Stocks turned in a solid week as the Dow reached a new all-time high. For the week, the Dow and S&P both rose a strong 2.2% while the Nasdaq gained 2.4%. Gold saw little change, rising just 0.3%. Oil rose slightly from its recent lows, gaining 1.4% on the week. The international Brent oil, used for much of the gas here in the east, rose a hair to just shy of $111 per barrel.
Source: Yahoo Finance
The major story on Wall Street this week was the market itself. By now you’re probably aware that the Dow reached a new all-time high. It looks like the new highs begat more buying as stocks rose every day this week, a feat not achieved since 2011.
The new record for the Dow was unique in that there was little fanfare. Indeed, when considering inflation since the past highs, this was no record. But it was the highest numeric level that the Dow has ever seen, an occurrence that is usually met with even minor celebration.
Investors have been burned badly over the past decade and it looks like they are more cautious at these high levels. In fact, we even saw the stock market record mentioned on ESPN’s SportsCenter, of all places, where the host worried of an impending drop. We become pessimistic on the market when we see an overexcitement, and we haven’t seen much this time around.
Looking at it from a contrarian perspective, could this many people negative on the market be a sign that it has room to run higher? It’s hard to answer that question, but that is a possibility. That said, we do remain worried at these high levels.
We’ve mentioned this many, many times, but we see the dominant factor in the market rise being the Fed. Printing trillions of dollars (trillions!) and keeping interest rates at zero percent for years has been the fuel for stocks to climb.
However, we heard many commentators mention the run has been fueled by corporate earnings (“unprecedented” was the word used by one prominent economist) and a strong economy. We firmly believe this is not the case.
The new record for the Dow was unique in that there was little fanfare. Indeed, when considering inflation since the past highs, this was no record. But it was the highest numeric level that the Dow has ever seen, an occurrence that is usually met with even minor celebration.
Investors have been burned badly over the past decade and it looks like they are more cautious at these high levels. In fact, we even saw the stock market record mentioned on ESPN’s SportsCenter, of all places, where the host worried of an impending drop. We become pessimistic on the market when we see an overexcitement, and we haven’t seen much this time around.
Looking at it from a contrarian perspective, could this many people negative on the market be a sign that it has room to run higher? It’s hard to answer that question, but that is a possibility. That said, we do remain worried at these high levels.
We’ve mentioned this many, many times, but we see the dominant factor in the market rise being the Fed. Printing trillions of dollars (trillions!) and keeping interest rates at zero percent for years has been the fuel for stocks to climb.
However, we heard many commentators mention the run has been fueled by corporate earnings (“unprecedented” was the word used by one prominent economist) and a strong economy. We firmly believe this is not the case.
Corporate earnings have been disappointing. While the fourth quarter was decent at a 4.2% annualized growth rate (according to the research firm Factset), they have been steadily declining over the past several quarters. This can be seen in the chart on the right (courtesy zerohedge.com. Chart is ex-financials, but was the best we could find for illustrative purposes. Roughly a percent or so can be added to these figures for the total earnings growth in recent quarters).
Plus, revenue growth has languished (revenue is the money the company actually earned through sales. Earnings, or profits, are what are left after subtracting costs), rising 4.0% in the fourth quarter (again, according to Factset). If we strip out one company, Prudential, who had an unusually large revenue rise, revenue growth would be 2.6%. The growth in earnings can largely be attributed to cutting costs, not by increasing revenue.
Not to mention, earnings growth was negative in the third quarter, its worst quarter in three years.
Plus, first quarter 2013 projections are extremely poor and forecast another negative quarter.
As for the strength in the economy, GDP grew just 0.1% over the most recent quarter, a terribly slow growth. The Beige Book (which provides an anecdotal account on the strength of the economy) released by the Fed this week also pointed to a modest growth. Worth noting, they found that the recent tax hikes and health care law requirements are having a negative impact on growth.
All-in-all, corporate earnings have been rather poor and the economy is sluggish. These aren’t exactly the conditions that lead to records in the stock market. Hence, we attribute the gains to the Fed and its stimulus programs.
Changing subjects, the other big story of the week was the employment report released on Friday. The number came in at a surprisingly high 236,000 jobs added in February. The unemployment rate stands at 7.7%, down from 7.9%, for its lowest level in four years.
Not to always focus on the negatives, but there are some important caveats to consider.
First, the quality of jobs added has been poor. Part-time jobs have been rising, while Gallup reported this week that very few full-time jobs were added over the past year.
Second, more people dropped out of the labor force last month, with the labor participation rate standing at a 30-year low. If we were to measure the unemployment rate using the participation level of just a year ago, we would have an 8.3% unemployment. Using the participation level from the beginning of the recession, unemployment would be closer to 12%.
Plus, revenue growth has languished (revenue is the money the company actually earned through sales. Earnings, or profits, are what are left after subtracting costs), rising 4.0% in the fourth quarter (again, according to Factset). If we strip out one company, Prudential, who had an unusually large revenue rise, revenue growth would be 2.6%. The growth in earnings can largely be attributed to cutting costs, not by increasing revenue.
