Stock Market Analysis
It was a good week for stock holders. Larger stocks, like those of the S&P 500, gained nearly 1.8%. Smaller stocks, such as those of the Russell 2000, also advanced and were up almost 1.5%. Some of the best plays on the week happened in Utility and Energy sectors. Both were up over 3.5%. Among the major sectors only Healthcare lost money. It was encouraging to see daily volume 32% heavier than normal (compared to the last year).
The rally we have seen over the last two weeks is not surprising. In our stock study dated 17 January 2016 we correctly noted this about the market decline, “Markets can move to extremes too rapidly, at such times they tend to reverse and retrace. Sentiment for stocks is too negative and therefore favorable.” Since then, the Dow Jones Industrial Average is up over 400 points and the obvious question is what comes next?
Examining sentiment surveys, we note both the American Association of Independent Investors (AAII) and Investors Intelligence (II) both have more bears than bulls. This suggests pessimism continues to hold court. However, the degree of fear is no longer at a fever-pitch and another sentiment gauge, the Put /Call Ratio, has retreated to levels which are slightly unfavorable for the future of the market.
Regrettably the current earning season is not a picnic either. Approximately 40% of the S&P 500 companies have reported. Sales and earnings growth from the reporting companies are averaging firmly in the negative camp. Demand or the lack thereof, seems to be a major contributor to this problem.
Indeed, the overall demand quagmire is reflected in the fourth quarter GDP report. The official GDP number came in at only 0.7% growth. As Barry James, the President of James Investment Research, likes to say, “Growth of 2% or less will feel like a recession.” Many businesses and consumers would agree.
Nor should we expect the international economic dynamo of China to rescue us anytime soon. Freight traveling on the rails of China continues to trend lower suggesting lackluster production. Further, Bloomberg News reports, “China’s official factory gauge signaled conditions deteriorated for a sixth month [in a row]...”
Some may think the stock decline has simply been a January phenomenon. This is not the case. Examining the typical stock on the NYSE, we note it has been trending downward since the spring of 2015. We have a bit of a hidden bear market as the typical stock is now actually in bear territory (down 20% or more from its peak).
Given the length of the decline in stocks and the continued level of pessimism, it would not be surprising if we are in the 6th or 7th inning of this bear market for the typical stock. Our most accurate indicators are signaling caution at the present time and we have generally been looking to lower risks and equity levels where appropriate. However this is not the time to lose hope. Indeed, the pullback in prices should provide a multitude of opportunities well before the year is over.
David W. James, CFA
Bond Market Analysis
Good news for bond investors! Almost across the board, bond prices rose. The largest gains were found in the 3 to 10 year maturities where yields fell 13 to 14 basis points.
The Dollar was mostly unchanged for the week, the DX index being slightly positive. Bank of America – Merrill Lynch data suggests the 3-Month T-Bill gained just slightly for the month of January while Treasuries maturing in 2 to 30 years scored even better returns.
Bond yields are likely to be responsive to international development, domestic economic progress, Federal Reserve initiatives, and stock market changes.
On the international scene, the Chinese Yuan continued to fall; it is now off about 1.26% year-to-date. A succinct recap of international aspects may be garnered from a recent (21 January 2016) Wall Street Journal headline, “Global Stocks Sink on Fresh Growth Fears.”
Domestic economic developments are lackluster at best. A recent Investors’ Business Daily (1 February 2016) article summarizes it thusly, “Inventories, investment, international trade weak” as the GDP grew at a depressed 0.7% during the fourth quarter.
If we read Federal Reserve intentions correctly, they perceive the need for a normalization of rates (that is, higher) in the face of the failure of their six year stimulus program, especially the so called Quantitative Easing. This program increased FED assets by nearly $2 ½ TRILLION, but failed to generate sufficiently strong growth in income and full-time employment.
In the face of this policy failure, and coming at nearly the same time as dismal domestic economic progress is being reported, it is more likely that a policy pause will ensue. The Japanese have now begun to experiment with yet another failed initiative, negative interest rates. This is likely to work no better than their repeated hikes in taxes, which have been quickly repealed on account of the deleterious economic impact.
Because bond prices have been negatively correlated with stock prices, as in 2008, it is wise to consider the likelihood of stocks slipping into a long lasting bear market at this point. Our judgment on the future of stock prices is reported at length elsewhere. But briefly, we doubt the mega bear story and the likelihood of a massive decline in the face of so much general pessimism while insiders are quite bullish.
Gold and silver both advanced. Sometimes this happens because a touch of inflation is in the air. Sure enough, we find the CRB Index advancing 1.8% for the week. Could this be the turn in the waterfall of declining commodity prices?? Except for Nickel, other leading metals rose in price. (Copper was up more than 3%!!) Moreover, soybeans, and wheat all advanced. Even crude oil, which has been in a waterfall type decline, reversed and rose 4.4% for the week.
Bond stochastics are signaling lower rates. But more interesting, the spread between Moody’s AAA bonds and U.S. Treasury issues has averaged about 90 basis points, this week it spiked up to about 130 basis points. Bond investors have been frightened and the spreads show the strain. That could be responsible for the strength of the Dollar and the increased interest in bond purchases as suggested by recent auction figures.
A stronger Dollar, and more approbation for the virtues of U.S. Treasury issues, of course works to benefit bond holders. Chances are these factors will continue to favor bond investors who focus on quality issues; at least until confidence in the Dollar is shaken. Bond prices have been trending higher, our Treasury bonds appear to be favored by foreigners and stocks have been volatile. These factors lead us to continue to recommend positions in the highest quality bonds with mixed durations, a portfolio that includes long term bonds as well as shorter issues. We should continue to monitor inflation adjusted TIPS bonds. We expect any correction in interest rates to be a buying opportunity for high quality bonds.
F James, PhD.
