Stocks continued to reach new highs this week. Through the close Friday, the Dow was higher by 1.1%, the S&P gained 0.9%, and the Nasdaq rose 0.7%. Bond yields moved lower again, nearing their lowest level in almost four months (so prices hit a four-month high). Gold kept moving higher, too, up 2.9% on the week. Oil hit its lowest level in four months, falling 3.2% to $97.85 per barrel. The other major type of oil, Brent, used in much of our gas here in the East, fell to $107.
Source: Yahoo Finance
Stocks crept higher this week, actually helped by poor economic data. The delayed September employment report was released on Tuesday, underwhelming at a gain of only 148,000 jobs on the month. Economists were looking for an increase closer to 180,000.
Since this number was lower than expected and showed a slower pace of job gains from the early part of the year, it was reassuring to investors. It meant that the Fed would not be pulling back on its stimulus program any time soon, so stocks popped higher on the news.
In fact, it looks like economists think the Fed won’t pull back on its money printing until March, 2014. Only a few weeks ago they were expecting a reduction in stimulus by September of this year.
It is clear that the actions of the Fed have pushed the market higher. It is less clear how effective it has been in actually helping the economy. After five years of these extraordinary measures, we would expect to see better jobs growth than a meager 148k. A change of course is needed, but seems very unlikely. We worry that this “solution” will end up doing more harm than good.
As stocks keep climbing, we are seeing a significant increase in the red flags being raised. Valuation indicators like price-to-earnings or market cap-to-GDP are above their historical norms. Investor sentiment from the American Association of Individual Investors (AAII) shows investors are the most optimistic in 10 months and least pessimistic in almost two years. Plus we’re seeing the highest amount of borrowing to buy stocks (referred to as margin) on record.
Additionally, many big name investors with long, successful track records are returning money to investors, citing fewer investment opportunities available.
We’re also seeing over-exuberance in momentum driven stocks. Last week we mentioned the hype around Google crossing the $1,000 a share mark. Other names in this group include stocks like Tesla (up 404% year-to-date), Netflix (up 260%), Pandora (up 194%), LinkedIn (up 112%), Facebook (up 98%), and Priceline (up 73%). All appear severely overvalued, yet nothing had been able to slow them down. The chart below (LINK) shows the run they’ve had so far this year. While their gains may be appealing, these momentum stocks can turn on a dime and usually fall much faster than they rise.
Since this number was lower than expected and showed a slower pace of job gains from the early part of the year, it was reassuring to investors. It meant that the Fed would not be pulling back on its stimulus program any time soon, so stocks popped higher on the news.
In fact, it looks like economists think the Fed won’t pull back on its money printing until March, 2014. Only a few weeks ago they were expecting a reduction in stimulus by September of this year.
It is clear that the actions of the Fed have pushed the market higher. It is less clear how effective it has been in actually helping the economy. After five years of these extraordinary measures, we would expect to see better jobs growth than a meager 148k. A change of course is needed, but seems very unlikely. We worry that this “solution” will end up doing more harm than good.
As stocks keep climbing, we are seeing a significant increase in the red flags being raised. Valuation indicators like price-to-earnings or market cap-to-GDP are above their historical norms. Investor sentiment from the American Association of Individual Investors (AAII) shows investors are the most optimistic in 10 months and least pessimistic in almost two years. Plus we’re seeing the highest amount of borrowing to buy stocks (referred to as margin) on record.
Additionally, many big name investors with long, successful track records are returning money to investors, citing fewer investment opportunities available.
We’re also seeing over-exuberance in momentum driven stocks. Last week we mentioned the hype around Google crossing the $1,000 a share mark. Other names in this group include stocks like Tesla (up 404% year-to-date), Netflix (up 260%), Pandora (up 194%), LinkedIn (up 112%), Facebook (up 98%), and Priceline (up 73%). All appear severely overvalued, yet nothing had been able to slow them down. The chart below (LINK) shows the run they’ve had so far this year. While their gains may be appealing, these momentum stocks can turn on a dime and usually fall much faster than they rise.
The excitement around stocks in this sector took a hit this week, though. Netflix rose 10% overnight after posting improved earnings. The CEO, Reed Hastings, came out the next morning and mentioned worries over the “euphoria” surrounding the stock. These remarks pricked the bubble and sent the stock down 6% for the day. It also sent other momentum-driven stocks lower, most of them closing the week in the red.
