SPECIAL INVESTMENT UPDATE
August 10, 2016
Dear Clients and Friends,
The financial markets are acting a little confused these days. Stocks, bonds, oil and the dollar all seem unsure of themselves, limping around indecisively from one trading session to the next. Over the past several weeks, the Standard & Poor’s 500 Index has traded in its narrowest range since September 2014.
It is important to note that investors experienced a climate of growing fear since the summer of 2014. First, it was fear of interest rate hikes by the Federal Reserve. Then fear of a global recession as well as a meltdown in the financial system induced by the collapse in oil prices. Most recently, the Brexit vote and the creeping shadow of negative interest rates in Europe and Japan led many investors to fear an unstoppable downward spiral for international trade. In addition, doomsayers have harped on China’s debt bubble and the threat it poses to the world economy. All of these were legitimate concerns and some still are. However, we feel that most of these fears are behind us and we are headed for a period of relative calm in the financial markets over the remainder of 2016 and possibly into 2017 as well.
From the technical side of the stock market, advancing stocks have been outnumbering declining stocks by a wide margin. In the 10 sessions ended July 12, advancing stocks on the New York Stock Exchange swamped decliners by a spectacular margin of 2.18 to 1. “Breadth stampedes” of this magnitude are extremely rare. The last readings above 2:1 occurred in March, July and September 2009, correctly foreshadowing the power and endurance of the post-crisis bull. Over the past 60 years, a ratio of 2:1 breadth stampedes have only occurred at major market bottoms or at the launch of an important extension to an ongoing bull market.
As we mentioned earlier, fear of all sorts dominated investors since mid-2014. This emotion can be measured by the so-called “fear gauge” the CBOE volatility Index (VIX), which measures the premium (prices) that options speculators are paying to protect themselves against a stock market decline. The pattern of fear, as represented by the VIX, touched a major bottom in the summer of 2014 and has just completed what appears to be a major top. We feel that this pattern of investor fear will continue to subside. As fear retreats, stock prices should advance further. As a result of our confidence in the stock market, we are re-investing the income on most of our stocks and mutual funds into the respective company’s Dividend Reinvestment Plans (DRIP).
However, there is no forecast in the financial markets that is guaranteed. As we go along, we will be watching two key benchmarks to confirm that this favorable scenario will take place. First, long-term Treasury yields should start to move up from their July lows. If stocks are to enjoy solid gains through the end of the year, the yield on the 10-year Treasury note should climb above 1.75% during the fourth quarter.
The second benchmark we will be watching is that reliable gauges of economic activity should pick up in a meaningful way. Specifically, we will be watching the monthly ISM purchasing manager’s Index’s manufacturing and the service reports. The ISM numbers come out early in the month, yielding the closet thing to a real-time snapshot of the economy. We would like to see the manufacturing index climb above 54 in the next couple of months and the non-manufacturing (services) index to be above 57. For both indexes, 50 is the dividing line between growth and contraction.
Even though we have a bullish forecast out to year-end 2016, we have to recognize that it will not be a one-way escalator ride up. Also, we have to keep in mind that the current bull market is now more than seven years old and it will not last forever. In order for us to continue to beat the stock market averages, we have to continue our discipline of investing in a balanced portfolio of value-oriented, safety-first equity stocks and fixed income instruments. Meanwhile, our balanced portfolio strategy is paying off handsomely. All of our portfolios have more than doubled the stock market’s gain year to date.
We want to thank all of you for giving our firm the opportunity to serve you. We thank you very much for the trust and confidence you have placed in our firm as it is always appreciated. Please contact me should you have any questions or comments. Also, we want to invite you to visit our website at www.farmandinvestments.com for a quick Retirement calculator, our latest firm news, and Market Commentary archives.
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