It’s summertime and the livin’ is easy. Thoughts of hanging at the beach in a favorite chair with the waves tickling your feet or the taste of a freshly grilled burger and corn on the cob is enough to make anyone high tail it out of the office early. And so it seemed on Wall Street, as investors got a week long jump on the three day holiday. From the tepid employment data to the slowest trading of the year, investors managed to push the markets just a smidge higher on the week. Investors did get excited, for a bit, about the core rate of inflation (which strips out food and energy), as it rose at the fastest pace in two years and if annualized, is above the Fed’s target of 2%. However, when looking at the rate on a year/year basis, it is in the range of inflation (1.6-1.8%) that has existed for the past three years. As if to confirm the less than stellar economic data, Fed Chief Yellen made a statement on Friday that the Fed will raise rates this year, but just not yet. They remain in a wait and see mode. The coming holiday shortened week will have little in the way of “big” economic data and a few Fed governors speaking, so as with last week, next week should be another yawner. Comments around Greece (again) from the G-7 and the second revision to GDP are on the calendar, but should not provide much in the way of early summer fireworks.
As mentioned above, daily trading volume was as slow this week as the Christmas holiday. Not that volume has been spectacular so far this year, as trading is below the same period last year. As the vacation season ramps up in the coming weeks, we normally see volume diminish. However, when looking at the summer trading volume, each year over the past six, trading volume has been less than the year prior. Why do trading volumes matter? When activity levels begin to decline, it takes that much less to move markets. So you are apt to see more volatility in thinner markets. That said, we also see large moves on huge volume, but that tends to be near an exhaustion phase and can signal a change in direction. Lower trading volume means fewer players are “determining” prices and may also be symptomatic of an investing public that is not interested in the markets. The last few weeks, although the markets have headed marginally higher, more stocks have declined than advanced. This means fewer stocks are pushing the averages up. Combined with low volume, these set of conditions could argue for at least a modest correction as we enter June.
For the first time in two years, the bond model has registered four consecutive weeks of negative readings. Two year treasury bonds have been moving higher in yield (lower in price) for the last six months. Long-term bonds are a quarter point higher in yield than at the end of the year. Utilities, one component of the model, have lost their luster this year. Finally, commodities are the only part of the model that is “positive” by declining this year. We have been broadly shielded from higher interest rates due to the part of the bond market we invest in, however if interest rates begin to really move higher, very few parts of the market will be left unscathed. The best defense is to actually own the individual bonds, as they will at least return principal upon maturity.
Save for the sell-off last October, the broad market has been stuck in a “momentum range” for the past nine months. On a 0-100 scale, the momentum readings have been in a narrow 50-60 range. Many other measures of investor complacency, sentiment and volatility are similarly stuck in a range. All that said, there are some shifts taking place, specifically in the interest rate sensitive parts of the markets. Utilities are highlighted above and real estate trusts (REITs) have also fallen below their long-term trend lines for only the third week in the past fifteen months. The erosion in these sectors say more about interest rates (and the likelihood of an increase) than they do about the broader market. There are some signs of deterioration that could lead to more than the pedestrian 3-5% declines experienced over the last two years. But in order for the market to suffer a significant decline, a recession needs to be looming. As of yet, the economic indicators do not point to that possibility.
Even though the markets have been looking tired for the past month, they have managed to eke out weekly gains. Markets outside of the US continue to perform well, although the recent strength in the dollar has taken some of the luster from international markets. The long-term play, in our opinion, is outside of the US and in the beaten down energy sector. The bond market is giving off signals that rates will be rising very soon. As such, we have been slowly reducing exposure to long-term bonds and more interest rate sensitive parts of the markets.
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.