Stock Market Analysis
Conclusions: The popular market indexes like the S&P 500 and Russell 2000 gained last week. Unfortunately there is much more to the overall story. Last week found more stocks declining than advancing. Indeed, an unweighted approach to the stocks on the NYSE suggests the typical stock actually lost ground last week.
Divergences between popular indexes and the overall market are worth noting and can be a subtle hint of upcoming market changes. What does the economic data suggest? Important releases seemed to follow the market’s lead with good headlines but dubious or questionable details.
The employment report is an excellent example. Fresh on the heels of the government shutdown many economists’ projections on payroll growth were for a subdued 120,000 jobs. Instead the headline number showed job growth of over 200,000. This is very encouraging until one examines the details. It turns out the economy in October lost over 600,000 full-time jobs and lost over 100,000 entrepreneurs. Paraphrasing Mark Twain, “There are lies, darned lies and then there are [employment] statistics.”
The nation’s overall economic growth is another fine example on the battle between appearances and substance. GDP for the third quarter came in at a solid 2.8% annualized rate. In the last 25 quarters there has only been 5 times where we have enjoyed better growth. Unfortunately a sizable portion of our growth came, not from sales, but from inventory buildup! Further, important drivers of economic activity such as personal consumption and business investment are trending downward.
Another general concern for the current market is the growing level of greed. One way of measuring the phenomena is looking at the Initial Public Offering, or IPO, market. IPOs are often met with great fanfare as they represent a new company for the investment world to take part of. Unfortunately, the initial glamour rarely holds up to scrutiny. Consider the actions of the smart money, in this case the company itself. The company recognizes their financials and market euphoria is at a relative high. What does the company do? Through the IPO the company sells shares to the public!
If the smart money is selling then perhaps investors should take pause. Indeed, although this may not be true in every case, our research suggests that until a stock has been around for at least 12 months it will tend to underperform the overall market.
Where does the market stand today? According to Bloomberg News the market value of all U.S. stocks which have had an IPO within the last 12 months are at their highest levels in well over 10 years. This represents lots of froth and a growing reason to be wary.
Over the last few weeks we have seen deterioration in our leading indicators. While they are not yet at levels which would prompt aggressive action they do remind us the need for caution. There are still powerful forces in favor of stocks such as the Fed’s Quantitative Easing and seasonality factors, however if our indicators continue their downward journey defensive action may eventually prove to be a prudent course.
David W. James, CFA
Bond Market Analysis
Conclusions: This last week might be labeled “surprise” week for those who believed in the overwhelming wisdom, direction, and power of government. It was, in fact, a week where big government fans saw their expectations for severe cut backs in economic activity to be dashed as employment actually moved ahead a bit as initial jobless claims declined from 345,000 to 335,000, GDP rose TO 2.8%, and private payrolls rose from 150,000 to 212,000 last month. Manufacturing payrolls rose from 4,000 to 19,000. All of this in the face of a government shutdown.
As Barron’s put it: “The government shutdown has ended, with little evidence of damage to the economy. ...68% of the 449 S&P companies that so far have reported October-quarter earnings have trumped profit forecasts - a better than average record. ” Could it be the free market advocates who favor limited government and would advise government to “Butt Out” have made a point, showing the economy can prosper even in the face of less direction from Washington? If so, this is a lesson for forecasters in the future. We do know that federal inactivity tends to be associated with rising stock prices.
With no guiding Washington bureaucrats would entrepreneurs find reasons to increase activity? In point of fact, the shutdown coincided with several very favorable economic developments. First, and thanks to American developed technology, the price of energy has headed down. According to AAA, we find prices at the pump for gasoline nationwide to be at their lowest prices in over 2.5 years. Prices are still rated as high but less so. Crude oil which as recently as September topped $110 a barrel now trades below $95 moving in the right direction for motorists. (We should mention, however, that natural gas rose more than 2% for the week.) If the U.S. achieves a low-threat peace with Iran, fears of a war on oil supply lines should diminish, along with shipping prices. It is a fact that oil prices have declined as the FED ceased its Quantitative Easing program. Most industrial metals declined in price last week, along with gold, platinum, and silver. Cheaper input materials support higher profits. Bonds are said to do best during time periods of economic distress. Last week our dollar increased in value, and by almost 2% against other world currencies. This is a favorable offset for bond holders.
In the face of these developments, 5 year Treasury bond yields increased as much as 5 basis points yield, and 10 year bonds some 12 basis points. Meanwhile, Wall Street media experts are preparing for a stock market decline, which can of course be expected to benefit bond holders. The Wall Street Journal suggests “...Good Reasons to Hoard Some Cash Now” A headline in this week’s Barron’s: “Planning for a Pullback.”
This week our bond section outlines economic advances during the government shutdown, while our stock section notes that the advances may not be as substantial as we would like. It is, of course, a mixed picture as it always is. This is yet another reason to rely on our James risk indicators.
Short term bond indicators are just a bit stronger this week; however the intermediate bond indicators are neutral. We would continue to move bond portfolios into a position of lower volatility while maintaining modest duration in high quality bonds and cash.
F James, Ph.D.