Not to mention, earnings growth was negative in the third quarter, its worst quarter in three years.
Plus, first quarter 2013 projections are extremely poor and forecast another negative quarter.
As for the strength in the economy, GDP grew just 0.1% over the most recent quarter, a terribly slow growth. The Beige Book (which provides an anecdotal account on the strength of the economy) released by the Fed this week also pointed to a modest growth. Worth noting, they found that the recent tax hikes and health care law requirements are having a negative impact on growth.
All-in-all, corporate earnings have been rather poor and the economy is sluggish. These aren’t exactly the conditions that lead to records in the stock market. Hence, we attribute the gains to the Fed and its stimulus programs.
Changing subjects, the other big story of the week was the employment report released on Friday. The number came in at a surprisingly high 236,000 jobs added in February. The unemployment rate stands at 7.7%, down from 7.9%, for its lowest level in four years.
Not to always focus on the negatives, but there are some important caveats to consider.
First, the quality of jobs added has been poor. Part-time jobs have been rising, while Gallup reported this week that very few full-time jobs were added over the past year.
Second, more people dropped out of the labor force last month, with the labor participation rate standing at a 30-year low. If we were to measure the unemployment rate using the participation level of just a year ago, we would have an 8.3% unemployment. Using the participation level from the beginning of the recession, unemployment would be closer to 12%.
The BLS creates a broader (and possibly better) measure of the employment picture, called the employment-to-population ratio. It is simple and straightforward, measuring the amount of people working to the total amount of people who are working-age. As you can see in the chart to the right, job growth has stagnated in the past three years (LINK to source).
Next Week
The market clearly has an upward momentum behind it, so we’ll see if it keeps pushing to new highs. The S&P 500, a broader measure of the market (the Dow only has 30 companies), is less than 1% from its all-time highs. It will be more noteworthy for that index to break new highs, which it could do next week.
There won’t be a whole lot of economic or earnings data to impact the market next week. We will get info on retail sales, import and export prices, industrial production, and inflation with the PPI and CPI. Several retail companies will also be releasing their earnings.
Investment Strategy
The path of least resistance is higher and the market may keep hitting new records from here. Sentiment is important and as we mentioned above, many investors are still cautious. Euphoria is not present, a signal to contrarians that the market may indeed have room to run.
However, we see reports of investors putting new money into the market as it reaches new highs. This makes us nervous. Buy low. Sell high. We think the risk is outweighing the potential returns at this point, though we’ve been nervous for several weeks as the market churned higher.
Adding to our concern, we don’t like the fundamentals and see growing risks. But the market does have the Fed and its printing press going for it, and that may be enough to drive prices higher.
We aren’t doing any more selling at this point and are not looking to do any buying in the broader stock indexes, either. Finding undervalued individual companies seems to be a better play for new money, even though many are expensive at this time. As for what we are looking for, we like higher-quality and dividend paying stocks. Companies with operations overseas have seen better earnings than those who don’t. We also like smaller and mid sized stocks that don’t have a strong correlation to the broader market and Europe.
Gold has been stuck at this lower price and we like it for the long run, but it may need to move a little lower before it looks attractive to buy again.
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 popped higher this week (so prices have fallen). A short position (bet on a decline in price) has provided a nice hedge, but we think 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.
Next Week
The market clearly has an upward momentum behind it, so we’ll see if it keeps pushing to new highs. The S&P 500, a broader measure of the market (the Dow only has 30 companies), is less than 1% from its all-time highs. It will be more noteworthy for that index to break new highs, which it could do next week.
There won’t be a whole lot of economic or earnings data to impact the market next week. We will get info on retail sales, import and export prices, industrial production, and inflation with the PPI and CPI. Several retail companies will also be releasing their earnings.
Investment Strategy
The path of least resistance is higher and the market may keep hitting new records from here. Sentiment is important and as we mentioned above, many investors are still cautious. Euphoria is not present, a signal to contrarians that the market may indeed have room to run.
However, we see reports of investors putting new money into the market as it reaches new highs. This makes us nervous. Buy low. Sell high. We think the risk is outweighing the potential returns at this point, though we’ve been nervous for several weeks as the market churned higher.
Adding to our concern, we don’t like the fundamentals and see growing risks. But the market does have the Fed and its printing press going for it, and that may be enough to drive prices higher.
We aren’t doing any more selling at this point and are not looking to do any buying in the broader stock indexes, either. Finding undervalued individual companies seems to be a better play for new money, even though many are expensive at this time. As for what we are looking for, we like higher-quality and dividend paying stocks. Companies with operations overseas have seen better earnings than those who don’t. We also like smaller and mid sized stocks that don’t have a strong correlation to the broader market and Europe.
Gold has been stuck at this lower price and we like it for the long run, but it may need to move a little lower before it looks attractive to buy again.
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 popped higher this week (so prices have fallen). A short position (bet on a decline in price) has provided a nice hedge, but we think 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.
