Stock & Bond Market Analyses (10/5 - 10/9)

Stock Market Analysis

How about that? In spite of many astronomical events, the Dow rose every day last week! It rose 3.7% while the small cap Russell 2000 jumped 4.6%. Advancing stocks swamped declining stocks and we had twice as many stocks set new highs as new lows. It's good to see small caps outperform since they have been lagging for a while. In addition, value stocks outperformed growth stocks after lagging this year.

A beach ball held under water wants to pop up above the surface. We saw some of this last week. Previously, Energy and Basic Materials stocks had been suffering from the global slowdown. Oil and Gas stocks rose over 8% while Basic Material stocks rebounded 7.4%. All other sectors of the market, except Healthcare, advanced. This may be an indication that short sellers are covering their bets since we don't yet see much money being committed from retail investors. We would like to see a broadening in participation as confirmation of this rebound. Until then, we can expect volatility to continue.

The strength in the market comes in spite of, or perhaps because of, uncertainty in Washington. The Republicans have a challenge in picking a new Speaker of the House. Both the Federal Budget (and possible government shutdown) and the debt ceiling are coming to a head in the next few months. In addition, both Republican and Democratic candidates for President are finding major challenges. The American people are tired of business as usual and both parties are seeing a revolt from the status quo. How this plays out will have a significant impact on our markets.

Third quarter earnings reports aren't setting the world on fire. Investors have to determine which numbers to focus on. Certainly, larger, export oriented companies have been feeling the brunt of the rising dollar which is up over 10% relative to the Euro or Yen in the last year. Smaller companies, while often dependent on larger companies for business, have less exposure globally and should have an advantage in the months ahead.

Last quarter, the typical stock fell 10.9% with the best value stocks losing more than twice that amount. Even though the S&P 500 lost 6.44%, the typical large or small cap stock had double digit losses. It was a brutal quarter for stock investors. Sentiment remains bruised and our stock risk indicators aren't showing high risks at this time. We are generally hopeful for higher prices but would not be surprised to see another setback at some point. Large cap stocks had been outperforming, but we look for a resurgence of small value issues in the future.

Barry R. James, CFA, CIC

Bond Market Analysis

Last week the two year U.S. Treasury bond yield rose 7 basis points to end the week at 0.65% and the 10 year U.S. Treasury rose 12 basis points to end the week at 2.10%. Both of these bellwether bonds are still below their respective starting yields for the year, indicating positive returns for holders of these bonds. The yield curve has flattened so far in 2015 indicating lower interest rate/inflation expectations for the future.

The U.S. Dollar took a tumble in value last week, down about 1.0%; however, its value compared to other major currencies is still higher than the end of 2014. The Euro strengthened over 1.0% last week while the Japanese Yen weakened slightly. The recent weakness in the U.S. dollar has not been enough to overcome the strength over the past year and the dampening effect on inflation. This tends to push inflation overseas and brings lower prices to those in the U.S.

Gold and silver rose last week as recent weakness was reversed. However, shorter term inflation expectations continue to decline, as the five year reading is now at the lowest point of the year. As Albert Edwards explains: U.S. inflation expectations are quickly converging on Eurozone inflation expectations. Our bond yields could follow suit.

Incredibly, crude oil rose 8.5% last week as the number of Baker Hughes oil rigs in operation dropped to 605. This is down from around 2,000 rigs in operation between 2008 and 2011. This highlights the flexibility of the oil industry to respond to changes in supply and demand and helps keep inflation and deflation in check. No government assistance needed.

The minutes of the last FOMC meeting were released last week and they highlighted concerns about the low level of inflation compared to the 2% target set by the FOMC. This is likely the main reason why the FOMC has not raised interest rates even as unemployment has continued to fall. The employment cost index will be released in the coming week and this is one of the FOMC's favorite inflation gauges. We will be watching this release for clues as to the future of interest rates.

Our indicators remain neutral and we would maintain moderate durations. Bond investors often prefer bad news as bond prices often head higher. Quality bonds are better defensive instruments.

Matt Watson, CFA, CPA