“I Think I Can, I Think I Can…”

Stocks reached a new 2016 high in the first half of last week at 2,120 for the S&P 500.  Traders and strategists agreed the next stop would be a short trip to 2,130 and a new record high.  This would break a 13-month drought without a fresh record close.  However, by week’s end the S&P was back below 2,100 and the optimism shifted to gloom as worries grew over U.S. interest rate increases, slowing global economic growth, and BREXIT.
The 2,100 level on the S&P 500 has been a difficult level to overcome.  This was where the markets began the year and before the nasty selloff that marked January and February.  After equities stabilized, the rally brought the S&P back to 2,100 in April from where it fell back again.  This latest assault appeared to be a ‘third time is a charm’ event as we traded 7 consecutive days above 2,100 before retreating.
Eventually the S&P as well as the Dow Jones Industrial Average will rally to make a new high.  But last week’s selloff raises the risk that we test materially lower before celebrating new all-time highs.  Market breadth deteriorated as stocks fell with Friday being especially weak.  This could be a sign of increased selling pressure before finding a bottom.
The worries mentioned above go beyond stock market turmoil.  Bond yields are the lowest in history.  Over $10 trillion of global government debt trades at a negative yield with Germany’s 10-year Bund trading just above 0% (at 0.02%).  The Swiss 10-year bond changes hands with a negative 0.5% yield and the Japanese 10-year bond is negative 0.17%.  Obviously, this would not be the case in a normally functioning economy or even the prospect of one.  The fact that more debt has recently slid into negative yield territory could also be a result of a declining confidence in policy makers and their various forms of quantitative easing.
While negative yields are a head scratcher, there are some bond market sectors that are performing well.   High yield bonds are those with credit rating of BB and lower (BBB and above are considered investment grade).  They normally are issued by medium and smaller companies and usually offer a higher interest rate to compensate for the higher risk of repayment.
High yield bonds, after being hit hard in 2015, have rebounded in 2016.  The declining price of crude oil and natural gas was a big component in last year’s selling.  Many energy producers used bonds to finance operations and investors sold that debt as commodity prices plunged.  Indeed, some in the energy area have filed bankruptcy in 2016.  However, there are many non-energy issues that got thrown out with the bath water and presented a good opportunity.
The high yield market bottomed in December.  Clearly, this area has been helped by crude oil’s rebound as $50 per barrel gives the producer more bottom line than a $30 price.  But, also sentiment got too pessimistic as there were predictions of widespread financial calamity in energy.
Looking at the two high yield bond ETF’s, HYG and JNK, they have performed well during 2016 and especially strong since the February market lows.  HYG is up 3.4% year-to-date and 8.8% since bottoming in February.  These returns are competitive with the stock market but exceed equities when the almost 6% dividend is included.  The JNK has similar YTD returns – 4% YTD and 12% since February.  JNK trades with a dividend of 6.3%.
As a comparison, here are the major averages for 2016.
2016 YTD                            
Dow Jones Industrial Average   +2.5%
S&P 500                                   +2.6%
Nasdaq Composite                    -2.3%
Russell 2000                             +2.5%
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends
The stock market often rallies when the headlines are bleak – climbing a wall of worry.  And while it can always get worse, it is hard to imagine anything exceeding the current news flow.  We have slowing economic growth combined with many levels of global uncertainty on top of ongoing terrorist attacks wrapped in a presidential campaign with two polarizing candidates.  That’s a pretty steep wall of worry.  Perhaps this is why some high profile investors (Stanley Druckenmiller, Carl Icahn, George Soros) are recommending getting out or shorting the stock market.
Nevertheless, we’ve been dealing with these obstacles for a while and it could be argued that they are priced in.  As mentioned in the last newsletter, investor sentiment has been pretty negative for some time.  In the short term, it would be constructive for the U.S. markets to hold their 50-day moving averages and the May lows.  That could recharge the stock market for yet another run at the record levels.  If that fails to happen, it might be a tough summer.
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
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