Stock Market Analysis
The S&P 500 started the week around 2,050, a level which it first reached in November of 2014. This is one way of saying that the stock market has been volatile but has not rewarded investors over the past 19 months. We highlighted this possibility in the Economic Outlook presentation we released in December 2014. A technician might say that after the “consolidation” period we have seen, a market move out of the range could be exaggerated.
It was a strong week for the U.S. stock market. The S&P 500 was up over 2% and the Russell 2000 was up over 3%. Technology stocks were up the most and Basic Materials stocks up the least. Year to date, Utilities (+13.6%) are leading the pack while Healthcare (-3.2%) stocks are down the most. On the NYSE, advancing stocks outpaced declining stocks by a 3/1 margin and new highs totaled 241 while there were only 50 new lows.
The Investment Company Institute reports U.S. Dollar inflows or outflows for equity and bond funds on a weekly basis. For the year, investors have withdrawn over $55 Billion from domestic stock funds while over $88 Billion has been added to bond funds.
The most recent earnings season for the S&P 500 ended May 15th and the results were lackluster. Companies in the index were again able to “under promise and over deliver” so that they reported better than expected earnings by analysts. If you get inside the numbers however, actual earnings growth was down 8.5% compared to the prior quarter. Sales were even more disappointing with expectations and growth both missing the mark.
The Bureau of Economic Analysis compiles earnings for all companies in the U.S. economy. A decline in profits of 3.6% validates the reports from the largest publicly traded stocks. Much of the decline seems to be due to a decrease in profit margins. From a high of around 10% in 2012, corporate profits have dropped below 8% recently. Increases and decreases in profit margins tend to be positively correlated with sales so the recent drop is not surprising.
Our intermediate and long term indicators are slightly unfavorable at this time. We have reduced equities for most clients as the market has rallied toward the top of its recent range. As last week illustrated, it is wise to still keep a healthy portion of the portfolio in stocks. We expect the market to work through this extended period of uncertainty and return to a more usual status, one that rewards common sense investing.
Matt Watson, CFA, CPA
Bond Market Analysis
It was a quiet week for bonds with only slight changes in yields. This was true across the different maturity bands. We do note that corporate bonds did enjoy better returns for the week especially longer term issues.
The big news came after the market closed on Friday as Fed Chair Janet Yellen offered a more hawkish tone in a speech. She noted, “It’s appropriate...for the Fed to gradually and cautiously increase our overnight interest rate over time, and probably in the coming months such a move would be appropriate.” This has led many observers to believe a rate hike will happen in June or July as long as the economic news remains positive.
Hiking rates is certainly within the Federal Reserve’s prerogative but the data so far does not suggest such action. The Fed’s own labor index is negative. Since the 1970s the Fed has only raised rates roughly 9% of the time when their index is negative. Further, they have never raised rates when their labor index is negative AND inflation (CPI year-over-year) is below 3%.
What of the state of the economy? Currently the second quarter is looking better than the dismal first quarter. Some areas, like housing are even showing strength with New Home Sales at their highest levels since 2008. Sadly, there are many more areas suggesting caution.
One method of gauging the economy is reviewing the regional Fed reports on manufacturing. After a mixed picture the previous two months, we are once again seeing a coalescence of negative readings this month. Another cautionary tale comes from the Durable Goods report which looks at items designed to last 3 years or more. When we exclude the volatile transportation component, we note 16 consecutive months, on a year over year basis, of falling new orders. Another worthwhile economic indicator is the Conference Board’s Coincidental-Lagging Index. Its’ latest reading of 93.5 is the lowest number in at least 40 years.
Taken together this suggests the Fed would be wise to consider caution instead of running into “hike” mode. Given Yellen’s speech came after the market’s close, it would not be unexpected for the bond market to initially react poorly as it tries to digest a potential new path by the Fed. If so, the improvement in our leading indicators suggests this may create a buying opportunity to extend durations where appropriate.
David W. James, CFA
