Another good week for the markets with many new records reached. This week, the Dow hit a new three year high and was up 2.4%. The S&P climbed 2.0% while the Nasdaq rose 1.9%. Additionally, small cap stocks measured by the Russell 2000 reached a new all-time high.
It was also a banner week for commodities, with gold reaching another all-time high, up 3.5% this week. Silver is just inches away from another record. Oil reached a 2 ½ year high as a barrel now stands just shy of $114. (The international crude, Brent, closed near $126). Lastly, the dollar hit a new three-year low.
Source: MSN Moneycentral
So why are all these records being reached? A major reason has to do with the weakness of the dollar. Events this week assured the dollar will weaken even further.
Ben Bernanke, the head of the Federal Reserve, held a much-hyped press conference where he answered questions from the press (this was very rare, but will now be a quarterly occurrence). Investors were anxious to hear any new insights or information about future Fed policies. Instead, we heard nothing new. He reaffirmed his easy, money-printing policies in an effort to stimulate growth. He even indicated he would like to target a higher inflation rate. That means the pounding the dollar has taken will only continue.
Many policy makers don’t mind the idea of a weak dollar. It helps exports. It also makes it easier to pay off national debts. However, since commodities are priced in dollars, it takes more dollars to buy that commodity, therefore the price goes up. That’s why we are seeing new highs in many, many commodities.
The downside of these high commodity prices is obvious. Almost everything you buy now costs more. And it will likely get worse from here. It is frustrating that our decision makers are okay with that.
Investors also interpreted the Fed message as a go-ahead to invest in stocks, which was part of the reason for the surge in stock prices. Since the announcement of the QE2 last fall, the performance of the market has had a very strong correlation to the size of the Fed’s balance sheet. That means the more money the Fed prints, the higher stocks rise. Since they aren’t cutting back any time soon, the market will likely keep rising. Hopefully this doesn’t turn into a Zimbabwe type scenario where they printed tons of money and the stock market soared, only to crash spectacularly.
Also contributing to the run in the stock market, corporate earnings have been very strong. Companies with overseas operations have been particularly stellar. We can’t forget that the market is just a collection of these individual companies with good earnings. Sometimes the fundamentals of the economy don’t match the performance of the stock market.
A major indicator of these fundamentals is the GDP (gross domestic product, which is the value of all the goods and services in the country). This week we received the GDP for the first quarter and it was extremely weak, showing just 1.8% growth. This was much lower than the 3.1% of the previous quarter. To give you some perspective, at this point in a recovery, GDP usually runs around 4%. High prices from commodities like food and energy were a major reason for the underperformance this quarter.
A bright spot in the GDP report, in our opinion, was a cut in federal spending (which is included in GDP). That cut came after the biggest spending spree since WWII, so that trajectory of spending was clearly unsustainable. Unfortunately much of the spending cuts came from defense, which is one segment we don’t like seeing cut.
The trillions spent so far has done very little to help the economy as main street still suffers. Unemployment continues to be a problem. Initial jobless claims were above 400,000 for the third straight week after several weeks in the 300’s. The press likes to point to stories of companies that are hiring and loved the news that McDonalds hired 62,000 people last week. Unfortunately, over 1 million people applied for jobs there. That means only 6% of applicants were hired! It is a sad situation when only 6% are taken for entry level work, showing just how tough it is out there.
Next Week
Next week will be another busy week. We continue to get first quarter economic data, but also April data since we are beginning a new month. The most important information comes on Friday with the April unemployment report. The rate currently stands at 8.8% and economists predict an improvement in this number. It is important to not take the rate at face value, but dig into the reasons behind any change. Shrinkage in the labor force has allowed the rate to get this low, so that will be an important factor to watch.
Corporate earnings will come in at a steady clip next week, as well. They have been pretty decent so far and the trend looks like it will continue. Either way, there will be plenty of data to move the markets.
Investment Strategy
We have been discussing the likelihood of a stagflation scenario here in the U.S. and feel the data is beginning to support that. Inflation is high and growing (even by the Fed’s standards) and growth is slowing, as evidenced by the poor GDP number.
So what does that mean for the markets? Probably not much right now. As long as the Fed keep printing money, the markets will likely head higher. As much as we disagree with their actions, you have to position yourself to make money.
It is hard to put new money to work as everything looks expensive at these levels. As value investors by nature, we like to buy things that look to be cheap or trading at a discount (using industry jargon, we like to have a margin of safety). Obviously we are uncomfortable here, but again, you can’t fight the Fed.
If we had to put new money to work, in equities we are focused on large cap higher-quality stocks, particularly multi-nationals. Commodities remain a long term favorite and any weakness could present buying opportunities since they are rather expensive at this time.
TIPs are important as we expect inflation to increase in the future, while U.S. Treasuries are a sector we are very bearish (pessimistic) on as we think yields will increase over time. Municipal bonds are still important despite the recent drop in prices. There are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible).
Finally, international stocks have had a significant run already and are facing many headwinds for the future, especially inflation. Still, if we had to put new money in, we are favoring developed international markets as opposed to emerging.
