The markets continued to reach new highs this week, not turning in a negative week so far this year. In the holiday-shortened week, the Dow was higher by 1.8%, the S&P climbed 1.1%, while the Nasdaq was again weighed down by a poorly performing Apple stock, rising just 0.5%. Gold sold off, falling 1.8%. Oil appeared to level off this week, losing only 0.2%. On the other hand, the international Brent crude moved higher, closing at $113.40 per barrel.
Source: Yahoo Finance (this chart includes Friday as we were unable to edit the timeframe)
The Dow and S&P 500 again reached new five-year highs, moving sharply (and uncomfortably) higher in the new year. Both are within inches of new all-time highs. Smaller stocks again hit new highs. It wasn’t just in the U.S. as markets around the world reached new highs of recent years.
With markets rising as fast as they have this year (the S&P 500 is up 5.4% and the Dow up 6% already), is the rally justified?
One indicator that received a lot of attention this week is called the “Dow Theory.” Basically, it states that a move in the overall Dow is justified if the Dow Transportation Average is also moving the same direction. If not, there is reason to be suspicious. As you can see in the nearby chart (courtesy of the Bespoke Investment group, LINK), the Transports have risen sharply, justifying the gains.
So with that justification, will the market keep going higher from here? Other indicators don’t paint as bright a picture. The Citi U.S. Macroeconomic Index, also referred to as the Economic Surprise Index, compares economic data to their expectations. It does a fairly decent job at predicting the direction of the market, as you can see in the chart to the left (courtesy Zerohedge.com, LINK).
Anyway, that indicator turned negative this week and could signal a downturn in the market.
Anyway, that indicator turned negative this week and could signal a downturn in the market.
Earnings released this week were also cited as justification for the rise in the market. We are in the thick of earnings season and almost half of companies in the S&P 500 have reported so far. About 67% have beaten estimates, just above the average.
Largely ignored is that the bar was set very low for these earnings, making it easier to beat. Additionally, those estimates have been revised sharply lower in recent months. Despite the optimism being reported, corporate earnings are trending lower and are not as great as they appear.
Apple grabbed much of the earnings spotlight this week. With a slight increase in revenue and flat profits, the stock tanked on concerns about future demand. It fell 12% this week (and is 37% off its high), hitting its lowest price in a year. It is safe to say the stock has fallen sharply out of favor.
Though we don’t own the stock outright and have no immediate plans to, it piques our interest when a stock becomes so unloved. Only a couple months ago, it was hard to find a person optimistic on Facebook stock (except for those who are permanently optimistic on everything). In that short time, the shares moved from a price in the high teens to now now trading in the low thirties. To paraphrase Warren Buffett, when others are fearful, you should be greedy.
Also helping this market this week was news out of Washington. The market moved higher when House Republicans passed a short term extension of the debt limit. This takes that near-term problem off the table, but sets up a fight in March over the sequester and government funding extension. It is very likely we will see some market volatility at that time.
As for economic data this week, the news leaned more towards the negative side. Reports on manufacturing showed a steady decline while housing data was mixed.
A seemingly positive report on weekly jobless claims came in at the best level in five years, receiving much fanfare. It turns out that three states, California, Virginia, and Hawaii, were unable to turn in their data due to the holiday shortened week. Therefore, their figures were estimated for the grand total.
Also adding to its unreliability, this data is especially fickle in the early part of the year due to seasonal adjustments. Unusually large adjustments are being used this year, likely skewing the data. While some of the data presented to us seems positive on the surface, a little digging is required to verify its accuracy.
Next Week
Next week will be a very busy week. Almost 20% of companies in the S&P 500 will be reporting their earnings, with a large number of technology and energy companies in that bunch.
We will also get a significant amount of economic data. Of note, we will get our first look at GDP from the last quarter and expectations are very low. The employment report for January will be released on Friday. Other economic data includes info on durable goods, housing, consumer confidence, personal income and spending, and construction spending. Whew!
