While the market has maintained a smiling disposition there are growing grumblings. Retail sales were announced this week. American consumers control roughly two-thirds of our nation's economy and retail sales show us their action, as opposed to opinions, in vivid black and white. Or, perhaps in this case, it would be more accurate to suggest red ink as the primary color. Sales for March fell 0.4%. Often there are valuable insights to find by looking inside the numbers. Regrettably most of the data is flowing with the current of lower sales. This is true with vehicles, electronics and at the gas station.

More concern comes from the monthly report on small business owners by the National Federation of Independent Businesses (NFIB). Small businesses are decidedly turning pessimistic. Today they predict slower sales, worsening earnings trends and a poorer economy. This is not the fertile grounds of an economic paradise. Why the problems? The survey asks business owners to name their single biggest problem. Although items like slow sales and competition are on the list neither make the top two. The two biggest problems for small businesses are taxes and regulations.

Considering that taxes have already risen in dramatic fashion in the "fiscal cliff" accord passed in January, it seems like a poor idea to go for a second helping in the budget dealings facing Washington today. Regulations are also a burden with some estimates suggesting the cost to business to comply with federal regulations reaching $1.8 trillion.

One should also consider the seasonal effect of the market. Since 1951, from November through the end of April stock prices rise on average an annualized 13.4%. Buy at Halloween??? But the saying "Sell in May and GO AWAY" (at least until Halloween) is also worth noting. During this phase stocks gain only a meager 1.1% annualized.

Of course at James we mostly rely on our weekly leading indicators and their guidance. Last week we noted these indicators appeared to be shifting out of the neutral camp and into the unfavorable arena. Market tops can last for extended periods this does not necessarily suggest stocks have to decline in the immediate future. It does, however, suggest risk levels are now elevated. Prudent investors may begin to lower equity levels where appropriate for their objectives.

David W. James, CFA

Bond Market Analysis

Conclusions: Last week some mortgage bonds advanced, so did very short (2 year or less) treasuries, while 5 to 30 year treasury bond yields were higher by 2 to 5 basis points. Over the past year long bond yields declined 27 to 22 basis points, yielding strong profits to bond holders.

The pattern among commodity indexes was mostly lower, with energy and precious metals especially weak. Grains and industrial metals rebounded from deeply oversold positions.

Last week lots of economic news broke, not much of it was good. Cyprus was in the headlines again with the news that a proposed E17 billion bailout (E10 billion from loans by international organizations, E7 billion purloined from bank depositors) is now inadequate to meet debt obligations, the new figure of need was said to be about E23 billion. The Japanese were roundly criticized for flooding the markets with freshly printed money (apparently following the U.S. example) to weaken the Yen. In the U.S., retail sales slumped to the lowest pace since the market bottom in 2009. Jobless figures looked better but when calculated including workers who have given up looking, it stands near 11 percent. Bloomberg's Economic Surprise index is still positive but sinking fast as it reflects the difference between anticipated and actual economic data points.

It is reasonable to conclude the U.S. economy continues to expand, but at a very unsatisfactory pace. The chief complaint we hear has to do with excessive regulations and taxes. The National Federation of Independent Business survey shows small business owners complaining of regulations and generally lack optimism for the future. Medical costs are major concerns. Among our own small firm, for example, we note a year over year increase in insurance costs for our staff to be nearly 30% while life insurance has risen a much more moderate 2%.

Among stocks, our Risk Exposure Ratio is slightly lower, not enough to say risks have been taken off the table, rather a sign the upward momentum of stocks is beginning to falter. Likewise, our stock indicators which were strongly positive last fall and then neutral for months, are now beginning to weaken. If assets are to come out of stocks, and out of overseas investments, where might they be placed? Where is the "safe harbor"? Gold has broken about 20% from its high, clearly not here, and commodities are mostly headed lower. If economic activity is to remain low then inflation is not a current risk (but maybe for the future) and bonds are attractive, especially high quality bonds.

Perhaps that is the message from our bond indicators, which continue to improve. High yield bonds have done well in the past, but their performance has been closely linked to equity performance. Since our stock indicators are faltering, we doubt high yield bonds would be the best selection today. Instead, emphasis should be on quality. We would continue to hold and even expand positions in high quality bonds with moderate durations.

F James, Ph.D.

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