Stock Market Analysis
Conclusions: February ended with a bang. Last week, the Dow rose about 1.4 percent while the small cap Russell 2000 jumped about 1.6 percent. The S&P 500 hit a new record high and we saw market breadth also hit a new high. Twice as many stocks advanced as fell and over seven times as many stocks hit new highs as new lows. The eight day selloff in January is but a passing memory as Superwoman (Fed Chair Janet Yellen) continues to lift the market with her words to Congress.
True to her writings, she is focused on jobs. She mentioned that the unemployment rate didn’t tell the whole picture and she is looking at labor participation and other measures as well. The question on Senator Schumer’s mind was about tapering and if it would continue. It likely means nothing, but it caused joy on Wall Street to hear her say, "Asset purchases are not on a preset course, so if there's a significant change in the outlook, certainly we would be open to reconsidering, but I wouldn't want to jump to conclusions here." That didn’t stop the market from jumping to positive conclusions. The market hasn’t likely read our research on new Fed chairs. It may be surprising, but since the 30’s, stocks have average a gain of only 1% in the 12 months after they begin.
The “soft patch” we have been going through has been attributed to the weather. If true, then February should be even softer. Employment reports have been soft as have retail sales. In addition, home construction, home sales and even manufacturing have been less than robust. The stock market has taken all these in stride and has kept on whistling. Even a Russian invasion of the Ukraine doesn’t seem to faze pundits. Barron’s quotes one wag as saying this situation is “Hopeless but not serious.” His premise, the entire Ukrainian market only has a value of Walt Disney stock and its economy is diminutive.
Our indicators had turned more favorable in late January and had not changed throughout February. In fact in our 26 January 2014 report we said “...our stock leading indicators are improving, we doubt the advent of a major bear market right now.” However, this weekend we saw a shift to a less sanguine reading. Our Risk Exposure Ratio isn’t yet screaming high risk, but sentiment remains overly bullish and many investors have become worried about missing the bull run. This week I remarked on CNBC that we may be on the Highway to the Danger Zone.
We have been maintaining modest positions in bargain stocks over the last month. Calling a market peak is almost impossible, and the market has a habit of going further than one would expect. Still, risks are rising and while they don’t point to an immediate collapse, we are looking to cull less attractive securities.
Barry R. James, CFA, CIC
Bond Market Analysis
Conclusions: Bonds had a great week as all sectors of the bond market advanced. Long treasury bonds did especially well, jumping 1.7%. As opposed to last year, every sector of the bond market has moved ahead so far this year. As we pointed out in our economic outlook, the bond market does much better after Quantitative Easing comes to a close. This is exactly what has been happening since tapering started in December.
While Fed Chair Janet Yellen suggested the Fed is flexible with regards to tapering, she was pretty clear that they weren’t convinced it was the time to cease. She, like most economists, thinks it is just the weather that is responsible for the current soft patch. However, there really isn’t much to convince us conditions have changed to greatly improve economic conditions. Germany is starting to see their economy slip, and China is on a path to slower growth. Expectations are high for the U.S. but we haven’t done anything to ameliorate our high tax and regulatory environment. As Einstein said, "Insanity: doing the same thing over and over again and expecting different results."
We’ve seen a steady drop off in a number of key indicators. The coincident to lagging indicator continues to wane and retail sales have been sluggish. Fed regional results have turned lower and new orders have also weakened. Housing starts have taken a hit and industrial production fell last month.
Our moves to extend maturities have been working of late. Our bond indicators remain firmly bullish and instability abroad usually means U.S. Treasury bonds become more valuable. We will have to keep an eye on changes in inflation and demand, but for now we find opportunities in high quality bonds.
Barry R. James, CFA, CIC