Investment Strategy
We thought the market was beginning to look expensive last week, which means it looks very expensive this week. The momentum is clearly to the upside, but we are hesitant to add new money to the broader market here. Instead, we would look to lock in some gains, increase our cash position, or add downside protection (buying S&P puts, for example).
While the debt ceiling increase took the risk of political drama off the table in the near term, it is highly likely that risk will return in mid to late February.
While the odds of a market sell-off have increased, investors know the Fed looms in the background, ready to ride to the rescue. Actually, central banks around the globe are committed to more stimulus, which has probably been the single biggest factor in the new highs in the market. Though it creates problems in the long term, the temporary sugar fix will probably keep the market from experiencing a larger-than-normal sell-off.
The rest of our outlook is unchanged. We aren’t looking to do any buying in stock indexes at this point, but if a buying opportunity were to present itself 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.
We still like gold for the long term. Central banks continue to print money to stimulate their economies are 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 and a short hedged position (bet on a decline in price) has done well here. However, we think this is unlikely to continue, making the short position 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.
Largely ignored is that the bar was set very low for these earnings, making it easier to beat. Additionally, those estimates have been revised sharply lower in recent months. Despite the optimism being reported, corporate earnings are trending lower and are not as great as they appear.
Apple grabbed much of the earnings spotlight this week. With a slight increase in revenue and flat profits, the stock tanked on concerns about future demand. It fell 12% this week (and is 37% off its high), hitting its lowest price in a year. It is safe to say the stock has fallen sharply out of favor.
Though we don’t own the stock outright and have no immediate plans to, it piques our interest when a stock becomes so unloved. Only a couple months ago, it was hard to find a person optimistic on Facebook stock (except for those who are permanently optimistic on everything). In that short time, the shares moved from a price in the high teens to now now trading in the low thirties. To paraphrase Warren Buffett, when others are fearful, you should be greedy.
Also helping this market this week was news out of Washington. The market moved higher when House Republicans passed a short term extension of the debt limit. This takes that near-term problem off the table, but sets up a fight in March over the sequester and government funding extension. It is very likely we will see some market volatility at that time.
As for economic data this week, the news leaned more towards the negative side. Reports on manufacturing showed a steady decline while housing data was mixed.
A seemingly positive report on weekly jobless claims came in at the best level in five years, receiving much fanfare. It turns out that three states, California, Virginia, and Hawaii, were unable to turn in their data due to the holiday shortened week. Therefore, their figures were estimated for the grand total.
Also adding to its unreliability, this data is especially fickle in the early part of the year due to seasonal adjustments. Unusually large adjustments are being used this year, likely skewing the data. While some of the data presented to us seems positive on the surface, a little digging is required to verify its accuracy.
Next Week
Next week will be a very busy week. Almost 20% of companies in the S&P 500 will be reporting their earnings, with a large number of technology and energy companies in that bunch.
We will also get a significant amount of economic data. Of note, we will get our first look at GDP from the last quarter and expectations are very low. The employment report for January will be released on Friday. Other economic data includes info on durable goods, housing, consumer confidence, personal income and spending, and construction spending. Whew!
Investment Strategy
We thought the market was beginning to look expensive last week, which means it looks very expensive this week. The momentum is clearly to the upside, but we are hesitant to add new money to the broader market here. Instead, we would look to lock in some gains, increase our cash position, or add downside protection (buying S&P puts, for example).
While the debt ceiling increase took the risk of political drama off the table in the near term, it is highly likely that risk will return in mid to late February.
While the odds of a market sell-off have increased, investors know the Fed looms in the background, ready to ride to the rescue. Actually, central banks around the globe are committed to more stimulus, which has probably been the single biggest factor in the new highs in the market. Though it creates problems in the long term, the temporary sugar fix will probably keep the market from experiencing a larger-than-normal sell-off.
The rest of our outlook is unchanged. We aren’t looking to do any buying in stock indexes at this point, but if a buying opportunity were to present itself 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.
We still like gold for the long term. Central banks continue to print money to stimulate their economies are 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 and a short hedged position (bet on a decline in price) has done well here. However, we think this is unlikely to continue, making the short position 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.
