Stocks turned in yet another record week. Through the close Friday, the Dow gained 0.8%, the S&P rose 0.7%, and the Nasdaq beat them both with a return of 0.9%. Gold was a bit more active but only added 0.8%. A story that has received little attention, oil continues to rise, climbing 2.0% this week to $98 per barrel. The other major type of oil, Brent, rose sharply to $116.65. Worth noting, February started with the highest gas price we have ever seen at this time.
Source: Yahoo Finance
New five-year highs were notched again this week as stocks continued to march higher. The Dow now stands only about 150 points from its all-time high. The S&P is about 3.4% from its all-time high.
We also closed out a solid January this week. A 5.8% return on the Dow was the best January since 1994. Per the saying, as goes January, so goes the year. And history has shown that when higher by more than 5% in January, the year nearly always closes with double-digit gains.
We also closed out a solid January this week. A 5.8% return on the Dow was the best January since 1994. Per the saying, as goes January, so goes the year. And history has shown that when higher by more than 5% in January, the year nearly always closes with double-digit gains.
The individual investor coming back into the market was cited as a big reason for the market rise. The Wall Street Journal ran an article (LINK) with a chart showing the flow back into stocks, seen right. Perhaps overlooked is the massive, massive, outflow in the month before. This occurred when investors were worried about rising taxes in 2013 and pulled money out of stocks to be cautious and record gains. After an outflow of that size, it is only natural that money would come back in. We’d be more encouraged if the inflow into stocks matched the outflow we saw in December.
Getting into the events of the week, economic data grabbed the spotlight despite a significant number of companies releasing their earnings.
Fourth quarter GDP garnered much of the attention. The figure came in significantly lower than expected, actually showing a negative growth of 0.1%. On a year-over-year basis, we grew 2.2% in 2012 and 1.5% in real terms (which adjusts for inflation). It is worth noting that real GDP numbers below 2% have historically lead to recessions.
Looking at the positive parts of the GDP number, both business investment and personal income showed surprising strength. However, they can both be explained by the phenomenon we discussed above regarding the inflow into stocks. People pulled activity (whether investment or income) into 2012 to avoid the higher taxes that were anticipated in the new year. These figures are not as strong as they appear.
The negative parts of the GDP number were described as not really being that bad. There was a significant drop in government spending that was cited as the culprit in lower GDP, thus it wasn’t a “big deal.”
However – and we feel this is important to note – government spending over the last quarter rose by $98 billion (LINK and LINK). There was no cut in spending. What was lower over that time was military spending. In fact, military spending dropped by 22% over the past year. A 22% cut while the rest of the government grew! With an immediate family member in the military, we know these cuts are very real and more are on the table.
The news of lower government spending was used as an excuse to not cut more spending. These days we often hear that it is necessary to grow a weak economy. Yet we have run trillion-dollar deficits for years, achieving very little growth. We grew 2.4% in 2010, 1.8% in 2011, and 2.2% in 2012. These are extremely weak numbers and hardly justify the massive spending. If anything, they show that government spending does not work.
We also have the Fed committed to more stimulus. This week they reaffirmed their commitment. They will continue to print $85 billion a month (once a massive number that no one blinks an eye at anymore). $40 billion will go to buying mortgage bonds while $45 billion will be used to purchase government bonds.
What is different since the beginning of the year is the Fed isn’t doing any offset selling to balance out their buying. This is likely a major factor behind the market rise this year. Still, the stimulus has done little to help the economy fundamentally grow. They printed $165 billion as stimulus over the last quarter, yet we had negative GDP growth. With the Fed, when you only have a hammer, every problem looks like a nail.
The employment report released Friday also made headlines. The number was little to be excited about as we only added 157,000 jobs in January, not enough to keep up with the growth in population. The unemployment rate rose to 7.9% and the broader unemployment rate stayed at 14.4%.
Additionally, more people left the labor force than were added in new jobs. If the unemployment rate were to be measured using the size of the labor force from the beginning of the Obama administration, our unemployment rate would be above 10%.
Investors did get excited about the report, though. That’s because it also revised higher the number of jobs added in November and December. However (isn’t there always a “however”?), very large seasonal adjustments were made at the beginning of this year and applied back to those months. Still, any increase is better than none at all.
This news, combined with a strong manufacturing number, was cited as the reason for the big gain in the market Friday. One must also take into account the ‘first of the month effect,’ where new money tends to enter the market and push up prices. The economy isn’t very strong and is difficult to cite as cause for optimism.
Next Week
Next week doesn’t look to be as exciting as the past week for data. Corporate earnings are past their peak, though we will still see a fairly long list of big names coming in this week. Economic data will be lighter, as well, as we get info on the strength of factory orders, the service sector, productivity, the trade deficit, and inventories.
Investment Strategy
We’ve been thinking the market is too expensive and is due for a correction. There were a few days this week where it was looking like that was the case. Yet the market powered higher.
We don’t think economic growth is as strong as perceived. In fact, this is the worst economic recovery since the 1940’s. Corporate earnings are poor in absolute terms, though the still beat the extremely low expectations. We may be headed the right direction, but it sure is slow.
Plus, we will have drama out of Washington resuming in the coming weeks.
The one thing the market has going for it is the Fed. The Fed is printing money hand-over-fist. As mentioned above, a new wrinkle since the beginning of the year is they are not doing any selling to offset their buying. We believe this has been the biggest factor in the market gains.
So does that mean the market will keep going higher as the Fed keeps printing? It certainly helps. But when everyone is as optimistic on the market as they are now, it raises a red flag for us.
The trend is clearly to the upside here and we have yet to reduce our stock positions, continuing to ride the rally. We are hesitant to add new money to the broader market here, though. We’ll tag along for the ride higher but are actively looking to look to lock in some gains once we see weakness.
The rest of our outlook is unchanged. While we aren’t looking to do any buying in stock indexes at this point, we are always looking for opportunities. In individual stocks, we still like higher-quality and dividend paying ones. We also like smaller and mid sized stocks that don’t have a strong correlation to the broader market and Europe.
Gold has done little in recent months, but we still like it for the long term. Central banks continue to print money to stimulate their economies and weaken the currencies, a condition that favors gold. We would look to add to our positions if it goes much lower from here.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth may weigh on commodity prices in the short run, though.
As for bonds, Treasury bond yields are higher than their recent average with the 10-year government bond crossing the 2% yield level this week (so prices have fallen), the highest in nine months. A short position (bet on a decline in price) has done well here. However, we think this is unlikely to continue, making the short position only a nice hedge. The potential for longer term profit is low at this time.
We also think TIPs are important as we still expect inflation to increase. Municipal bonds provide a nice way to reduce taxes, though new itemization laws may reduce their benefits in some cases.
Finally, in international stocks, we are less enthusiastic on developed markets, but not totally sold on emerging, either.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
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.
