A sharp drop Friday wiped out a week’s worth of gains in stocks. For the week, the Dow lost 0.8%, the S&P posted the smallest gain possible of just 0.01%, and the Nasdaq gained 0.4%. Gold continued its trend lower, falling 0.5% on the week. Oil saw the week close with little change, up 0.1% to just over $102 per barrel. The international Brent oil, primarily used for our gas here in the east, moved higher to $108.13 per barrel.
Source: Yahoo Finance
This week was fairly uneventful in terms of market-moving news. There was only a handful of economic data, while the geopolitical events with Ukraine/Russia and Israel/Gaza remained just as bad as they have been. This allowed investors to focus on corporate earnings releases.
This was the peak week for corporate earnings with nearly 30% of companies in the S&P 500 reporting their results – and the results have been good. Per Factset, companies are on pace to grow earnings 5.6% year-over-year in the second quarter. This is an improvement in estimates we saw heading into earnings season, where analysts expected a 4.9% increase. Revenue growth has been modest (revenue is what a company makes through sales, earnings are what remain after costs are subtracted), but decent relative to its recent performance, climbing 3.1% over the past year.
While these numbers have been good and stocks are up, we worry the market is becoming overly optimistic and complacent. A couple indicators we watch are signaling caution – high yield bonds and small cap stocks. When either of these moves one direction, it often signals the broader market will follow.
High yield bonds (or junk bonds, the least credit-worthy and riskiest bonds) show how much risk investors are looking to take and can forecast trends in an economy. Small cap stocks are slightly less reliable as an indicator than high yields, but are important because smaller companies tend to rely more on the domestic economy. They, too, can signal coming trends.
This week, both high yield bonds and small cap stocks continued to move lower. High yield bonds saw the largest amount of selling in a year as prices hit three-month lows. Small cap stocks saw a similar sell-off, notching their third straight week lower. While these aren’t always correct as leading indicators, it does signal to be a little cautious.
Below is a two-year chart showing how closely the S&P 500 trades to the high yield bond index. The S&P is in orange, high yield bonds in black. While it isn’t perfect (nothing is), it can be a good guide to watch.
This was the peak week for corporate earnings with nearly 30% of companies in the S&P 500 reporting their results – and the results have been good. Per Factset, companies are on pace to grow earnings 5.6% year-over-year in the second quarter. This is an improvement in estimates we saw heading into earnings season, where analysts expected a 4.9% increase. Revenue growth has been modest (revenue is what a company makes through sales, earnings are what remain after costs are subtracted), but decent relative to its recent performance, climbing 3.1% over the past year.
While these numbers have been good and stocks are up, we worry the market is becoming overly optimistic and complacent. A couple indicators we watch are signaling caution – high yield bonds and small cap stocks. When either of these moves one direction, it often signals the broader market will follow.
High yield bonds (or junk bonds, the least credit-worthy and riskiest bonds) show how much risk investors are looking to take and can forecast trends in an economy. Small cap stocks are slightly less reliable as an indicator than high yields, but are important because smaller companies tend to rely more on the domestic economy. They, too, can signal coming trends.
This week, both high yield bonds and small cap stocks continued to move lower. High yield bonds saw the largest amount of selling in a year as prices hit three-month lows. Small cap stocks saw a similar sell-off, notching their third straight week lower. While these aren’t always correct as leading indicators, it does signal to be a little cautious.
Below is a two-year chart showing how closely the S&P 500 trades to the high yield bond index. The S&P is in orange, high yield bonds in black. While it isn’t perfect (nothing is), it can be a good guide to watch.
Moving on to economic data for the week, we received information on inflation at the consumer level. The Fed has been pumping up the economy to create inflation above 2%, thinking it will lead to economic growth (which we disagree with), and that is what they continue to get. The CPI report shows inflation of 2.1% on an annualized basis, the third straight month above 2%. It signals inflation is heating up, but any regular shopper doesn’t need a government report to tell them that.
As for other economic data, weekly jobless claims hit their best level in over eight years, though they can be volatile this time of year. Also, housing data was mixed as previously owned home sales improved while new home sales fell.
Next Week
While this week saw little in the way of economic data, next week will be the exact opposite. We’ll get info on several important economic metrics, including second quarter GDP and July’s employment figures, plus info on housing, consumer confidence, and manufacturing.
It will also be another busy week for corporate earnings, with nearly 30% of companies in the S&P reporting their results.
