The word out of Washington is no new taxes! In what is being hailed as a huge compromise between the two parties, the Bush tax cuts have been extended for another two years. What is missed in the analysis is that taxes will be unchanged, and therefore little new economic activity is likely in the next year, as we’ll have to revisit the extension in two years. Meantime the Fed is keeping their collective feet to the metal of fiscal easing as long as the economic data remains “better than expected” but certainly nowhere near a normal recovery. All this after nearly 2 years removed from the economic/financial bottom. Many of the economic indicators we look at are certainly better than they were at the March bottom and even better than 6 to 9 months ago, the still pale to what a normal recovery should be at this point. The two biggest parts of the economic landscape that remain stuck in low are employment and housing. The tax extension and easy fiscal policies are likely to do little to help either; they are the main drags to the much hoped for and still elusive durable economic growth that is to lift the economy from the dark holiday molasses.
As the equity markets continue their march toward higher ground, little in the technical make-up of the markets are flashing signals an impending larger than normal correction is on the horizon. The net number of advancing to declining stocks did turn lower during November, however the decline was much less than either the May or August drops. Lack of volume remains a concern, however the net advancing to declining volume is making a new high, surpassing the April peak. Certainly the markets are “over bought”, meaning the markets should be taking a break for a while to allow investors to become more worried and concerned the gains of the recent past won’t persist well into the future. The “wall of worry” needs to be rebuilt! Investor sentiment is very bullish and what little volume has been generated, has been concentrated on those stocks that have been advancing. This is beginning to look more like a classical momentum market and one built on a circular argument: the market is rising as investors are buying; why are they buying; because the market is rising. The same arguments are made for emerging market as well as nearly every other asset class. At some point the momentum will change, however guessing when that will occur is a futile game.
The bond market is seeing a generational move to higher yields. The speed at which yields are rising has not been seen (outside of very depressed ’08 bounce) since the ‘70s. The bond model remains negative, indicating yields are likely to continue their trend toward higher yields. For the first time this year, bonds are trading below their long-term average price. It can be argued that the Fed bond buying spree should be keeping rates low, or that with inflation so low, real rates of interest are higher than they have been in years, however investors are fleeing bonds anyway. Maybe fearful of future inflation or higher yields to continue to attract capital here, either way, the jump in bond prices has gone a long way to wipe out the returns of the past six months. If the economic data continues to point to “better than expected” yields could rise even further, however any hint at weakness could rekindle the bond rally.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.
