May 18 - May 22, 2015 - Here's what happened in the stock/bond markets last week
Stock Market Analysis
While the Dow fell for the week, most major indices made progress but more stocks fell than rose in price. Small caps, as represented by the Russell 2000 rose 0.69% and we still have more than twice as many stocks hitting new highs as new lows. The market is clearly sending mixed signals as 5 sectors fell while 4 rose in price last week. Fortunately, all except Utilities have risen this year, with Healthcare leading the way, as it has for the last 1, 3, and 5 years.
The Federal Reserve is also giving mixed signals. Board minutes from the April meeting admitted growth and employment slowed in the first quarter and inflation is running below their objective. They maintain their policy of reinvesting principal payments back into agency, mortgage backed and treasury bonds. In addition, they said that, “even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” Not much of a mixed signal there, but members commented on equity valuations and Chair Yellen said they are “Quite High.” All of this leaves the Fed with the conundrum, raise rates and hurt stocks, or keep rates low and encourage business activity. This tells us the Fed is not anxious to raise rates and we should expect increases later rather than sooner.
The sluggish economy is not a surprise to the Fed. A FED district developed a quantitative indicator called GDP Now which predicted the poor growth in the first quarter. Unfortunately, it is pointing to another sub-par quarter. Our own economic indicators are running half full or half empty as the beholder views it. Unfortunately, indicators have been getting progressively worse over the last three quarters and we do not see any quick fix for the economy on the horizon. The trade bill may be a good long term development, but no one seems to know what is in the bill so we should not make any assumptions.
Companies are trying to lure shareholders and they have been buying back shares and raising dividends to do so. They have also been using cash to buy other companies. This has helped the market rise to new highs but it has not been rising rapidly. To some, valuations are a concern, but this has helped shift sentiment in a bullish manner. Our risk indicators continue to hang around neutral and tell us to stay steady as she goes. Volatility is still likely, but we do not see a major bear market in the near term.
Barry R. James, CFA, CIC
Bond Market Analysis
Bonds had another lousy week. No major bond index advanced, and high yield bonds did the best even with no return. Longer term Treasury bonds fell 1.3% with long term corporate and foreign bonds doing even worse. France and Germany saw dollar losses of 3.9% last week, getting clobbered by the jump in the dollar.
Bonds had been struggling for a while as investors thought the Fed would raise rates. After the release of April’s Fed meeting, it did not appear a Fed hike would be coming in the near future. However, Fed Chair Yellen reassured investors the Fed would be raising rates this year, but she insisted they would be cautious. That is a bit like the dentist saying this will only sting a little. Words do not always match deeds.
The inflation report came out this week and it rose 0.1%, the third increase in a row. However, even with the increase, inflation is down over the last 12 months. That is largely due to lower oil prices, but none of us are complaining about lower costs to fill up our cars.
Most economic reports were not very encouraging. Industrial Production fell for the fifth straight month and the Chicago Fed National Activity report fell for the fourth straight month. However, housing starts and permits have been rising and I have heard many folks talking about a seller’s market. Today, a friend told me they were trying to buy a house in Colorado Springs and some of the houses would get 5 bids on the first day and wind up selling for $20,000 more than the asking price. Wisely, they are choosing to rent.
Our short term indicators point to some more pain for bond holders but our intermediate term indicators have improved. We would maintain a neutral stance toward durations, while continuing to favor quality bonds.
Barry R. James, CFA, CIC