precursor to the market finally heading lower. As mentioned earlier, some of the more useful technical indicators, like advance-decline and high low averages are rolling over, in spite of advances in most indices. Lastly, words of caution seem to be drowned out. When I was on CNBC a couple of weeks ago, I literally couldn’t get a word in edgewise with the exuberant bulls. I could only get in one brief comment that our Risk Exposure Ratio was pointing to a 75% probability of a significant correction.

It is hard to argue with a rising market, but our approach has always been a “salami slice” one. When it appears risk has risen too high, we take a cut in equity levels and then wait to see what our indicators say. Last week we took another slice out of stocks. This week our indicators are turning more negative, to the worst levels we have seen this year. The market can easily keep rising from all the new money now chasing the stock advance. However, this doesn’t come without a cost and we believe it is more prudent to lower equities to a modest level.

Barry R. James, CFA, CIC

Bond Market Analysis

Conclusions: The price on the 10 Year U.S. Treasury note fell as yields rose yet again for the fifth straight week. The yield on the 10 Year ended the week at 2.18%. Yields on the 30 Years U.S. Treasury bond rose to 3.4%.

The Institute for Supply Management released their figures on the manufacturing sector this past week and many components fell below 50, pointing to an economy on shaky ground. In addition, the PMI fell to 49.0 in May; the first time it has slipped into the area of contraction since November of 2012. More concerning is the fact this reading is the lowest in over 4 years. Other components such as new orders, production and exports also declined for the month. These indicators of contraction are a discouraging sign for the manufacturing sector.

While manufacturing struggles to find its footing, the job market was able to add 175,000 jobs in the month of May. This was the 32nd straight month that jobs have been created. But, what does this all mean and how does this recovery compare to others?

The “great recession” began in December of 2007 and finally came to an end in June of 2009. During that time the number of nonfarm payrolls took a significant hit as over 7.4 million jobs were lost. Fortunately, since the end of the recession, over 5 million jobs have been added. Most would assume this is a good number, but it is weak compared to previous recoveries.

Historically, looking at the previous 11 recessions, the average amount of time to return to the old employment high was about 27 months. Where are we today? Currently it has been 65 months since employment peaked and nonfarm payrolls are still 2.4 million away from those highs.

Our indicators remain favorable for the bond market. The economy does not look as if it is running on all cylinders and this is typically a good thing for bond investors. All in all, we still see opportunities for bonds and especially those that are of higher quality.

Trent Dysert
Barry R. James, CFA,CIC

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