Stock Market Analysis
The market continued to twist and turn last week. The S&P 500 was nearly unchanged while smaller stocks like those of the Russell 2000 enjoyed a gain of 1.2%. So far 2016 has been highlighted by solid returns in Utilities, Energy and Basic Materials while Healthcare and Financials have lagged.
Stocks have been listless for the last 18 months. Just looking at prices, the Dow Jones Industrial Average is down 0.2%. Furthermore, the difference between the high and the low during this time (on a month end basis) is only around 11%. It doesn’t always feel like it, but this is a narrow band over such a long time frame. We looked at the data going back to 1900 and it is rare to see such a rudderless market. Indeed, many investors may feel they are in purgatory.
With the lack of movement over an extended period, it is easy to understand why many market participants are antsy. The normal push-pull emotions of greed and fear are on the sidelines. The question for investors is what to do until the market establishes a direction.
We believe most investors will benefit from higher exposure to commodities like precious metals and energy. Both are under attack in the popular headlines. One headline from Yahoo-Finance quips, “Oil’s ‘new normal’ may be lower than you think”. Another headline, from Bloomberg, reports, “...UBS says gold set to ‘roll over’”. These headlines seem to represent the consensus and are not isolated in thought. As contrarians it does suggest opportunities in these areas.
Another potential avenue for investors is higher dividend securities. As mentioned previously, Utilities already enjoy the best sector performance in 2016. Given the economic uncertainty after Friday’s poor jobs report, the steadiness of Utilities may continue to draw attraction. In addition, select REITs may also be worthy of study. We haven’t yet experienced the glut of new commercial buildings which would typically point to problems ahead for them.
Overall, the stock market headlines remain complacent. Last week’s cover of Barron’s highlights this. It suggested, “The stock market won’t crash –yet”. While these types of headlines are worrisome for the contrarian the tone and direction from the media could easily change now that job growth is again faltering.
Nonetheless, we are seeing some improvement in our leading indicators. This is good news and always a reminder to never become too optimistic or pessimistic about the markets. Objectivity and flexibility are important characteristics of successful investors. For now, we continue to suggest holding a moderate level of equities.
David W. James, CFA
Bond Market Analysis
It was a good week to own high-quality bonds. Yields on Treasuries fell across all maturities which pushed their prices higher. The 1-Year Treasury enjoyed a 6 basis point drop and the 30-Year Treasury saw a drop of 13 basis points. A good week indeed!
Of course much of the move occurred on Friday, with the release of the disappointing jobs report. Against expectations of job growth of 160,000 the reality only showed 38,000 jobs were created last month. This is the worst monthly number since September 2010 when the economy lost 52 thousand jobs.
Regrettably the employment situation is actually worse than the headline suggests. Announced job cuts for the first five months of the year are running at their highest pace in five years. Many of these announced cuts have not yet hit the unemployment system but they will.
While job losses are likely to mount, what about job creation? One key for this is to follow the entrepreneurs. ADP (Automatic Data Processing) finds roughly half of all jobs in the United States come from small businesses. Thus, to see good job growth in the future we need to see growth in the number of entrepreneurs. Unfortunately this is not happening. Over the last 12 months we have actually lost 317,000 entrepreneurs. This is a strong headwind for future job growth.
Next we turn to the quality of the jobs created and if they pay well. We can compare job growth in high paying industries (such as finance, information technology and manufacturing) to low paying industries (including leisure, hospitality and temporary workers). It is no surprise low paying jobs have dominated since the Great Recession ended. What may be a surprise is last month our nation created 57,000 low paying jobs but lost 36,000 high paying jobs.
The Federal Reserve is seemingly nonplussed. According to Reuters, on Saturday Cleveland Federal Reserve President Loretta Mester indicated the latest disappointing U.S. jobs number has not changed the overall economic picture and gradual rate hikes remain appropriate.
We would question most assertions of a strong economy. It is true the forecasts from the Atlanta Fed’s quantitative approach suggest much better GDP growth for the 2nd quarter. However, these estimates are already being lowered from their recent levels.
Another gauge of economic health is Industrial Production. On a year-over-year basis Industrial Production has been falling for eight months in a row. Since 1940, we have seen recessions occur every time it fell six months in a row. We may not have a recession this time, but manufacturing area remains weak.
Looking to our bond risk indicators, we note they have been strengthening the last several weeks. Given the Fed’s desire to raise short-term interest rates how should investors proceed? While we would maintain a posture of moderate duration with high quality bonds we would advise taking a barbell approach. Using a barbell, investors usually focus on short term and longer term bonds. The short term bonds will likely enjoy higher coupons as the Fed eventually raises rates but longer term bonds are usually more sympathetic to the future of the economy than the movements of the Fed.
David W. James, CFA