In a normal market, all these red flags would receive a lot of attention and frankly, there have been red flags for a while now. But as long as the Fed keeps printing money, stocks keep moving higher.
Finally, it looks like a new, reliable metric for determining the direction of the market is…the World Series. A St. Louis paper reports that in the year following a St. Louis World Series victory, stocks on average rose 12.4%. On the other hand, a Boston win averaged only a 0.2% growth. It’s clear that investors should be cheering for a Cardinal win.
Next Week
We’ll get another busy week next week. Corporate earnings continue to come in at a strong pace. As for economic data, we’ll see reports on inflation at the consumer and producer levels, retail sales, and info on industrial production and manufacturing.
The Fed will also be in the news as they make their announcement on the level for interest rates. A few weeks ago, many investors thought they would announce a reduction in the stimulus at this meeting. The government shutdown and poor economic data make that highly unlikely now, though.
Investment Strategy
No change here. Above we mentioned serious concerns for the longer run. In the shorter run, though, stocks probably have a little more room to run. Especially as long as the Fed keeps printing money.
We wouldn’t add any new money to stock market indexes at this point, instead looking for undervalued individual names to invest in. Fundamental analysis tells us how good a company is while the technical (or chart) side gives us a good idea of when to buy. We would avoid stocks in sectors with a strong correlation to the broader stock market and interest rates. Our timeframe is shorter (looking out a couple weeks or months), so we can keep one foot out the door in case the market turns abruptly.
In bonds, yields have fallen (so prices have risen). We see yields rising (and therefore prices falling) when it looks like the Fed will pull back on its stimulus, but that doesn’t seem likely in the near term. A short position (bet on the decline in prices) will do well at that point, but serves only as a nice hedge now. It isn’t intended to be a longer term investment.
TIPs have showed some recent improvement, and remain an important hedge against future inflation. Municipal bonds are in the same boat and work for the right client. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold had a nice week this week, but has had a shaky stretch in the longer term. It’s good for a hedge here, but caution is warranted.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth seems to be weighing on commodity prices here, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we are still not interested in developed markets and 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.
In a normal market, all these red flags would receive a lot of attention and frankly, there have been red flags for a while now. But as long as the Fed keeps printing money, stocks keep moving higher.
Finally, it looks like a new, reliable metric for determining the direction of the market is…the World Series. A St. Louis paper reports that in the year following a St. Louis World Series victory, stocks on average rose 12.4%. On the other hand, a Boston win averaged only a 0.2% growth. It’s clear that investors should be cheering for a Cardinal win.
Next Week
We’ll get another busy week next week. Corporate earnings continue to come in at a strong pace. As for economic data, we’ll see reports on inflation at the consumer and producer levels, retail sales, and info on industrial production and manufacturing.
The Fed will also be in the news as they make their announcement on the level for interest rates. A few weeks ago, many investors thought they would announce a reduction in the stimulus at this meeting. The government shutdown and poor economic data make that highly unlikely now, though.
Investment Strategy
No change here. Above we mentioned serious concerns for the longer run. In the shorter run, though, stocks probably have a little more room to run. Especially as long as the Fed keeps printing money.
We wouldn’t add any new money to stock market indexes at this point, instead looking for undervalued individual names to invest in. Fundamental analysis tells us how good a company is while the technical (or chart) side gives us a good idea of when to buy. We would avoid stocks in sectors with a strong correlation to the broader stock market and interest rates. Our timeframe is shorter (looking out a couple weeks or months), so we can keep one foot out the door in case the market turns abruptly.
In bonds, yields have fallen (so prices have risen). We see yields rising (and therefore prices falling) when it looks like the Fed will pull back on its stimulus, but that doesn’t seem likely in the near term. A short position (bet on the decline in prices) will do well at that point, but serves only as a nice hedge now. It isn’t intended to be a longer term investment.
TIPs have showed some recent improvement, and remain an important hedge against future inflation. Municipal bonds are in the same boat and work for the right client. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. We keep a longer term focus with these investments.
Gold had a nice week this week, but has had a shaky stretch in the longer term. It’s good for a hedge here, but caution is warranted.
We like other commodities for the long term, especially due to weaker currencies around the globe. A slowdown in global growth seems to be weighing on commodity prices here, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we are still not interested in developed markets and 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.