Finally, the Fed will also have an impact on the market with another of their policy meetings. They are nearing the end of their bond buying (money printing) stimulus program, so no surprises are expected there. However, investors will be closely watching for any clues on interest rates. They have pledged to keep rates low for long, but with improving economic conditions, many are expecting and increase sooner than expected.
Investment Strategy
Still no change here. We expressed our caution on the market in the above section, pointing out how high yield bonds and small cap stocks have moved lower recently. We worry this may indicate a downturn in the broader market. Friday’s drop in the market may have been part of that.
While we may just see a modest drop at this point, we fear a much larger sell-off is in the future, but first there will be a trigger to set it off. We only need to look at the sharp drop in stocks after the recent Portuguese bank problems to see how jittery markets currently are. Today’s debt levels are much higher than at the peak of the debt crisis, but bond yields are the lowest levels they’ve been in hundreds of years in some cases. This indicates little fear. We think these debt issues and low interest rates are leading to bad investments that will someday correct sharply. Now doesn’t seem to be that time, though.
While we are cautious, we are not yet selling. If putting new money to work, we prefer finding undervalued individual names to invest in. We look at a company’s fundamentals to tell us if it is worth buying, and technical analysis, or the charts, tell us if it is a good time to buy.
On bonds, prices fell this week (so bond yields rose), but they remain volatile. Despite this move, prices have been in this flat range for nearly a year now, so they haven’t established a trend either way. With prices so high, though, it increases the chance they will fall in the future. A position to profit in this scenario (a short position, where your profit increases if prices fall) acts as a nice hedge in that case. Floating rate bonds are also gaining popularity for this same reason, but they tend to be riskier, so caution is warranted.
Bonds to protect against inflation, or TIPs, have done well on the recent higher inflation data. We think they remain an important hedge against future inflation and are likely to do well as inflation increases. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. 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 is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines and has been stuck in the same range for over a year now. Still, it is a good hedge if things go south.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
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.
As for other economic data, weekly jobless claims hit their best level in over eight years, though they can be volatile this time of year. Also, housing data was mixed as previously owned home sales improved while new home sales fell.
Next Week
While this week saw little in the way of economic data, next week will be the exact opposite. We’ll get info on several important economic metrics, including second quarter GDP and July’s employment figures, plus info on housing, consumer confidence, and manufacturing.
It will also be another busy week for corporate earnings, with nearly 30% of companies in the S&P reporting their results.
Finally, the Fed will also have an impact on the market with another of their policy meetings. They are nearing the end of their bond buying (money printing) stimulus program, so no surprises are expected there. However, investors will be closely watching for any clues on interest rates. They have pledged to keep rates low for long, but with improving economic conditions, many are expecting and increase sooner than expected.
Investment Strategy
Still no change here. We expressed our caution on the market in the above section, pointing out how high yield bonds and small cap stocks have moved lower recently. We worry this may indicate a downturn in the broader market. Friday’s drop in the market may have been part of that.
While we may just see a modest drop at this point, we fear a much larger sell-off is in the future, but first there will be a trigger to set it off. We only need to look at the sharp drop in stocks after the recent Portuguese bank problems to see how jittery markets currently are. Today’s debt levels are much higher than at the peak of the debt crisis, but bond yields are the lowest levels they’ve been in hundreds of years in some cases. This indicates little fear. We think these debt issues and low interest rates are leading to bad investments that will someday correct sharply. Now doesn’t seem to be that time, though.
While we are cautious, we are not yet selling. If putting new money to work, we prefer finding undervalued individual names to invest in. We look at a company’s fundamentals to tell us if it is worth buying, and technical analysis, or the charts, tell us if it is a good time to buy.
On bonds, prices fell this week (so bond yields rose), but they remain volatile. Despite this move, prices have been in this flat range for nearly a year now, so they haven’t established a trend either way. With prices so high, though, it increases the chance they will fall in the future. A position to profit in this scenario (a short position, where your profit increases if prices fall) acts as a nice hedge in that case. Floating rate bonds are also gaining popularity for this same reason, but they tend to be riskier, so caution is warranted.
Bonds to protect against inflation, or TIPs, have done well on the recent higher inflation data. We think they remain an important hedge against future inflation and are likely to do well as inflation increases. Some municipal bonds look attractive for the right client, but not as good as they did several months ago. 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 is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical worries and falling once they are out of the headlines and has been stuck in the same range for over a year now. Still, it is a good hedge if things go south.
We like other commodities for the long term, especially due to weaker currencies around the globe. This is a longer-term play, so buying on the dips may work with a longer time horizon.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets.
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.
