Stock Market Analysis
Once again it appears our market was taking cues from Greece. Their market opened again to a torrent of selling, losing over 15% for the week. This seemed to spill over to the Dow, which fell 1.65% and to smaller stocks, with the Russell 2000 losing 2.54%. About twice as many stocks fell as rose and three times as many set new lows as new highs. Negative news from Disney led media stocks lower while oil stocks continued to follow the price of oil lower. Utility stocks were the only sector to advance, showing the negative sentiment ruling the market.
We generally look at four areas in trying to determine the risk levels of the market. We look at economic developments, monetary changes then technical and sentiment trends. We have developed dozens of indicators which are designed to actually make money when they give a signal. We especially have a bias to those that make money when they say to sell prior to the market falling. Of course, no one indicator is right all the time, so we try to avoid those that are costly in their misdirection. Every two years we go through the process of revalidating all of our indicators and testing new ones for possible inclusion. While the markets are driven by fear and greed, the market place changes its perceptions of what is useful.
Our most useful indicators, those of intermediate term, are strongly favorable today. After a seven day slide in the Dow, they are suggesting it is a time of falling, not rising risk. Of course, they can’t tell us what will happen tomorrow, but they help give us the courage to take action, even when we don’t feel like it. Sentiment readings, like those of AAII, or Citigroup point to a rising level of fear. Ron Paul, Stansberry and others have come out with reasons why we are getting ready for crisis that will wipe out a lot of wealth. In our 40 years in business, we find these proclamations are usually better times to buy than to sell. Fear gives the chance to buy low.
Of course, we do need to look at valuation levels and earnings. Valuation levels are somewhat elevated, but not to an extreme. Earnings have been fading somewhat, but the typical stock in our 8,000 stock database has an earnings momentum of 7%, down from 9% three months ago. We are starting to see smaller stocks gain more traction in this area as they have less exposure to our strong currency. This hasn’t translated to performance yet, but we do see some smaller value oriented stocks doing better.
The recent pullback in stocks raises opportunities. Our indicators are positive and this is a better time to buy stocks than to sell. Ignored, bargain type domestic stocks are especially attractive.
Barry R. James, CFA, CIC
Bond Market Analysis
Bonds continued to take advantage of the selloff in stocks. As usual, investors hunker down in bonds when stocks weaken. Bond yields dropped across the yield curve and the 30 year treasury is down to a 2.83% yield. That is a drop of over 0.25% in just 4 weeks. Our bond indicators have been positive for the six weeks, correctly, trumping popular opinion.
Everyone seems to be caught up in the Fed Rate Hike decision, which hasn’t been made yet. On one side is the 5.3% unemployment rate and steady, if unspectacular growth in jobs. In addition, inflation, as measured by PCE is now running near the preferred 2% rate. Retail inflation is running ahead of wholesale inflation and commodity prices are in the tank. Lastly, hourly wages took a very modest step up last month. On the other hand, job creation isn’t keeping up with the growing number entering the work force and we still have over 93 million who don’t have jobs. The unemployment rate is only this low because the participation rate is at lows seen decades ago. This represents the number of people who either have a job or are looking for jobs out of the available workforce. A case for raising rates or keeping rates low can be made. So many have already expected a rate hike that it won’t likely have the impact many have anticipated.
Bonds were helped by trouble in Greece, which is nothing new. In addition, quality bonds continue to offer alternatives to some Puerto Rican and Illinois municipal bonds which are flirting with default. Higher quality munis have been lagging lately, perhaps offering a better buying opportunity than earlier in the year.
We had a mixed bag of economic reports last week. Consumer and construction spending weren’t as strong as last period. However, the ISM nonmanufacturing report was much stronger than anticipated. Vehicle sales were up nicely and even factory orders seem to be steady. However, the bigger news is in the area of commodity prices. With the slowdown in China, prices continued to slip for gold, oil and gasoline. There are few reasons for interest rates to rise rapidly.
Our bond indicators remain in the favorable camp but we don’t expect major fireworks in either direction. As they have shown last week, bonds provide a great stabilizing force when other investments falter. We would maintain our position in moderate duration, high quality bonds.
Barry R. James, CFA, CIC
