Stock Market Analysis
Larger stocks edged higher last week as the Dow only rose 0.02 percent. However, small cap stocks rallied 0.59 percent. Advancing stocks only modestly beat out falling stocks, but new highs swamped new lows. This is not surprising considering the Dow and the S&P 500 hit new highs on Monday.
Oil prices surged almost 9 percent last week, so it should be no surprise Energy stocks led the advance. The bond sell off seemed to hurt Utility stocks, as they were the biggest losers on the week.
However, Utilities are still up 18.1 percent this year. Many investors are looking to pick up yield in their portfolios and utility stocks are a natural fit. Still, reaching for yield can be a dangerous obsession. We examined high-yield stocks and found 290 which were bigger than $1 billion in market cap and had yields over 5% last August. On average they lost just over 6% in price. While these high-yield stocks fell, regular stocks of this size actually gained. Yield is no panacea.
The market does appear to be growing weary. It has been running a marathon, and like Meb Keflezighi at the Olympics, it could slip at the finish line. Fortunately, he bounced up and crossed the line. Poor earnings remain the puddle the market could slip on; this last quarter was negative once again. This, along with rising prices, has pushed valuations higher. The S&P 500 now sports a P/E of over 25 and trades near 3 times book value. A market bottom, like we saw in 2009, had a P/E of less than 11 and a Price/Book value of about 1.5.
What other signs do we see of rising risk? First, our Risk Exposure Ratio suggests a 65% probability of a market correction. In addition, insiders have been selling at a feverish pace. The Insider Trade Reports calculates we are seeing about 19 times more selling than buying. These directors and employees are often early, but they usually catch decent prices when buying and selling. In addition, some sentiment readings are too favorable. Call options on the S&P 500 recently hit a record, an indication of strong buying sentiment. We also have seen speculative long positions on Dow futures and options reach record levels.
Our leading intermediate indicators are no longer positive but they are not deteriorating significantly. Overinvested accounts could use the recent rally to trim some, but market tops usually take considerable time and we would not lower equity levels at this time. The time is coming and we are preparing a list of stocks we would consider as candidates for sale.
Barry R. James, CFA, CIC
Bond Market Analysis
Bond yields rose and prices fell last week. Long-term Treasuries fell about 1 percent and long-term corporate bonds declined 0.5 percent. Sovereign and high-yield bonds took a different path and their prices rose. Sovereign bonds were helped with a dip in the Dollar. So far in 2016 the Dollar is down 4.3% percent versus the Euro and a whopping 19.9% percent versus the Yen. High-yield bonds reflected the improvement in small cap stocks.
After hitting a low yield of 1.36 percent in July, the 10-Year Treasury yield has risen to 1.58 percent. Generally speaking, few believe rates will fall back to their lows. Economic reports have not been overwhelming, but there has been some improvement. Industrial production rose in July, but is still down over the last year, an indication of persistent weakness. In addition, while the Leading Economic Indicators have turned higher, the Coincident/Lagging indicators remain in a long-term funk. We have actually found it to be a better predictor of the economy than the Leading Indicators.
The Fed’s Labor Market Conditions Index has also improved but it is not strong. We are hearing a few rumbles of the Fed raising rates which seem to coincide with some improvement in the regional reports. However, inflation, as measured by CPI is only running at 0.8 percent and the election is just around the corner. The Fed will not be anxious to raise rates too soon.
Our intermediate term indicators remain favorable. We would look for opportunities to raise durations and become slightly more aggressive where appropriate.
Barry R. James, CFA, CIC
