Market Party Should Continue Until at Least May

by: Finance Banter

Super Bowl weekend has come and gone with one of the original teams winning, it now assures a winning year for stocks. Actually it didn’t matter who won, as both have been around for over 70 years. But more importantly is the butter production in Bangladesh, as that seems to have an even better correlation between market gains than the Super Bowl winner. Now, if I could just find that website!

The monthly economic version of the Super Bowl was the employment report, which unfortunately had few declared winners. Blaming the weather for rather punk numbers (well below expectations), this report also revised the past two years – much lower. The weekly jobless claims figures are once again trying to get below the magic 400,000 mark. So if people were able to get to the claims office for the weekly check, why was the employment report skewed by snow? Hopefully this will get all straightened out by early March when the weather should be more conducive to getting a job (or getting jobless benefits). This months report provided little decent information on the key employment situation.

The equity markets continued their push to ever-higher ground on the better than expected news from the Institute for Supply Management (formerly the purchasing managers index. Both the manufacturing and services indices came in better than expected, however both showed noticeable increases in prices paid, that so far, are not being passed through to the consumer. Egypt also remained front and center as investors continued to wrangle with the economic implications (for now mainly energy) of what has been so far a very fluid situation.

The focus on the S&P500 stocks in January has given way to the commodity and small cap issues that had starred during much of the fourth quarter. There are plenty of things to worry about regarding equities, from generally very low trading volume to equities priced richly on very high margins, to high and rising commodity prices around the world.

Bernanke, in his public press conference (something rather new) indicated that the Fed was on the job and took credit for the higher equity prices, but passed the responsibility for higher commodity prices to growth in China/India. For now, the continued flow of funds from the Federal Reserve purchases of Treasury securities will keep a bid under stock prices, so any correction is likely to be (even if sharp) rather short as investors seem to be itching to get into the markets. Since the Fed intervention is to last until June, the party continues at least into May.

Long-term bond prices continue to decline (pushing yields higher) and creating a historically steep yield curve. As short-term rates are anchored at near zero, bond investors have been requiring a higher yield to compensate them for what is being seen as rising inflationary pressures that may begin showing up in the “official” data later this year. As a result, bond mutual funds that hold long-term bonds and even individual bonds have declined in price.

What has been holding up a bit better for income investors have been corporate bonds, benefiting from improved corporate balance sheets (and in some cases upgrades in quality ratings), convertible bonds that provide some equity exposure and preferred stocks. For individual clients looking for income, we are using a combination of all three.

There have been some changes in the overall asset classes based upon performance of the various asset classes. Emerging markets, once the darling of the equity markets and still showing a gain since September, have weakened considerably as compared to their S&P500 brethren.

One other asset class that has had a very good run, but is beginning to wane are REITs. Here too, the SP&500 has far outpaced the gains from the REIT markets as investors begin to focus on the large U.S. multinational companies and begin to shy away from the international scene (maybe due to the continued turmoil). REITs may also be suffering from the rising rate environment that has hurt bond investors as well. This also follows the industry groups of the S&P500, where the more interest-rate-sensitive groups like utilities and some of the higher yielding consumer/healthcare stocks are lagging the broader averages. Meanwhile, the industrial/commodity companies remain dominant performers for the overall market. At some point this trend will reverse, but as of now the signs are not yet there.

The much anticipated employment report was greeted with a yawn on Wall Street. However, as discussed above, the changing performance dynamic of the markets are requiring the review of our holdings in REITs and emerging markets. Fixed income investors may find better opportunities outside of the traditional bond world by looking at convertible securities or preferred stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: 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.