Stock & Bond Market Update (4/21-4/25)

Stock Market Analysis

Conclusions: For the week large stocks were mostly unchanged while smaller issues, such as those of the Russell 2000, fell 1.3%. Overall the number of advancing and declining stocks tilted very slightly in favor of advancement.

Historically, April is often one of the best months for stock investors. However, so far this month most of the major indexes are lower. This is especially troubling given the old adage, “Sell in May and GO AWAY.” Unlike many Wall Street idioms, this one seems to work. Since 1951 during the go-go months between Halloween till the end of April stocks average an annualized 13.5%. During the “Go Away” periods from May 1st through Halloween the annualized returns are only 1.4%. Scary times indeed!

Longer term, valuation levels are a concern. The academian Robert Shiller has developed the Cyclically Adjusted Price-to-Earnings or CAPE. This figure compares the market’s price versus the average earnings generated over the last 10 years. Although this number rarely has an impact on stock returns in the short run it often gives excellent guidance in looking at future returns over the next five to ten years. Our research has found CAPE values over 20 to be especially worrisome with very low returns following these readings. We have now seen CAPE top the 20 mark for 31 months in a row suggesting the next few years will likely be challenging for stock investors.

There have been some positive economic developments. The four regional Federal Reserve reports with the most clout (Chicago, Philadelphia, New York and Virginia) are all positive. Likewise the Conference Board’s Leading (economic) Index continues to advance.

Against this, we find a major breakdown in housing with new home sales falling for the third time in four months with the latest reading a heart-wrenching dip of 14.5%. Further, the Coincident-to-Lagging (economic) Index provided by the Conference Board has declined over the last three and the last twelve months.

Our current readings on our leading indicators do show slight improvement from recent readings. However they have yet to signal that stocks are in a high-reward / low-risk scenario. With international tensions in the Ukraine remaining elevated we continue to favor a cautious approach for equity investors.

David W. James, CFA

Bond Market Analysis

Conclusions: This was a week of joy for the bond bulls as rates fell from 5 or more basis points for longer U.S. Treasury bonds while yields were mostly steady on shorter maturities. By the end of the week, 10 year bonds were selling to yield 2.68%.

Also by week’s end, and in spite of higher bond prices, the dollar was slightly lower against the Euro and the Yen. Commodities were mostly higher, except for energy items, as might be expected against a threat of military action with Russia. Prolonged conflicts tend to push commodity prices higher.

We had previously outlined several considerations that would enhance the odds for interest rates to move lower. Among them were falling stock prices; foreign buying in a search for safety; institutional disappointment at the prospect of extended economic stagnation; not good expected growth; prospects of extended returns near zero for safe short term paper; and threats of armed conflict. At least two of these considerations came into play last week, declines in stocks and possible conflicts with the Soviets over the Ukraine.

Unfortunately, the declines in stock prices threaten to become more widespread, as we take note of the year to date changes in size groups such as the S&P400, 600, and 500. The largest stocks are holding up well, while smaller issues are tending to break down. This is often found before significant stock declines. We are concerned also with the excessive optimism among stock sellers. Analysts rate stocks as a “buy” by a ratio near 11 to 1 today, 8 is more the long term average, today we find too much optimism, Should these considerations lead to a stock decline, history teaches that bonds will likely rise in prices.

Another consideration favoring bonds is the stagnant economy, which resisted FED stimulus and Washington speeches-- and continues stagnant. Housing demand is judged as a key factor in most economic recoveries. Unfortunately, the latest statistics are a disappointment. Loans for new homes are down from the fourth quarter, according to the WS Journal, and sales for new homes fell 14.5% in March. A slow economy favors bond investments and lower rates.

Many years ago, a Russian dictator took his measure of a young American President and felt emboldened to ignore convention and ship nuclear weapons to Cuba. Should today’s American President be measured in a similar way, might another Russian leader come to similar dangerous conclusions? In times of peril, investors tend to flee to safe bonds.

These are among the considerations that led us to recommend bonds for a portion of most investment funds.

After the recent favorable move in bond prices, with 10-year treasury yields falling from near 3.0% at the beginning of the year to less than 2.7% Friday, with a corresponding increase in bond prices, we now find our indicators to be neutral for the intermediate term, while continuing very favorable for the longer term. We had previously recommended buying longer term quality bonds and extending duration. We suggest investors maintain the lengthened duration for high quality bonds.

F James, Ph.D.