The Return of the Bear

Let’s go way, way back in time and look at the stock market. I’m talking about that time long ago when the S&P 500 had dropped through the floor and had “crashed” down to 1863. Now to understand the significance of the “crash”, you must remember that--back even farther--the S&P 500 stood at about 2011. This means that the S&P 500 had dropped more than 7%.

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The Long View

I always find it interesting to listen to news reports about the stock market. When it is just coasting along, it is not newsworthy. When it is going up, it does not appear to be newsworthy. But, when the markets move down – it is newsworthy! Thus we have been hearing a great deal about the recent market swoon. To put this in perspective, consider that since the middle of last year the market has been moving up quite nicely. This isn’t to say that there haven’t been some bumps along the way. From mid-January to mid-February the market dropped about 7.2%.

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Leading Indicator

A leading indicator is an economic factor that changes before the economy starts to follow a trend. Examples of leading indicators include: production workweek, building permits, unemployment insurance claims, money supply, inventory changes, and stock prices. The Federal Reserve watches all of these in determining the direction of interest rates. Last year we watched as stock market prices increased sharply. This was a harbinger of better economic news for 2014.

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Inflation and Relative Value

The inflation rate for August is likely to be reported as about 1.9%. What does this mean relative to the value of your investments? From time to time, I still have people telling me how they remember the “good old days” when they were making 16% on their CDs.  The only problem with that memory is that they have forgotten that, at the same time, the inflation rate was 18%! As fast as your money was growing, it was losing purchasing power faster.  If you buy a CD today that is paying, say, 0.5%, and inflation is at 1.9%, your loss of purchasing power is only 1.4% vs.

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10-Year Treasury @ 2.345%

It was not that long ago when the 10 year U.S. Treasury bond was over 3%. The expectation was that it would continue to go higher as the economy improved. The drop in the rate is a clear indicator that there is a flight to safety, as more money is flowing into the safest types of bonds. These include U.S. Treasuries as well as U.S. Corporate investment grade bonds.

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Conflict and the Markets

A great deal of conflict is transpiring in the world at this time. The Middle East, Asia, Africa, and Eastern Europe are all in different types of conflict, and in addition, we are experiencing tense relations with Iran, Russia and China. Domestically, we are dealing with a major immigration issue, as thousands of children are streaming across our southern borders, in search of refuge. In the past, such conflict, turmoil and loss of life would have resulted in the stock market sinking and the bond market making a mighty surge, as investors sought the greatest safety possible.

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All Stocks are Not Created Equal

A report in the Saturday edition of the Wall Street Journal reviewed the 30 stocks of the DJIA that have now reached the cumulative 17,000 milestone, and how they have fared since the average hit 16,000 on November 21, 2013. The overall average was up 6.6% for the period, a decent return over the past 7 months. Averages, however, can be misleading. In this case, 13 stocks had returns above 6.6% and 17 had returns below 6.6%. Of the 17 below 6.6%, seven of them were in negative territory! This means that 23 stocks in the DJIA were up, even if only slightly, and seven were down.

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Inflation in the Wings?

The Federal Reserve (FRB) has been targeting a 2% inflation rate for the past few years. With the economy in rocky shape, the rate of inflation during the past several years has remained stubbornly below this target. The FRB believes that a 2% inflation rate would indicate that the economy is growing, accompanied by fewer unemployment claims and a greater number of new jobs. Recently revised government statistics indicated that the economy contracted 2.9% in the first quarter and that consumer spending was down.

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Interest Rates Gone Global

An article about U.S. Treasury bonds in today’s Wall Street Journal made it very clear that interest rates have gone global, especially for high quality bonds. The article pointed out that at the close of business this past Friday, the 10-year Treasury bond carried an interest rate of 2.597%. Given the growth prospects of the U.S. and political stability, the U.S. Treasury bond is of very high quality.

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Lost Momentum

The U.S. Government recently released results of economic growth for the first quarter. The report indicated that the economy shrank by 1%. While the expectation had been for slow growth, this significant negative reversal signaled a loss of momentum from the fourth quarter of 2013. The impact is visible in the housing industry, where both existing home and new home sales slowed. One would think that this information would result in a negative stock market reaction, but the S&P 500 soared to a new high.

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