“I Ain’t Gonna Work on Maggie’s Farm No More”[i]

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Every market nerd (hand raised) knows that September’s employment data is released this Friday.  However, last week we got some different yet important jobs related news.  First as everybody knew, Derek Jeter retired.  But the other headline was a real shocker as Bill Gross unexpectedly changed employers.

 

Derek Jeter, for those who don’t read The New York Post sports page, was the shortstop for the New York Yankees for the past 20 years.  He had an all-star career winning 5 World Series championships and will be voted into baseball’s Hall of Fame.  He announced his retirement before this season began and played his last game on Sunday.

 

As the financial world knows Bill Gross is the co-founder of Pacific Investment Management (PIMCO).  The firm’s flagship mutual fund, the Total Return Fund, had over $270 billion in assets while the firm wide total exceeded $1.25 trillion as of June 30th.  With these remarkable numbers it is no wonder that Mr. Gross is considered one of the kings of the fixed income market.

Naturally the media was abuzz about Gross’s decision as everyone wanted to analyze both the why as well as its consequences.  Heck we suspect it was even a topic on Friday’s “The View” and “Good Morning America” but only in between fashion updates and coverage of George Clooney’s wedding.

 

Of course, Mr. Gross’s decision presents more challenges than just learning his way to Janus’s men’s room.  Undoubtedly there will be massive outflow from PIMCO and a corresponding inflow to Janus.  But perhaps more importantly, PIMCO, led by Gross, was noted for its “New Normal” economic forecast.  This centered on a slower potential growth rate for the U.S. when compared to past recoveries.  This included such things as subdued job growth and lower reported inflation.  Further it called for lower than normal interest rates for longer than others were predicting.

 

This “New Normal” approach resulted in PIMCO being a “vol seller” or taking positions that benefit from lower volatility, lower interest rates, and low inflation.  Reportedly, this was implemented by such positions as long high yield spreads, TIPS (inflation protected bonds), emerging market debt, and maybe some short positions in equity.  As these positions get unwound and re-established, the markets trading those securities could be a little choppier than normal.

 

Last week’s markets were wild enough without the Gross bombshell.  The Dow Jones Industrial Average moved 100 points or more in each of last week’s trading days – 2 days higher but 3 days lower.  Thursday was especially bloody as the Dow plunged 254 points and all of the major averages lost between 1.5% and 2%.   An astounding 92% of trading volume on the NYSE was in declining stocks.  It was the highest reading since February 3rd.  The glass half-full view is that this can be a sign of capitulation and recent occurrences have happened around the lows of a move.  On the other hand, market internals continue to be poor and traders usually look for capitulation after a more painful correction.

It’s possible, however, that given the declines by the small and mid-cap market sectors (covered in the previous newsletter), the average stock has experienced a meaningful decline and is ripe to recover.  This also points to the narrow leadership driving the major averages which masks the underlying stock market weakness.  For example, on September 19th the Russell 3000 set a new record high.  Significantly, this index equals 98% of the investable stock market.  As the index made an all-time high, only 55% of its components were above their 200 day moving average.  A more typical and much healthier percentage would be above 80%.   The last time such a level of narrow leadership happened was March 2000 – not a good time for the markets.

 

Coming into the end of September (and the 3rd quarter), stocks have had a tough month.  The S&P 500 is down 1.4% for the month (with two days to go) while the mid and small cap indexes are down over 3% and 4% respectively.  Here are the year to date performance for the major averages.

2014 YTD[ii]

 

Dow Jones Industrial Average  +3.2%                           

S&P 500                                       +7.3%
Nasdaq Composite                      +8.0%                           

Russell 2000                                 -3.8%                            

I

indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

 

The lousy performance outside of the large caps, including a painful three months for small caps, might be a function of a correction in the high yield market and strong U.S. dollar.  First, junk bonds reached a multi-year high (in price) toward the end of the second quarter.  Since then these bonds have lost around 3%.  Certainly on the surface this is not an alarming number but in the lower volatility world that is supposed to be fixed income, this is a big number.  Also, it represents a large portion of the 4.5% – 5.5% yield that most high yield bonds provide.

 

The losses in the junk market might be a result of reduced risk appetites, the end of Fed bond buying (although QE was not in high yield), or worries over the economy’s strength.  Whatever the cause, this sector of the bond market is at the riskier end of fixed income and it usually correlates with stocks especially smaller caps as they use this market for capital.

 

Turning to the U.S. dollar, it will record its best quarterly performance in more than 5 years with a better than 7% advance.  Looking at a longer term measure, the U.S. dollar index remains well below the levels of early to mid-2000’s, but this recent rise has pressured oil, gold and other commodities.  Crude oil closed last week around $93 per barrel and gold finished at $1,214 per ounce.

