By Thomas J. Smith
The market continues to send mixed signals. These signals are making some nervous and others remain firmly in their respective bull or bear camps. The technical condition of small cap stocks remains weak relative to their large cap brethren. Value continues to outperform growth.
The signal that has the most people gnashing their teeth currently is the recent trend in bond yields. Leading economic indicators (LEIs) and bond yields tend to be highly correlated. Improving numbers on the LEI front tend to coincide with rising bond yields. That has not been the case over the past several weeks. We have also seen a steady improvement in employment numbers. This is not a scenario that leads to falling yields.
One factor that has to be examined in the yield picture is what is going on in Europe. European growth rates are slowing and the general consensus is that the bankers in Europe are going to be extremely accommodative going forward. Many investors have jumped on this and bid up European bonds in anticipation of central bank actions in Europe. This surge in buying has brought down yields of comparable maturity European bonds relative to U.S. issues. Since the payoff for taking the greater risk of owning foreign bonds has greatly decreased recently, many are just adding to U.S. bonds and thereby reducing rates. This action and the injection of stimulus by our Fed are the driving factors for the trend in rates here, in my opinion.
The continued positive relative performance of the industrial sector bodes well for our economy. This goes back to the title of this week's piece. To some, the bond market is signaling a slowdown in our economy. U.S. industrial stocks do not reflect this same opinion. Industrials continue to be a leadership group. This is an important trend. As long as industrials in general and the transports in particular continue to perform well I will be willing to give the U.S. economy the benefit of the doubt. I will keep you informed on how this sector performs going forward.
Value stocks continue to outperform more growth oriented issues. Many momentum names in small cap land provided superlative performance last year. That outperformance simply was stretched too far and many momentum oriented names continue to correct. Names that provide a more predictable earnings stream with storing, and rising, dividends are in favor at the moment.
The technical picture of the market underscores the fact that large caps are currently in favor. The S&P 500 and Dow are in far better shape than the NASDAQ and Russell 2000 averages. As we enter the summer months, and a mid-term election later in the year, investors are becoming more defensive.
The four averages I update you on are the S&P 500/Dow/NASDAQ and Russell 2000. Here are the intermediate term support and resistance levels for these averages: 1813/16,000/4000/1080 and 1904/16,740/4200/1165. There have been a series of divergences lately, both positive and negative. They have done a pretty good job of pointing us to turning points. Remember, a positive divergence takes place when some but not all of the averages see their support levels breached. The opposite is true for a negative divergence.