Steady As She Goes
It was a huge build up to crescendo levels. It was to be very important for the market, providing direction for investors for the coming month. Instead of something surprising, the employment report and comments from European Central Banker Mario Draghi were exactly as expected. In many ways the lack of a surprise in itself was surprising. It is a rare occurrence that economists actually get the numbers correct. Mr. Draghi pushed rates lower and made them even negative for bankers in hopes to spur lending and once again grease the economic wheels in Europe that seem to have been slow moving recently. The much anticipated employment report lacked any sizzle, coming in as expected with little revisions to prior months. All the job losses from the recession have now been recovered, six years later. Wage growth has picked up some, but remains at relatively low levels. The other economic reports during last week remain supportive of a slowly growing economy that shows little signs of falling into a recession. As a result, stocks and bonds acted accordingly as stocks rose on the week, while bonds slipped a bit. Summer on Wall Street has begun and the living is easy!
Market pundits are wringing their hands about the low volatility in the markets and the impending doom that usually follows such slow periods. What many miss is market losses mount once volatility picks up, not during the “quiet period”. Just how persistent has this market been so far? Of the 22 weeks this year, the markets have declined in merely 6 of those weeks, with only one back-to-back weekly decline. There have been three separate periods where the markets have gained at least three weeks in a row. Investors have taken notice and have become very bullish in their market views. Investor Intelligence reads of the past week is the highest in over seven years. Even professional sentiment readings are among the highest in years. What is and continues to be the case with the market is that the bulk of the stocks are rising, with many making new yearly highs. It is not in this environment that bear markets are born. Corrections, certainly, but prolonged declines are born from rising “averages” without the support of most of the underlying stocks. Those conditions are not yet present and lead us to call for little more than a garden variety 3-5% decline at any point in the future.
The stronger manufacturing reports early last week and better employment data did push bond prices down a bit last week. Admittedly, the rally in bonds has been terrific so far this year and some giveback can be expected. Inflation figures due out next week are likely to support the idea that inflation remains relatively low from a historical perspective. Our reading of the bond market is similar to stocks, some declines, but relatively small in the big scheme of things. Wage growth in the latest employment report was good however only at 2.5%. By way of comparison, this has been the low point of wage growth over the past 30 years. If/when growth gets above 4% annually then we can worry.
Like an office elevator bank, the industry groups within the SP500 move up and down in a rather random fashion. The trick is to be overweighted when they are moving higher and underweight when moving lower. That generally requires much more trading than is normal for long-term investors. It is instructive though to know where in the cycle various industry groups perform best. For example, in a “normal” business cycle, the groups that perform best as the economy is recovering tend to be energy and basic materials. The basic material group has been performing well vs. the SP500 for the past year, while energy has just recently kicked into gear. As the business cycle begins to peak, healthcare and utilities tend to lead as investors begin looking for more defensive sectors that do well in an economic downturn. Up until
recently, healthcare has been doing very well for two years. Utilities have had 3 month windows of good performance vs. the SP500. So based upon the industry group performance, where are we in the economic cycle? It is never as neat or clean as the textbook, but an educated guess would put the economy in the mid-recovery stage as a “booming” economy remains yet ahead.
The SP500 has had four positive weeks and seven of the last eight have been higher as well. As long as investors believe the Federal Reserve will keep the party going with easy monetary policy, whether through quantitative easing or low interest rates, the markets should continue to have a positive bias. Bond investors have benefited as well. Like stock investors, the forced low rates will provide a tailwind until the recovery becoming a booming recovery.
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.