Stock Market Analysis
The market started the year on a good note as both the Dow and the S&P 500 hit record highs on Friday. Although the Dow never touched 20,000 it still rose 1.07 percent last week. The smaller cap Russell 2000 advanced 0.76 percent. We saw more than three stocks advance for every one that fell and we saw more than thirteen times as many stocks hit new highs as new lows. Technology and Healthcare stocks did well while Energy and Utility stocks lagged. Retail department store stocks like Macy’s and J.C. Penney had an especially bad week.
Retailers did suffer from weaker holiday sales as mall traffic was light and online buying was more robust. They are also facing a growing fear of changes in import tariffs. Congress is floating the idea of a 20% import tax which would raise prices on imported goods, especially clothing. Some speculate a stronger dollar would offset the import tax, but markets have a way of anticipating the worst possible outcome when the future is in question.
We have pointed out the upside down nature of the market in much of 2016. The top third by valuation, earnings and price strength had done poorly through the third quarter while the worst of the worst of the worst produced spectacular results. The fourth quarter shows this is starting to reverse. The best had strong results for a change, a sign the market is beginning to return to normal. We also reviewed key stock characteristics and we find some interesting developments in the last quarter.
First, size really mattered as the median large stock actually fell in the quarter while results improved the smaller the size of the company. Micro cap companies did especially well. We also saw our normal evaluation approach starting to work as it has historically. In fact, the best rated stocks advance nicely while the worst rated ones fell in price and this produced about a 10% difference in their returns last quarter. This is what we hope to see, but it has not been the case in 3 of the previous 4 quarters.
While the market is returning to more usual patterns, we are seeing a rise in overall risk. Where sentiment readings had been favorable for stocks, they have since moved through neutral and are now mostly negative. The pace of the advance has been too rapid and some settling of prices is to be expected. We have performed a review of the market’s performance after an election where the party in the White House changes. The market usually rallies from the time of the election until shortly after the inauguration and then undergoes a bit of a correction. Now that Congress is back in session, many new bills will be considered and a changing landscape may cause investors to take pause. Nothing is known of Mr. Trump’s governing approach and surprises, as many companies have already found, rarely settle well with investors.
Our indicators continue to point to higher risks in the market and we would use advancing prices to trim back stocks which have either underperformed of late or are too richly priced. While we think the market will do relatively well this year, we may be reaching a point where stocks take a breather.
Barry R. James, CFA, CIC
Bond Market Analysis
Bonds rallied this past week with long-term Treasuries rising 1 percent on a total-return basis. Most sectors of the bond market advanced while GNMA bonds fell slightly and intermediate term bonds showed no gain. The dollar showed strength against most currencies and commodity prices surged. Gold rose 1.9 percent while silver advanced 3.3 percent.
The economy continues to be a big player for the bond market. Often the fortune of bonds is the opposite of the economy. What do we see?
Economic reports were reasonably favorable for the week. Manufacturing seems to be showing some signs of life and these have nothing to do with Mr. Trump’s challenges to several companies to keep manufacturing here in the States. Both the Institute for Supply Management Manufacturing and Non-Manufacturing reports showed strength. We also saw the addition of manufacturing jobs in December. On the other hand, factory orders and durable goods orders fell in November.
The unemployment report came out on Friday and it was a mixed report. The number of new hires was lower than expected and the unemployment rate rose. However, hourly wages rose and are now up 2.9% over the last year. Dissecting the report, we continue to see more signs of weakness than strength. The length of time to get a new job remains high and the percentage of adults with a job remains lower than normal. In addition, the number of jobs being created is not keeping up with the growth in the adult population. In fact, in the last year alone we have seen about 700,000 fewer jobs than potential hires. Hopefully, the fact wages are rising may indicate conditions could be shifting and perhaps more jobs will be created if businesses and consumers believe economic conditions will improve.
Bond yields surged too quickly and we are experiencing a normal reversion. Our indicators point to continued risk in bonds and we would use this recent rally to continue realigning portfolios into a more conservative position. We would use it to sell longer term bonds, move into a more laddered approach, and pick up floating rate and inflation protected bonds.
Barry R. James, CFA, CIC
