Stock Market Analysis
Last week we concluded our analysis with “Given the turmoil from Brexit this appears to be a keen opportunity to buy select issues. We would add equities for underinvested accounts.” This flew in the face of conventional wisdom but we actively bought on the day the results were known and in the following week as well. We are relieved the market had its best week of the year. The Dow jumped 3.18 percent while the small cap Russell 2000 rose 2.67 percent. Market breadth was wide and almost 600 stocks set new 52 week highs.
The market had been vacillating for some time and we have been noting anomalies. We had seen growth outperforming value for a decade where the opposite is the norm. More recently, our research shows more than half of the stocks are entrenched in their own bear market (down 20% or more from their yearly high). We have seen the market approach the record highs set in 2015, only to fall back to earth again. Lastly, we had seen tremendous rotation in the different sectors of the market. For instance, Basic Material and Energy stocks have had good rebounds after suffering in 2015. At the same time, Technology stocks have fizzled out this year after posting stronger returns last year.
As we have mentioned before, much of this is indicative of a market in transition. We have been locked in the doldrums since the Fed put an end to Quantitative Easing. The market has been trying to digest the usual drivers of market returns, valuation and earnings. Neither have been overly favorable, thus the market seemed to go nowhere while the internal movements lead to frustration. The air may have been cleared, at least for the time being, by the Brexit vote.
As we said in our Opportunity From Brexit study, the United States shouldn’t feel much impact on our trade and liquidity levels worldwide were at record levels. We thought these funds might move into the U.S. as a result of Brexit. We concluded the report with, “The volatility created by the Brexit outcome should be considered a buying opportunity for U.S. Investors.”
Our intermediate term indicators remain favorable and we would use any residual volatility to buy bargain stocks for underinvested portfolios. Some stocks have more than made up for the Brexit selloff and we wouldn’t chase them at this time. However, plenty of stocks did not rebound to the same extent and may offer good prospects for appreciation.
Barry R. James, CFA, CIC
Bond Market Analysis
Bonds had their best week of the year. Long term treasury bonds jumped 4.5 percent and are now up over 15 percent for the year. Every sector of the bond market, except for high yield, also advanced during the week. Long term high quality corporate bonds and sovereign bonds also have enjoyed double digit returns for the year. Rates are getting close to the lows of the cycle established early last year. The ten year treasury yield is below 1.5 percent and the 30 year treasury is down to 2.3 percent.
It is growing harder to make a case for a rapid drop in rates for the rest of the year. Brexit fears helped bond yields plummet last week as investors moved to safe havens. This may be an overreaction, pushing rates lower than they might otherwise be.
It is also hard to see a rapid increase in rates as economic growth remains tepid. Both the Dallas and Richmond Manufacturing Indexes fell again last month. While 1st quarter GDP was nudged upward, both personal consumption and inflation measures were revised downward. Looking at more recent inflation news, the May PCE (Personal Consumption Expenditure) showed modest levels of inflation. The broad measure showed a 0.9 percent year over year rate of inflation, while the core (which excludes food and energy) was slightly higher at 1.6 percent. Last month also saw construction spending and new home sales decline.
Now that international events are moving further behind us, bonds will respond more to domestic economic and inflation trends. The Federal Reserve is likely on hold for the remainder of the year, so the bond market will also take that into account. Our intermediate and longer term bond indicators are not favorable and we would use the strong rally to trim durations slightly where appropriate.
Barry R. James, CFA, CIC
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