Stock Market Analysis
Conclusions: Last week large quality stocks moved lower, the Dow Jones Industrials declining about 1/3 of one percent and the Nasdaq 100 large cap universe also falling. Approximately 1,900 stocks advanced and 1,200 stocks declined, with 353 new highs against only 52 new lows. Volume was highest on Wednesday, the only day of daily declines, but stocks lost 43 Dow points in the last half hour of Friday’s trading.
At the beginning of this year, we forecast little relief in the big depressing factors: higher taxes, more regulations, perceived hostility to business. We thought the economy would be “stagnant” which is to say, little growth. There is some evidence now that we were too optimistic.
The hard evidence is that employment continues to lag and along with it fewer hours worked. The typical after-recession boost in employment typically generates more purchasing power and promotes business expansion. Our coincident/lagging index just declined for the 2nd month in a row. ISM new orders also declined last month as the average workweek contracted. Auto sales are disappointing, and existing home sales are weak, especially among low and moderately priced homes. Many blame the weak home sales report on weather problems [Barron’s “Snowbound”]. However the big slowdown occurred in the West where the weather was best. The Northeast, with the worst storms, only saw a minor drop in the sales of lower priced homes. The index of industrial production in consumer goods and business equipment are falling. Obamacare, while well intentioned, has brought higher costs and uncertainty to business firms.
Where is the sentiment? Reuters reports bearish numbers for insider sales and buys, with sales of 662 million shares and buys only 17.5 million. Historically, ratios above 20:1 are bearish, and currently we are in excess of 38. By contrast, Analysts ratings on SP 500 stocks are usually bullish, by an 8:1 buy/sell ratio. However, we saw excess enthusiasm last week when the ratio surged to 10:1. The Investors Intelligence report was especially disquieting, as it shows extremely low levels of bearishness among professionals, only 17%. Furthermore, the bull – bear spread has narrowed from near record levels, which should be good news, but this has often marked the beginning of major downtrends. Lastly, Moody’s reports global business sentiment “...as strong as it has been since the survey began 11 years ago.” All of these are negative to contrarians.
Above, we report faltering prospects for business and corporate earnings, which are likely to eventually overtake equities. But stocks are in the midst of a strong rally and our indicators have yet to turn negative. The advance-decline line recently set a new high. At 64, our Risk Exposure Ratio does not display signs of immediate, short term danger. It is prudent to follow our bullish indicators, maintaining a modest position in the most favorable bargain stocks, ones with good defensive characteristics, while always keeping an eye on the exits.
F James, Ph.D.
Bond Market Analysis
Conclusions: Short two to five year bond yields rose nearly 3 basis points last week, while the 10 year treasury rose in price as yields declined about 2 basis points. Year to date, the ten year bond yield is down about 31 basis points, and the dollar up slightly, about 0.13%. Utilities set a yearly high last week, rising in response to demand for higher yields. Commodity prices rose a bit over one percent.
It seems the FED’s proposed reduction of the “Quantitative Easing” program (to “only” $780 billion a year) is in disfavor with foreign central banks, who have welcomed the inflow of dollars into their country. While it has led to inflation, stronger economic activity also has taken place, and foreign investment activities on account of the higher yields. Stock prices inside the United States are well correlated with the QE program elements, especially the FED balance sheet. Inflation is yet to come, awaiting stronger economic activity. At any rate, the FED is now targeting a hefty, if reduced, $65 billion monthly bond purchase.
Strong economic activity is often associated with rising interest rates and a slow economy with declining rates. Thus economists carefully study economic readings for clues to the future. Most would not deny that economic indicators show disappointing readings. However, at least one administration leaning economist credits this to “The Winter Blahs.”
Widely recognized economic consultants speculate, “In our view, colder than usual temperatures hurt employment in January and have reduced economic activity since November. As temperatures normalize, growth should reaccelerate.” Of course the weather has impact, however we have reviewed weather impact in this week’s stock study, finding housing disruptions occurred mostly in the sections of the U.S. which had the fewest weather problems. Nationwide, we find housing starts fell 16% month over month, and permits 5.4% month over month.
In addition to housing problems, NY manufacturing lagged, pushing the “Empire State” statistic lower. This is one of the four major territories our researchers focus of national significance.
Bond yields displayed some volatility, dropping across the yield curve on Tuesday as the housing market data and Empire State Manufacturing data were much weaker than expected. On Wednesday, in response to the Federal Reserve minutes, bond yields increased as the prospect of continued "tapering" by the Federal Reserve was confirmed.
The U.S. Leading Index data published by the Conference Board on Thursday also impacted, being better than expected. However, if you get inside the numbers as David James, our Director of Research, always encourages, the ratio of leading to lagging indicators continues to stagnate. The ratio of coincident/lagging indicators has declined to its lowest level in a year.
Investor sentiment towards bonds continues to deteriorate with fund flows out of mutual funds. In the month of January another $3 Billion was withdrawn from the largest bond fund in the U.S. Contrarian investors may find opportunity here.
Margin debt continues to climb on the NYSE, and at a rate above 25%. Is it too high, too much enthusiasm? As a percent of total NYSE capitalization it is near long term highs of 2.5%. It was last in this area after the tech bubble in 1999.
It is favorable that inflation has risen by no more than 1.6% year over year and 0.1% month over month. Our bond risk indicators continue favorable, long bonds have outpaced equities so far this year, and we have increased durations.
Matt Watson, Asst. Portfolio Manager
F E James, Ph.D.