 

“For Everything There is a Season, and a Time for Every Matter Under Heaven”[iii]

 

As 2014’s 4th quarter begins (head shaking in disbelief), we face typical market cross currents.  On a global stage, we are confronted with protests in Hong Kong, the Ukraine, ISIL, Ebola, and a struggling Europe.  Within our stock market, we have weakening signals and worrisome divergences.  On the other hand, the 4th quarter has historically been the best three-months for equities.  According to Bespoke Investment Group, during the past 100 years October has averaged a gain of 0.22%, while November and December have averaged increases of 0.71% and 1.47% respectively[iv]


Once again it seems that the capital markets are at an inflection point.  Perhaps we are entering a long anticipated painful correction that many have been calling for and we see the large cap indexes move lower.  Or perhaps we regain momentum with the bullish seasonality and we madly sprint to year end.  Or perhaps the correction has already taken place in certain sectors and the areas that haven’t been hit just slither sideways for a while.  We may not get developments such as Bill Gross’s departure from PIMCO but it promises to be an exciting stretch.

[i] Bob Dylan, 1965

[ii] The Wall Street Journal, September 27-28, 2014

[iii] Ecclesiastes, chapter 3, verse 1

[iv] The Bespoke Report, September 26, 2014

 

Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.  The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index.  Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

 

2ND QTR KILDARE ASSET MGMT PERFORMANACE LETTER

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Often, when making investment decisions, the obvious needs to be questioned.  In other words, when something becomes so widely known that virtually everyone “knows” it, it’s a pretty good bet that it is already reflected in the current price.  If this obvious information is already in the securities price, future price movement will likely be caused by other reasons.

An example might be our recent financial crisis.  Money printing, bailouts, QE, and poorly thought out stimulus programs causing record fiscal deficits were the policy responses implemented to fix things.  Many thought these would ultimately lead to more and bigger problems and even those in favor of these extreme and untried approaches acknowledged that they contained risks  And when it seemed ‘obvious’ to everyone that things were going from bad to worse, the economy and markets stabilized and began to move higher.  This was largely in spite of policy rather than a result of it as businesses figured out the new landscape, adjusted and moved forward.  The point is that what appeared to be obvious (bad approaches would cause more and deeper problems) ended up missing new developments (businesses adapting and figuring out how to progress).

 

Within the context that history doesn’t repeat itself but does often rhyme, the 2014 stock market has some similar underlying characteristics that force us to look beyond the obvious.  Right now everyone knows the stock market is at all-time highs.  However, this clear fact has an element of distortion.  First the Dow and S&P 500 both began at record levels so any move higher, no matter how small, results in a new record.  This nugget seems to be overlooked by journalists as they report on the daily stock market action.  To be sure, a “record stock market close” is much more interesting than reporting that the Dow inched higher by 10 points.  However, a casual follower could easily be misled by this omission.

 

2014’s advance, in addition to being shallower than perceived, has also been narrow.  The 6-month chart below show both points (Please note this chart includes July.  Also, the color code is as follows Dow – blue, S&P 500 – red, Nasdaq composite – purple, and the Russell 2000 – green).  As you can see, the S&P 500 has had the smoothest journey this year and especially in the second quarter.  Further, despite the media’s portrayal, the majority of the market has made little progress above the March highs.

 


The chart points out another important development – a substantial divergence between the large cap and small cap of the market.  From the beginning of April, the Nasdaq and Russell gave back all of 2014’s gains and then some by mid-May.  While they rallied along with the rest of the market throughout July, their 2014 performance has lagged the S&P 500.  This divergence grew materially in July as you can see.

 

Of course, the deviation in the averages can also be seen in the major averages’ quarterly and year to date numbers. Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

 2nd Qtr       2014 [i]                    

Dow Jones Industrial Average    +2.24%         +1.5%
S&P 500                                      +4.69%         +6.1%
Nasdaq Composite                      +4.98            +5.5%

Russell 2000                                +1.70            +2.5%

 

For Kildare Asset Management clients, accounts averaged an increase of 4.7% in the second quarter while the weighted average increase of all Kildare Asset Managed accounts was 5.22%.

 

The year-to-date performance for 2014 was an average increase of 14.54% and a weighted average increase of 14.36%.  These numbers are after all expenses.

 

While there are few steadfast investing rules, divergences can be a significant indicator of future price action.  There has not been this type of separation among the major averages in recent years and certainly nothing came close during 2013’s rally.  This type of movement (the broader averages weaker than the larger, narrower ones) might be an indication of upcoming turbulence.  Of course, there are past examples where this type of divergence is resolved with the broader market regaining strength and closing the price gap (weaker averages catching up).  Nevertheless, it is something to monitor.

