Sept 29, 2013 - Here's what happened in the stock & bond markets last week...

Stock Market Analysis

Conclusions: Last week, the Dow rose another 1.1 percent while the Russell 2000 small cap index edged 0.3 percent higher. While the Dow didn’t hit a new high, both the S&P 500 and the Russell 2000 hit new yearly highs. The market continues to show excellent depth and breadth. Risings stocks nearly doubled declining ones and we had 688 new highs and only 40 new lows. Surprisingly, Utility stocks did the best last week while Financials lagged.

Our government may be funded for a few more months, but its ability to perform as advertised is in question. The implementation of the Affordable Care Act has been an unmitigated disaster. Millions are losing their individual insurance plans and face significant increases in cost. Even worse, they also have very limited options. I know firsthand because a number of our employees received their notice of termination from their insurance companies. Their affordable coverage did not meet the stringent requirements of the Act, even though they had chosen it themselves. We also have spouses who have been dropped from their partner’s plan and are now in limbo. I only wish I had confidence Washington was up to the task to fixing it.

While Washington and our job market remain in a funk, we find solace in the performance of the stock market. We are finding solace in a number of positive indicators for the market. Capital goods orders are up over 5% this year, historically an excellent omen for stocks. Furthermore, all the significant regional Fed reports are positive, pointing to a reduced probability of another economic slump. In addition, Europe is waking from its economic slumber and any increase in trade would be welcome news. Lastly, the Fed continues to pump money into our system, increasing the appetite for riskier investments. Fortunately, this appetite hasn’t be satiated and there is still room for the market to advance.

Our indicators are positive and don’t indicate any immediate end to the current uptrend. We are likely to get a breather in the recent advance, but this may help us find ways to take advantage of this opportunity. Historically, this is the favored season for smaller value stocks as well.

Barry R. James CFA, CIC

Bond Market Analysis

Conclusions: After the taper surge, it is great to see rates heading back down, even if they aren’t back to earlier lows. With the exception of high yield bonds, every other major sector of the bond market has lost ground this year. However, the last three months have seen stabilization and rates edging lower. This is true in the last week, month and yes, three months.

We’ve previously spoken of the disdain for bonds and the fact that we thought we should see stabilization. In fact, three months ago, in our 27 July 2013 analysis, I wrote “The short term trend is not favorable for bonds, but our risk indicators give us some confidence this shouldn’t last. We would continue to hold high quality bonds of modest duration.” I also mentioned that investors had been leery of Municipal bonds and the selloff in them may have been overdone. I’m as surprised as any to see Muni bonds have been the top performing sector in a firm bond market over the last three months.

Muni bonds still carry the stigma of Detroit and the possibility of other municipalities following the same path. However, the market appears to have gone too far in making these allowances. We note that a number of closed end muni funds are paying a yield over 6 percent (tax free no less) while trading about 10% cheaper than the underlying valuation of the assets they are invested in. Markets rarely stay this far out of alignment and muni bonds appear to be a bargain.

Yields are at the lower end of their recent trading range and it may be difficult for rates to fall precipitously from these levels. At the same time, the rate of inflation and economic growth pose few threats to bonds and the Fed seems content to avoid making news. The quagmire in Washington appears to have helped the bond market in spite of the threats of calamity. Our indicators remain muted and we would continue to move portfolios into a position of lower volatility while maintaining modest duration in high quality bonds.

Barry R. James CFA, CIC