I update each Saturday with my view of the stock market for the next few weeks. The monthly “Long Term” update will be on a Wednesday soon after the 15th of each month, and this supports investors who want to buy and hold, but want to sell to avoid the bulk of a crash, and buy back in for most of the next bull market. You can always scroll down a few weeks and find the latest “Long Term” update.
In a mixed report that confirms a reputation for unusual volatility, new home sales swung 11.4 percent lower in April to a much lower-than-expected annualized rate of 569,000. In the latest bad news for April housing, existing home sales fell 2.3 percent in the month following similar weakness in yesterday’s new home sales report. Crude oil inventories fell by a larger-than-expected 4.4 million barrels in the May 19 week to 516.3 million, extending the drawdown streak to 7 consecutive weeks. Jobless claims continue to hold near record lows and continue to point to solid strength in the labor market. Initial claims edged 1,000 higher in the May 20 week to 234,000. Durable goods orders, down 0.7 percent in April, do not confirm the month’s big jump in industrial production nor all the strength in the regional factory reports. First-quarter GDP gets a small but much needed upgrade in its first revision, now at a 1.2 percent rate of annualized growth which is nearly double the initial report of +.7 percent. Corporate profits rose 12.0 percent year-on-year in first-quarter 2017, an excellent showing. That is not due to just cost cutting, as the employment picture have been very strong. Consumer sentiment is holding steady at optimistic levels, posting a final May reading of 97.1 which is up 1 tenth from April’s final.
The economy looks good, especially the upgrade of first quarter GDP to 1.2% growth, and the strength in corporate profits. The softness in home sales and durable goods orders are bothersome. Home sales usually rise April – July as school is ending and it is a good time to move, so the weakness is a concern. Did low rates pull sales forward and now that rates are moving up, is it pushing home affordability out of the reach of working folks? Durable goods orders are a view of the future, they become sales when they are shipped and invoiced. It’s a cautionary note, although the service sector is now much bigger than the manufacturing sector.
The Fed released the minutes from its May meeting and took no action on interest rates. The following excerpts are the highlights:
“Expecting economic weakness in March to prove temporary, most members said a rate hike would be coming “soon”. And expectations in fact are strong that the FOMC will, at the upcoming meeting in June, raise its target range by a 1/4 point to a 1.0 percent midpoint.
Today’s minutes also offer a proposed structure for tapering using “gradually increasing caps” aimed at unwinding the Fed’s $4.5 trillion balance sheet in a predictable manner. These “caps” would limit the amount of Treasury and agency securities that would be allowed each month to run off (not reinvested and moved out of the financial markets). This would fix the pace that the balance sheet is reduced. These caps would be initially set at low levels and then raised every three months making for a gradually increasing pace of stimulus withdrawal.”
The interesting part is the unwinding of the Fed balance sheet. The Fed bought bonds of all durations during their QE (quantitative easing) program which was designed to drive down longer term interest rates. The Fed provided a bid on bonds, and if you wanted some bonds, you had to outbid the government, driving the price up and the yield down on bonds. This expanded the Fed balance sheet (inventory of bonds) from $1 trillion, to $4.5 trillion. As short term bonds have matured, the Fed has bought new short term bonds with the proceeds, putting a bid under those bonds and keeping rates lower than natural. Now, based on a schedule, let’s say $10 billion of 90-day notes mature and the principal goes to the Fed, they will buy $5 billion of bonds and hold the other 5 billion to loan to banks. Some of the bid will leave the bond market, which will have to be made up by bids from other financial institutions in the private market. Private players have the objective of capturing as much yield as possible, so they will probably bid less for the bonds than the Fed did, and that will put gradual pressure on rates to rise. Investors from Europe still like US bonds as their yields are held low by the ECB, but even the ECB has been making noise about ending extraordinary accommodation, and if they do, that would remove another bid for bonds, which would put downward pressure on bond prices and upward pressure on rates.
The bottom line: I have not liked bond funds or long term bonds for several years, and while I was very early in disliking them, the reason I disliked them has finally arrived. The Fed was accommodative for much longer than they ever have been, a “black swan event”. The market will always do what it is supposed to do. Picking the time when the market will do what it is supposed to, is difficult.
TLT, a long term bond ETF holding treasuries, is down 10% since last summer. Making 3% interest while losing 10% of your principal is a disaster. This situation has a long way to go on the downside. The Fed will move slowly to try and avoid an all-out bond market panic, but there is no guarantee on that.
Why do I watch interest rates so closely in my stock market analysis? One, it is the Fed’s tool to stimulate or cool the economy. Two, the cost of capital is a major expense to business when they want to expand, so if their cost of borrowing rises, their profitability will fall a bit.
The market sold off hard last Wed. (the 17th) on news that Comey had documented when Trump asked him to let go of the Flynn investigation. I took that as not significant to the market beyond a short term shock, and I started buying on Thur. the 18th and continued on Friday and Monday. The market recovered its loss quickly so I quit buying, and as the market neared overbought status, I sold out on Thur. this week. The S&P set a new record high on Thur. and while it usually follows thru to the upside, I’m running around visiting my new grandson and just can’t watch the market that close on a daily basis at the moment. I had a good one week profit, I took it, and I have to live life for a few days.
Technically RSI has zoomed up to near overbought at 62, and MACD has turned positive this week showing good momentum. The fact that we broke out above the potential double top and moved to a new high is very good news, confirming the bull market is still in effect. I don’t want to be a buyer at near overbought levels, but I will plan to buy the next dip. Technically, if I was going to be watching the market closely, I would have stayed in a little longer and let the market show me what it was going to do. I just don’t sense a lot of strength here, but I could be wrong.
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Rich Comeau, Rich Investing