Dear Clients and Friends:
Last week’s reports from the Labor Department show that inflation at both the retail (CPI) and wholesale (PPI) level exceeded the analyst’s forecasts in January. Bond yields spiked upon the CPI news last Wednesday, reaching a peak of 2.93% on the 10-year Treasury, although they actually eased a bit on Thursday as well as Friday. This news was no big surprise. What is puzzling is the stock market’s reaction to the inflation data and the bond sell-off. The headline indexes rallied sharply on Wednesday, Thursday and Friday. Wall Street’s speculative fervor is alive and well. This was in contrast to the previous week on Wall Street, with the headline stock indexes all falling down sharply.
Of course, it is possible that the market has formed a V-shaped bottom and will never look back, which has happened before. However, a recent study of 10% drops in the Standard & Poor 500 that dates back to 1980 reflected there were 25 instances of an approximately 10% decline in the index. Of these, only 16% resulted in a V-bounce where the original low for the move was never revisited. In the other 84% of the situations, the market returned back to test its lows. Based on historical record, the Standard & Poor 500 will creep back to the area of its February 8th closing low of 2581 before the market can resume its climb to new all-time highs.
We remain optimistic for stocks but we will be closely watching the 10-year Treasury yield. If bonds can stabilize during the next several sessions, the equity pullback may well be over. On the other hand, if yields continue to streak higher, we can expect more trouble on the equity side as “risk parity” traders sell stocks to lower the overall volatility of their portfolios. Pending resolution of this issue, we are not making any changes in our portfolios’ asset allocation mix.
Thus we continue to maintain our standard two-pronged strategy of substantial exposure to common stocks (and mutual funds) as long as there is a reasonable prospect for double-digit returns. We took advantage of last weeks sell-off to pick up a few bargains that were on our “standby list”, which we will discuss in more detail in our Quarterly Investment Update.
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 us should you have any questions or comments.