The markets are flashing other red flags.  The cumulative advance-decline ratio (the summation of the number of issues advancing and declining) has weakened.  Further as the market regained record territory at the end of June the number of stocks trading at new 52-week highs was not as great as the number when the April highs were achieved.  This means fewer issues were leading the charge.

While this deterioration must be watched, there is no arguing that this has been a remarkable rally.  As measured by the S&P 500, we have gained 193.5% during the past 1,942 calendar days which ranks fourth in strength and duration.  Interestingly, this move will have to continue through early May 2015 in order to overtake the third longest rally which started in October 1974 and ended in November 1980 (2,248 days).  In terms of strength, third place belongs to the 1980’s (August 1982 through August 1987) with a 228.8% gain.  For those interested, the same two bull markets capture first and second in both longevity as well as percentage gain.  Second place transpired from June 1949 and ended August 1956 (2,607 days) and rose 267.1%.  As some might guess, the greatest rally began in December 1987 and ended when the tech bubble burst in March 2000 (4,494 calendar days).  During this stretch, the S&P 500 rose an amazing 582.1%.

While it would be quite enjoyable for the current rally to continue to gain on these other historic moves, we must consider the possibility that it falls short.  To that end, I continue manage your account with risk control being a high priority.  As you know, this involves using part of the portfolio in a combination of hedges and cash balances.  Further, I remain diligent in looking for opportunities that present favorable risk vs. return situations.

 

Looking forward I think the markets will face some obstacles.  Current conditions offer many sources of possible causes – geo-political conflicts, the end of QE, inflation, etc.  Any of these developments could worsen to a point that they impact the stock market and the economy.  This market setup reminds me of a quote from global hedge fund manager Paul Tudor Jones.  Mr. Jones is quoted as saying “I’m always thinking about losing money as opposed to making money.  Don’t focus on making money, focus on protecting what you have.”[ii]  Indeed this will be our priority.

Thank you for your continued trust and business.  Please contact myself or Connie with any questions or comments.

[i] The Wall Street Journal, July, 1 2014

[ii] Raymond James Equity Research, July 23, 2014

 

 

Sincerely,

 

Jeffrey J. Kerr, CFA

 

 

 

 

Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.  The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index.  Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

“Speak in French when you can’t think of the English for a thing”[i]

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Two weeks ago France’s government dissolved – in Paris the capital markets reacted with the CAC 40 (the French stock market index) jumping 2% while interest rates dropped to fresh lows.  Naturally, the mind is immediately overwhelmed with the possibilities of these developments providing similar results in markets around the world including the United States of America.  While it’s possible that the former French government was more incompetent than Washington, Wall Street’s response to a change in our Federal leadership could potentially be beyond belief.

 

Of course, anarchy is not a good outcome, something that even the most callous Wall Streeters realize (or at least most of the callous Wall Streeters realize it).   However, watching the quote screens during the past few weeks it seems U.S. stocks aren’t waiting for a government collapse to move higher. Prior to last week the S&P 500 had not had a down week since the last week of July.  In late August the index reached the 2,000 level for the first time.

 

Of course, reaching this threshold combined with the widespread excitement of the Dow Jones Industrial Average repeatedly reaching records gives the illusion that the entire equity market is having another gangbuster year.  And while the S&P 500 and Nasdaq are providing very nice returns so far in 2014, the Dow was only up 3% year-to-date on September 1st (‘only’ relative to the number of records it has set) while the Russell 2000 increase was less than 1%.

 

Here are the major averages year-to-date results through August. 

2014 YTD[ii]                                  

Dow Jones Industrial Average     +3.1%
 S&P 500                                       +8.4%
          Nasdaq Composite                        +9.7%

Russell 2000                                  +0.9%

 

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

 

“Twinkle, Twinkle, Little Star”

 

As mentioned, the Dow has gotten a lot of mileage out of a 3% return. However the security that has unexpectedly become the 2014’s star is the long term government bond.  Few realize that many long maturity fixed income securities have provided double digit total returns.  In fact the total return of the long-bond ETF (symbol = TLT) is 16.88% in the first eight months.

 

Please remember that at the start of the year the overwhelming consensus was that bonds were to be avoided.   Yet the 10-year Treasury bond’s yield has declined from 3.03% at the end of 2013 to last month’s low of 2.30% – falling yields mean higher bond prices.  The August low (in yields) might be an important level as the yield has moved higher in September and closed last week at 2.61%.  With the end of QE (although interest rates actually fell when other QE programs concluded) and economic growth seeming to strengthen, perhaps August was the low for the longer end of the yield curve.

