Stock Market Analysis
It was another positive week for the popular indexes. The large-cap S&P 500 advanced 0.5%; closing the week at a new record high. The small-cap Russell 2000 Index also performed well and gained nearly 1%. However, while the indexes enjoyed the week it was not all smooth sailing. The number of advancing stock and declining stocks were nearly equal suggesting this stage of the rally is no longer broad-based and is getting narrower.
Much of the market's gain came Friday on the heels of the surprising employment report. While job growth is good to see one must look at this data with a discerning eye. July is often a month where the official numbers are pushed higher by seasonal effects. In 2014, 2015 and 2016 the seasonal effect has added over 100,000 jobs from what really happened (non-seasonally adjusted) to what makes headlines (seasonally adjusted numbers).
Perhaps more importantly are where the job gains come from and where they are not occurring. Last month the country lost 112,000 from the entrepreneur class. As entrepreneurs help provide almost half of the jobs in the United States this is disquieting.
On the other hand there is a place where job growth is occurring that stocks generally dislike. That area is the regulatory class. While it is highly important that we have clean air and clean water the regulatory class can often be overzealous in applying rules and this can cause issues for corporations. Our research at James suggests starting in 2010 when the regulatory class is shrinking that stocks have made nearly 25% on an annualized basis. When the regulators are on the rise? Stock returns usually fall 3.5% annualized. The recent rise in regulators may suggest trouble ahead.
Earnings continue to be a mess. Presently, 86% of the S&P 500 companies have made their quarterly report according to Bloomberg News. In aggregate they are showing declining growth in both revenue and earnings. This mirrors last quarter's report. If this data continues then the S&P Index will not only be dealing with a profit recession but a sales recession as well.
Last week's study was encouraged by pessimism on Wall Street. Some of this continues asinvestors underweight stocks over the next three months. What often happens during market tops is they tend to be long-lived and frequently do not end until the pundits and headlines suggest the future finally looks great.
Still, we have concerns. Valuation levels remain elevated which typically leads to subdued stock returns over the next 3 to 5 years. Profits, as mentioned earlier, are declining. Additionally our leading indicators are deteriorating. After having been highly favorable (and correct) with the Brexit situation we now find our indicators are no better than neutral. While it would not be surprising for the advance to continue for a time it will likely occur on the backs of fewer and fewer securities. For now we would suggest most investors to generally maintain their equity levels but vigilance is clearly needed.
David W. James, CFA
Bond Market Analysis
U.S. Treasury Bonds declined in price last week as yields rose. The yield curve steepened as the 30-Year U.S. Treasury bond rose 14 basis points to yield 2.32% and the 2-Year U.S. Treasury bond rose 5 basis points to yield 0.72%. Year to date, long term U.S. Treasury bonds are up 15.1% while intermediate U.S. Treasury bonds are up 3.3%.
The U.S. Dollar rose in value against the Euro and the Pound more than it fell against the Yen and the Canadian dollar last week. A rising U.S. Dollar is generally good for bond holders as it tends to import deflation from abroad and attract international investors.
Gold declined 1% and Silver declined 2.5% last week. Crude oil, while briefly dipping below $40 a barrel, rallied almost 1% last week and is up 13.3% in 2016. While the overall CRB Commodity Index is up 3.2% in 2016, other commodity prices have declined such as corn, and wheat.
The July Employment Report was released on Friday and there were 255,000 jobs created. The markets reacted positively as the reported figure was higher than the highest economist estimate. On the bright side, the participation rate rose 0.1% to 62.8% and the average workweek rose 0.1 hour to 34.5 hours.
However, when we analyzed the numbers further we found some disturbing trends are still present. Small business entrepreneurs declined by 112,000 during the past month. Additionally, there were approximately 3.6 low wage jobs created for every one high wage job. Lackluster high wage job growth is one reason why real median household income in the U.S. is about the same as it was in 1996. This is a concern for many Americans.
The market interpreted the employment data as though it was more likely the Federal Reserve will raise interest rates next month. However, as we mentioned in our 2016 Economic Outlook, official inflation data continues to remain low. The Federal Reserve prefers the Personal Consumption Expenditure (PCE) and it was also released last week. The 1.6% YOY rate is still below the Fed's 2% target.
Personal Income and Spending at the consumer level rose in June. Incomes rose 0.2% while spending rose 0.4%. The savings rate declined to 5.3% to compensate for the smaller increase in income vs. spending. Service sector spending rose while durables spending (autos) fell. Also, some service sector spending was due to higher crude oil prices rather than higher demand.
We find intermediate bond indicators moving into a slightly more favorable configuration. After a respite last week, we believe the trend to lower yields (and higher bond prices) will likely continue. We would recommend maintaining a moderate duration position in bonds by emphasizing longer and shorter bonds.
Matt Watson, CFA, CPA
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