Our short and medium term investments are the only ones affected by these weekly and monthly changes. These fluctuations have little impact on positions we intend to hold for several years or longer.
It was also a banner week for commodities, with gold reaching another all-time high, up 3.5% this week. Silver is just inches away from another record. Oil reached a 2 ½ year high as a barrel now stands just shy of $114. (The international crude, Brent, closed near $126). Lastly, the dollar hit a new three-year low.
Source: MSN MoneycentralSo why are all these records being reached? A major reason has to do with the weakness of the dollar. Events this week assured the dollar will weaken even further.
Ben Bernanke, the head of the Federal Reserve, held a much-hyped press conference where he answered questions from the press (this was very rare, but will now be a quarterly occurrence). Investors were anxious to hear any new insights or information about future Fed policies. Instead, we heard nothing new. He reaffirmed his easy, money-printing policies in an effort to stimulate growth. He even indicated he would like to target a higher inflation rate. That means the pounding the dollar has taken will only continue.
Many policy makers don’t mind the idea of a weak dollar. It helps exports. It also makes it easier to pay off national debts. However, since commodities are priced in dollars, it takes more dollars to buy that commodity, therefore the price goes up. That’s why we are seeing new highs in many, many commodities.
The downside of these high commodity prices is obvious. Almost everything you buy now costs more. And it will likely get worse from here. It is frustrating that our decision makers are okay with that.
Investors also interpreted the Fed message as a go-ahead to invest in stocks, which was part of the reason for the surge in stock prices. Since the announcement of the QE2 last fall, the performance of the market has had a very strong correlation to the size of the Fed’s balance sheet. That means the more money the Fed prints, the higher stocks rise. Since they aren’t cutting back any time soon, the market will likely keep rising. Hopefully this doesn’t turn into a Zimbabwe type scenario where they printed tons of money and the stock market soared, only to crash spectacularly.
Also contributing to the run in the stock market, corporate earnings have been very strong. Companies with overseas operations have been particularly stellar. We can’t forget that the market is just a collection of these individual companies with good earnings. Sometimes the fundamentals of the economy don’t match the performance of the stock market.
A major indicator of these fundamentals is the GDP (gross domestic product, which is the value of all the goods and services in the country). This week we received the GDP for the first quarter and it was extremely weak, showing just 1.8% growth. This was much lower than the 3.1% of the previous quarter. To give you some perspective, at this point in a recovery, GDP usually runs around 4%. High prices from commodities like food and energy were a major reason for the underperformance this quarter.
A bright spot in the GDP report, in our opinion, was a cut in federal spending (which is included in GDP). That cut came after the biggest spending spree since WWII, so that trajectory of spending was clearly unsustainable. Unfortunately much of the spending cuts came from defense, which is one segment we don’t like seeing cut.
The trillions spent so far has done very little to help the economy as main street still suffers. Unemployment continues to be a problem. Initial jobless claims were above 400,000 for the third straight week after several weeks in the 300’s. The press likes to point to stories of companies that are hiring and loved the news that McDonalds hired 62,000 people last week. Unfortunately, over 1 million people applied for jobs there. That means only 6% of applicants were hired! It is a sad situation when only 6% are taken for entry level work, showing just how tough it is out there.
Next Week
Next week will be another busy week. We continue to get first quarter economic data, but also April data since we are beginning a new month. The most important information comes on Friday with the April unemployment report. The rate currently stands at 8.8% and economists predict an improvement in this number. It is important to not take the rate at face value, but dig into the reasons behind any change. Shrinkage in the labor force has allowed the rate to get this low, so that will be an important factor to watch.
Corporate earnings will come in at a steady clip next week, as well. They have been pretty decent so far and the trend looks like it will continue. Either way, there will be plenty of data to move the markets.
Investment Strategy
We have been discussing the likelihood of a stagflation scenario here in the U.S. and feel the data is beginning to support that. Inflation is high and growing (even by the Fed’s standards) and growth is slowing, as evidenced by the poor GDP number.
So what does that mean for the markets? Probably not much right now. As long as the Fed keep printing money, the markets will likely head higher. As much as we disagree with their actions, you have to position yourself to make money.
It is hard to put new money to work as everything looks expensive at these levels. As value investors by nature, we like to buy things that look to be cheap or trading at a discount (using industry jargon, we like to have a margin of safety). Obviously we are uncomfortable here, but again, you can’t fight the Fed.
If we had to put new money to work, in equities we are focused on large cap higher-quality stocks, particularly multi-nationals. Commodities remain a long term favorite and any weakness could present buying opportunities since they are rather expensive at this time.
TIPs are important as we expect inflation to increase in the future, while U.S. Treasuries are a sector we are very bearish (pessimistic) on as we think yields will increase over time. Municipal bonds are still important despite the recent drop in prices. There are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible).
Finally, international stocks have had a significant run already and are facing many headwinds for the future, especially inflation. Still, if we had to put new money in, we are favoring developed international markets as opposed to emerging.
Our short and medium term investments are the only ones affected by these weekly and monthly changes. These fluctuations have little impact on positions we intend to hold for several years or longer.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