 

Staying in fixed income and returning across the pond, Spain sold a 50-year maturity bond at a remarkable yield of 4% in early September.  This is noteworthy in the terms but also given the underlying credit as Spain’s S&P credit rating is BBB or at the low end of investment grade.  It’s astonishing that this got sold at such a long term with such a low rate.  However when we compare it to Germany, it is not that noteworthy.  Investors buying 2-year German debt in August effectively paid the government to invest as the yields were negative.

We wouldn’t expect European interest rates to move higher as ECB president Mario Draghi announced a continental version of quantitative easing.  On September 4th the European Central Bank unexpectedly cut interest rates and said they would begin buying asset backed securities and euro denominated covered bonds in October.  This was a new step for European bankers and is thought to help the economies as they weakened and risked falling back into a recession.

“Or Just a Brilliant Disguise”[iii]

 

The fixed income markets are not the only area of unnoticed deception.  While our aforementioned S&P 500’s accent on the 2,000 is historic, it masks some troubling undertones.  According to Bespoke Investment Group, the average stock in the S&P 500 is down 7.5% from its 52-week high even as the index is making all-time highs.  This divergence is larger within the mid and small cap sectors.  The average stock in the S&P 400 Mid Cap Index is 11.1% lower than its 52-week high and the average S&P 600 Small Cap Index name has plunged 17.3% from its high.  As Bespoke points out, “For this area of the market, the average stock isn’t far from bear market territory”.   Blending it together, the average stock in the S&P 500 is 12.4% lower than its 52-week high.[iv]

 

Breaking it down by sector, Utilities (-6.6%) and Financials (-8.6%) are only sectors where the average stock is not down by more than 10%.  The energy sector is the biggest loser – the average stock is down 19.7% from the 52-week high.  Combining the two weakest sectors (small cap and energy) results in stocks with lower approval ratings than the NFL.  The average small cap energy stock is 29.4% lower than their 52-week high!!

 

That the average stock is weak at the same time that the indexes are reaching record highs is a clear sign of sector rotation together with a narrowing of breadth.  This could be considered a healthy sign in that nothing gets too overheated and there is an eventual recharging of buyer power.  On the other hand, a smaller number of stocks leading the charge to record levels could result in these “generals” ultimately falling and the arrival of the long awaited correction.

 

This rotation could also be a function of the global investment landscape.  Excitement over the new I-Phone together with Alibaba’s IPO and a steady economy is offset by numerous international conflicts, a slowing Europe, an Ebola outbreak, and an ending of US monetary easing.  Interestingly, as these crosscurrents get digested, the S&P 500 has traded in a narrow range in the past few weeks.  At the end of August and beginning of September, the index traded between 1,997 and 2,002 for 8 straight trading days!!  Recently the S&P 500 spent 13 consecutive trading sessions without closing 0.5% higher or lower than the previous close.  We have to return to the year 1995 to find a comparable stretch.

 

MKM Partners researched similar behavior to see what happened after such compression.  Going back to 1980, there were 5 instances where the S&P 500 traded 10 days or more without closing more than a 0.5%.  The average returns after these churns was positive in 1 week, 2 weeks, 1 month and 3 months – respectively 0.85%, 1.24%, 1.83% and 4.71%.[v]  If history rhymes with these past occurrences, the S&P 500 will break out to the up side.  Many are watching 1,990 on the S&P 500 as major support.  This trend could be broken if the index falls below that.

 

France is the 5th largest economy in the world (larger that the United Kingdom, Canada, Australia and the BRICs).  It is remarkable that such an important country’s government can fail and then re-form without much more than a hiccup.  Out of such change opportunities often arise and perhaps this is an indication of political irrelevance together with a sign that the global economy is, in general, doing ok.  And if Europe can take steps to resolve their problems, the S&P 500 might continue to make history.

 

[i] Lewis Carroll, “Through the Looking Glass”

[ii] The Wall Street Journal, August 30-31, 2014

[iii] Bruce Springsteen, 1987

[iv] The Bespoke Report, September 12, 2014

[v] MKM Partners, “Technical Strategy”, September 8, 2014

 

Jeffrey Kerr is a Registered Representative of and securities are offered through LaSalle St. Securities LLC, member FINRA/SIPC. Mr. Kerr is an Investment Advisor Representative of and advisory services are offered through Kildare Asset Management, a Registered Investment Advisor. Kerr Financial Group and Kildare Asset Management are not affiliated with LaSalle St. Securities LLC.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Past performance is not indicative of future results. Investing involves risks, including the risk of principal loss. The strategies discussed do not ensure success or guarantee against loss. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.  The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index.  Trading of derivative products such as options, futures or exchange traded funds involves significant risks and it is important to fully understand the risks and consequences involved before investing in these products. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.