Stock Market Analysis

Stocks were a mixed bag this week. The large-cap S&P 500 managed to advance nearly 0.25 % while smaller stocks such as those in the Russell 2000 fell over 1.1%. Leading the charge were Financial and Utility stocks (both of which gained 1.5% or more). Energy stocks were among the laggards and lost 1%.

Last week we discussed the change in leadership based on a company's tax situation. What else has changed during this rally? Market breadth is one example. In the one month following the election, over 56% of the stocks in the S&P 500 outpaced the index. Since then? Less than 46% can make that same claim.

SentimentTrader found another method of quantifying this. They looked at times when the S&P 500 closed at a record high and pondered, what percentage of NYSE and NASDAQ stocks are setting 52-week lows? The current answer is only 6%, the second worst number going back to 1965. They note similar occurrences in 1973 and 1999 and said "...both preceding significant corrections".

What about smaller stocks like those of the Russell 2000? SentimentTrader notes the index recently set an all-time high (July 25th) but less than 5% of the stocks were at 52-week highs. Our takeaway is to be cautious regarding indexes and indexing strategies as they may be vulnerable. Still there may be quite a few individual stocks which are better bargains and relatively undiscovered at this time.

On the economic front many were enthused by the employment report. Job growth topped 200,000 and was well above Wall Street expectations. Unfortunately, it was not as smooth sailing as the headline number suggested. We have previously noted how full-time jobs often go hand-in-hand with the entrepreneur class. More entrepreneurs usually lead to more full-time positions.

Unfortunately, last month our country lost 278,000 entrepreneurs. Thus it should not be surprising to note the economy gained 300,000 part-time jobs while losing over 50,000 full-time jobs. This also helps explain the disturbing lack of growth in personal income even though a gain of 0.4% had been predicted by pundits.

Presently, our leading stock indicators are shifting from neutral to a slightly unfavorable. Diminishing breadth in the market means this is a great time to re-evaluate individual stock holdings to ensure a bargain focus. While the high-flyers may continue to rise in the short run, they are likely to be at greater risk when the market next hits a period of volatility.

David W. James, CFA

Bond Market Analysis

Last week U.S. Treasury and mortgage bond prices rose while corporate and high yield bond prices fell. The U.S. Treasury bond yield curve flattened as yields on longer term maturities fell more than shorter term maturities.

The U.S. Dollar (USD) increased almost 0.5% in value against other major currencies last week. A strong jobs report helped the USD rally over 1% at one point on Friday. A stronger dollar has the effect of increasing returns for international investors and is generally positive for bonds.

Precious metals saw price declines as silver prices fell over 2.5% and gold prices declined about 1%. Crude oil prices fell a bit less than 1% while natural gas prices tumbled over 5.5%. This should be helpful for bonds as falling commodity prices tends to keep a lid on inflation.

Inflation, as measured by the Consumer Price Index, peaked in February at a 2.8% year-over-year (YOY) basis and is now down to a 1.6% YOY rate. Another gauge of inflation comes from the market participants themselves through their inflation assumption. Currently, the inflation assumption imbedded in 10-Year U.S. TIPS (Treasury Inflation Protected Securities) fell to 1.8%. Lower inflation helps bond investors as their purchasing power is increased adding value to the income from current bonds.

A little over one year after Argentina's most recent bond default, it sold $2.75 billion dollars of a new bond issue in June. The bond had a coupon of a little over 7% and will mature in 100 years. As Reinhart and Rogoff cited in their book "This Time is Different," Argentina has defaulted on external debt seven times during its roughly 200 year history. Even with the risk of default, the reach for yield still shows the demand for bonds.

We have heard much about proposed tax cuts here in the United States. In an interesting experiment, Norway recently started a program to allow its citizens to voluntarily pay additional taxes. Norway's 5.2 million citizens donated $1,325 in voluntary tax in the month after the initiative began. With the highest personal tax rate at 38.52% and a corporate tax rate at 24%, Norwegians seem to be saying their taxes are already high enough. Typically, high tax rates lead to slower economic growth and tax cuts to higher growth. So, if tax cuts pass in the U.S., then this may actually hurt the performance of bonds.

Presently our intermediate bond indicators are favorable. This suggests bond investors should continue to own high-quality bonds with moderate to slightly higher durations in their portfolio.

Matt Watson, CFA, CPA