Finance, Insights

March Like a Russian Bear

PaulNolte-2We’re getting right back to where we started from…and according to Martha Stewart, that’s a good thing! While the markets have erased their January losses, the economic reports continue to be shrouded in snow and cold. Housing data came in better than expected last week, as new home sales jumped nearly 10%, however mortgage applications fell to their lowest level since 1995. Most of the decline is tied to refinancing activity, which is now at levels similar to crisis levels when housing was frozen. Confidence was also high after the delayed testimony from Fed Chief Yellen to Congress, reiterating the Fed’s position that interest rates would remain low well into even next year. The new month brings a raft of new economic data, including the unemployment report on Friday. Weather may still play a role in the economic releases this week, but we’ll have a few more data points to help begin drawing some conclusions about its impact.

The three week rally has investors once again confident that the Fed is on their side and low interest will force all money into the stock market. The rally to new highs has been accompanied by a strong plurality of stocks as the “advance/decline line” is making new highs as well. Investor’s sentiment is also getting bullish again, after getting very pessimistic at the end of January. The SP500 sits precariously at the 1850 level that provided resistance through the early weeks of January and once again is proving to be a formidable barrier. Friday’s move significantly higher, only to fall later in the day has been symptomatic of the market of late, very strong out of the gate, only to limp into the close. The patter of strong opens and weak closes has been the hallmark of February’s strength, with roughly 63% of the month’s gain coming in the first hour of trading. Typically the retail investor is buying in the first hour, with “smart” buying occurring in the last hour. The rally back to the yearly highs has come on weaker momentum than in late 2013, fewer new highs and weaker volume. These divergences don’t necessarily mean the market is doomed in the months ahead, just a warning sign that the markets are not as healthy as they were last year. This may lead to continued volatility that has so far marked this very young new year.

From May to October of last year, the bond market was under pressure, with many believing the low rate environment has ended and interest rates were destined for significantly higher levels. Beginning in late September, the bond model has provided only one weekly negative reading, indicating lower rates were ahead. The bond index has also spent the last four weeks above its long-term average, which it has been below since last May. A strong bond market has usually meant a competitive return to stocks. Bond performance has matched stocks since Christmas, without the large daily swings. The environment continues to be favorable for bond investors both from an economic and historical perspective. Bonds have tended to perform well into the spring and again in the fall. With inflation pressures still low, bonds could be one of the surprising investments in 2014.

While the markets have rallied back, it is the composition of that rally that is a bit disconcerting, as the more defensive parts of the markets are doing well. The bond market as highlighted above, has bested stocks so far this year as have the utilities and healthcare sectors. Financial stocks, which were strong all last year, have also floundered and are now being led by REITs (which are part of the financial sector), a very defensive part of the market. Looking at individual stocks, the big winners have been the more speculative issues including biotech and merger “stories”. This dichotomy within the markets usually resolve in favor of the broader industry groups, meaning the more speculative portions of the markets come back to earth. This is also true within the very broad asset classes, as bonds, REITs have percolated back toward the top performers, while emerging markets and the large cap stocks have, so far, performed poorly this year. This may just be part of a corrective process that the markets are going through before pushing to ever higher levels later this year, however the shift in asset classes and industry groups below the market’s surface indicate a rising caution within the markets. If the markets remain focused on the defensive parts of the markets, another correction could be in the near future to keep investors off balance.

The market internals are beginning to flash a few warning signs, but nothing to worry that a major shift in the markets lies ahead, just a bumpy ride. Sentiment is once again very bullish, which tends to be negative for stocks in the short run. Bond investors have enjoyed nice returns without the jarring ride. If the stock market remains volatile, bond investors will continue to be rewarded this year.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.