Apr 2, 2013 - Market Commentary by: James Investment Research

Stock Market Analysis, week of 3/2513 - 3/29/13

Conclusions: Stocks moved ahead last week, with 1,883 advancing and 1254 declining. More than 600 stocks set new highs against fewer than 55 new lows. Generally speaking, volume increased on most advancing days. Commodity indexes and especially industrial metals sold off while energy moved higher. The dollar and bond yields generally moved in favorable directions.

Consumer confidence increased last month as citizens began to realize the slowdown in government spending (Sequester) does not foretell disaster. The administration has lost credibility by claims otherwise. Indeed, our work shows that 29 of the 30 quarterly cuts in government spending since 1946 have preceded stronger GDP growth.

Copper futures are selling off. Does this foretell poor economic times? One of my favorite indicators, the Coincident/Lagging index, barely moved ahead last month from 89 to 89.1. The Chicago Fed national index currently is near neutral, at 0.44, which we are told means “the recession has ended.” More people are working, but hours are constrained. Bloomberg’s surprise index of more than 30 indicators has been on an uptick and is presently reading about 0.28. The business equipment survey (nondefense capital goods ex air) is well correlated with employment but it was off 0.10 at latest reading. Business continues to fight higher taxes, rising health care costs, hostility from Washington, and more regulations – this is a menu for slow growth.

Sentiment figures are becoming more bullish, at least among professionals. Morgan Stanley, Goldman Sacks, Raymond James, United Bank of Switzerland, and JP Morgan are favoring more equities. A variety of sentiment indicators we monitor including II bulls-bears ratio, VIX option premiums, and mutual fund/ETF allocations show sentiment among the public is beginning to turn, but among many, severe caution continues, a fear of once again buying at the top and staring at a big decline.

Our leading stock indicators began the year very strong but now are neutral. The coincident indicators are weaker. The situation in Cyprus is yet to be completely resolved and the dollar strengthens.

Our balanced fund’s posture of highest quality bonds, moderate positions in domestic stocks, and very modest at-risk international holdings appears to be working well. Presently we continue to maintain and upgrade the equity positions we have been holding, weeding out stocks with impaired relative strength and poor prospects; emphasizing value stocks in the finance, auto, energy, and homebuilding areas.

-F James, Ph.D.

Bond Market Analysis

Conclusions: It was another profitable week to be a holder of high quality bonds. For the third consecutive week yields on the 10 and 30-year Treasury bonds fell.

Once again we find analysts’ expectations of imminent doom to be overblown. Bloomberg News surveys numerous economists and analysts for their projections on where bond yields will end at a quarter’s end. The last survey for the first quarter was completed with about two weeks left in the quarter. Less than 1 in 5 believed rates would be this low. When analysts reach a conviction on bonds there is often money to be made by going the other direction.

What do the analysts believe will happen in the second quarter? Higher yields, of course! In fact they expect higher yields every quarter for the next six quarters. Cover stories for leading financial periodicals, like The Investment News, seem to be heralding the idea that bonds are in a bubble that is ready to burst. As we mentioned last week, financial bubbles are rarely heralded with dire warnings in the press. Typically the headlines read that even though prices are up in a parabolic fashion, that “this time is different”.

It also seems that, in the intermediate term at least, there is a voracious buyer of our nation’s debt. Every month the Federal Reserve goes on a buying spree and purchases $85 billion worth of our bonds. Already the Fed owns more of our bonds than China, Japan, or any other foreign nation.

Economically speaking there are signs of optimism. We have found the Fed reports for Chicago, New York, Philadelphia and Virginia to be especially insightful. We have dubbed them the “Four Horseman of the Economic Apocalypse”. When all four of them are negative it has preceded an economic contraction about 60% of the time. Today, however, all of the readings are positive, not negative. Historically, contractions have only occurred around 10% of the time.

Additionally we find housing is continuing to improve. New home sales (on an annualized basis) have topped the 400,000 level for two straight months; a feat last accomplished in the summer of 2009. Readings on prospective buyers continue to remain at healthy levels and home prices are once again on the rise.

However all is not perfect in paradise. Last month’s employment data suggested we were losing full-time employees and replacing them with numerous part-time workers. Many of the regional Fed reports suggest this trend is continuing as hiring practices are up but that the average hours worked are declining. This seems to be in direct response to the new healthcare law which effectively punishes companies for having too many full-time positions.

Living on part-time wages is a very difficult thing to do so it is no surprise that last month we had the largest single-month jump in multiple jobholders on record. Are workers pleased with this new reality? Not quite. Consumer confidence has now fallen in four of the last five months.

Further consumer concerns can be observed in the latest personal income and spending data. While it is true the one month numbers were above expectations, at James we often like to examine longer trends. We typically find disposable income, spending and the savings rate follow the rule of 7. This means income and spending usually grow at a 7% a year pace while the savings rate stands at 7%. Today we are not even running at half of those levels.

Our research suggests that while the economy may be improving, it is hardly on healthy ground. The heavy burden of regulation continues to hamper our nation’s potential. Taxes are also an economic challenge. This continues to allow opportunities for bonds. The financial meltdown in Cyprus also shows the value of the safety of the United States. Thus, it is not surprising that our bond indicators remain entrenched in the favorable camp today.

David W. James, CFA