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Weekly Market Commentary

December 10, 2012

Where do investment opportunities lie?  First consider drifts of the overall market.  Normally, doubt and uncertainty depress stock prices and create bargains.  That was true at the time of the World Trade attack in 1991, also true at the portfolio insurance crash of 1987.  Today the “Cliff” threat offers an opportunity to take advantage of bargains.
-Dr. Frank James, founder, James Investment Research

Stock Market Analysis

Conclusions:  While more stocks declined than advanced last week, major stock averages rose. Most of the progress lay in the larger stocks.  More than four stocks hit new highs against each new low.  Information technology and materials stocks struggled while financials moved ahead.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

The dollar was little changed, up slightly and also ahead over the past year to date, and the past 12 months, with a 2.26% return.  Energy, precious metals, and most commodities declined.

In the news, ISM reports manufacturing is faltering and factory orders fell from 4.5% to 0.8%, not a sign of encouragement. The labor market report is a disappointment for those who had looked for strong improvement, but also a reminder that the lethargic pace of economic activity continues.  Ratios looked better only because so many people quit looking for jobs and dropped out of the labor force.  This could hardly be taken as a sign of progress, although the unemployment rate did fall to 7.7%. 

The latest Quantitative Easing (printing money, buying bonds) began in mid-September, but, unlike earlier easing, the reaction of the equity markets has been negative overall.

Where do investment opportunities lie?  First consider drifts of the overall market.  Normally, doubt and uncertainty depress stock prices and create bargains.  That was true at the time of the World Trade attack in 1991, also true at the portfolio insurance crash of 1987.  Today the “Cliff” threat offers an opportunity to take advantage of bargains.  And in spite of likely higher taxes and weak prospects for economic activity over the next year, our indicators are strengthening, suggesting stock prices are apt to defy the economy and rise for a time. 

Especially attractive are financial firms.  Last quarter’s  strong bank profits came from the wide spread in net interest margin; refiners, where weak prices for petroleum lessen production costs; housing related stocks where unit sales  prices appear to be stabilizing as the debt burden on citizens has been lowered.  Automobile sales are rising, another area of opportunity. Bankruptcy is undesirable but it does serve to lower the consumer debt burden.  The result is cars are priced at among their most affordable levels relative to family income in decades.

We are talking of limited gains, not a new bull market, but an opportunity to capitalize on pessimism with investment in promising stock sectors.  While seasonal tendencies and our intermediate term leading indicators are strong, short term ratios are negative and it would not be surprising to see a short term correction to the recent rise in equities before extensive further advances.

                                                                                                                                F James, Ph.D.

Bond Market Analysis

Conclusions:  The U.S. Treasury bond market fell this week as yields edged higher.  The 10-year U.S. Treasury note closed at 1.64%, up slightly from 1.62% a week earlier.  Investors favored lower quality bonds as the high yield sector advanced 0.9%.  Investors will be focused on the FED meeting this week as officials discuss the economy and the possible extension to programs such as “Operation Twist” which end this month.

The job market received some encouraging news last week as the unemployment fell to 7.7%; the lowest in four years.  So far this year the U.S. economy has averaged 150 thousand new jobs each month and has added a total of 1.67 million new jobs.  Unfortunately, there are troubling figures when you look inside the numbers.  The duration of unemployment is still above 40 weeks and the economy continues to see the labor force disappear.  We also find that the employment gap between today’s level and the peak at the start of the recession is a staggering 4.1 million jobs.  At the rate of 150 thousand jobs a month it would take the job market 27 more months just to get back to peak employment in 2008.

So why has the recovery in employment been so sluggish?  One suggestion might come from an article in the Wall Street Journal, “A Jobless Dilemma: What’s Wrong With Fort Wayne?”  The article mentions that some companies have been struggling to fill job openings not because of the lack of applicants but because the applicants are lacking the skills needed for the job.  In the last two months alone the rate of unemployment for those with less than a high school education has risen to 12.2% from 11.3% while the rate among those with a bachelor’s degree and higher has been falling. There is also the lack of confidence for the future among employers, many look for much higher costs ahead from federal mandates.

The news for manufacturing was not as promising as the ISM Manufacturing PMI Index fell more than expected indicating possible contraction ahead.  Manufacturing was not the only negative surprise as consumer confidence fell well below expectation to 74.5.  The enthusiasm from the elections looks to be wearing off as the fiscal cliff and tax increases start to weigh on the minds of consumers.

As the job market and manufacturing look for ways to recovery, some industries seem to be doing rather well.  The housing industry, for instance, notes advances in both prospective buyers as well as home prices.  Even the auto industry has gained strength as sales are up 14.5% over the past year and are now above 15 million annually for the first time in almost 5 years.

Our indicators have shifted, now slightly less bullish, and we have begun to trim durations where needed.  However, we have not abandoned high quality bonds as some factors still favor quality and because of their defensive characteristics.  The U.S. unemployment rate is still high, Europe is still contracting and the tensions in the Middle East are rising.  Should these factors worsen the flight to safety will make U.S. Treasury bonds even more attractive.

Trent Dysert