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BOTTOM LINE: Overall, last week's market performance was very bullish. The advance/decline line rose sharply, almost every sector gained and volume was above average on the week. Measures of investor anxiety were mostly lower. The AAII % Bulls rose to 34.88% this week from 23.85% the prior week. This reading is still below average levels. The AAII % Bears fell to 43.02% from 57.80% the prior week. This reading is still above average levels. Moreover, the 10-week moving average of the % Bears is 46.04%. It has been this high only 1 other time since record-keeping began in 1987, the significant market bottom during the 1990 recession and Gulf War. It never even reached current levels during the depths of one of the greatest stock market collapses in US history during 2002. Many other measures of investor sentiment are still near levels associated with meaningful market bottoms.
The average 30-year mortgage rate fell 8 basis points to 6.72%, which is 151 basis points above all-time lows set in June 2003. I still believe housing is in the process of slowing to more healthy sustainable levels. Mortgage rates have likely begun an intermediate-term move lower, which should help stabilize housing over the next few months.
The benchmark 10-year T-note yield fell 5 basis points on the week as economic data were mixed, oil prices declined and the Fed made dovish comments in its Beige Book report. Inflation concerns have likely peaked for the year as investors continue to anticipate slower economic growth, unit labor costs remain subdued and the mania for commodities continues to reverse course.
The EIA reported this week that gasoline supplies fell more than expectations as refinery utilization declined. Unleaded Gasoline futures fell and are now 23.3% below September 2005 highs even as refinery utilization remains below normal as a result of the hurricanes last year, some Gulf of Mexico oil production remains shut-in and fears over future production disruptions persist. According to TradeSports.com, the percent chance of a US and/or Israeli strike on Iran this year has fallen to 19.8% from 36% late last year. I continue to believe the elevated level of gas prices related to crude oil production disruption speculation will further dampen fuel demand over the coming months, sending gas prices back to reasonable levels.
US oil inventories are at 7-year highs. Since December 2003, global oil demand is down 1.19%, while global supplies have increased 5.19%. Moreover, worldwide inventories are poised to begin increasing at an accelerated rate over the next year. I continue to believe oil is priced at extremely elevated levels on fear and record speculation by investment funds, not fundamentals. Escalating violence in the Middle East and the onslaught of hurricane season will likely lead to a major top in oil over the next couple of months as demand destruction further accelerates. As the fear premium in oil dissipates back to more reasonable levels, global growth slows and supplies continue to rise, crude oil should head meaningfully lower over the intermediate-term.
Natural gas inventories fell more than expectations this week. Supplies are now 21.6% above the 5-year average, a high level for this time of year, even as some daily Gulf of Mexico production remains shut-in. Natural gas prices have plunged 54.1% since December 2005 highs. At this time last year, 5 tropical storms and 3 hurricanes had already threatened Gulf of Mexico production. There is now some evidence of a pick-up in industrial demand for the commodity. Natural gas has likely made an intermediate-term bottom before moving to new cycle lows in December or January.
Gold rose on the week on Middle East tensions, US dollar weakness and dovish Fed commentary. The US Dollar fell on a dovish Fed Beige Book report and increased speculation for a Fed pause. I continue to believe the Fed is done hiking rates for this cycle.
Technology and commodity stocks outperformed for the week as worries over an imminent recession faded and most earnings exceeded estimates. Profit growth for the second quarter is coming in at about 12%. This would mark the 16th straight quarter of double-digit profit growth, the best streak since recording keeping began in 1936. Despite a 71.0% total return for the S&P 500 since the October 2002 bottom, its forward p/e has contracted relentlessly and now stands at a very reasonable 14.7. The average US stock, as measured by the Value Line Geometric Index(VGY), is down .6% this year. The Russell 2000 Index is still up 4.7% year-to-date, notwithstanding the recent correction.
In my opinion, the current pullback is still providing longer-term investors very attractive opportunities in many stocks that have been punished indiscriminately. In my entire investment career, I have never seen the best “growth” companies in the world priced as cheaply as they are now relative to the broad market. By contrast, “value” stocks are quite expensive in many cases. Moreover, the most overvalued economically sensitive and emerging market stocks should continue to underperform over the intermediate-term as the manias for those shares subside. I continue to believe a chain reaction of events has begun that will eventually result in a substantial increase in demand for US stocks.
In my opinion, the market is still factoring in way too much bad news at current levels. Problematic inflation, substantially higher long-term rates, a significant US dollar decline, a “hard-landing” in housing, a plunge in consumer spending and ever higher oil prices appear to be mostly factored into stock prices at this point. I view any one of these as unlikely and the occurrence of all as highly unlikely.
Over the coming months, an end to the Fed rate hikes, lower commodity prices, decelerating inflation readings, lower long-term rates, increased consumer confidence, rising demand for US stocks and the realization that economic growth is only slowing to around average levels should provide the catalysts for another substantial push higher in the major averages through year-end as p/e multiples begin to expand. I still believe the S&P 500 will return a total of around 15% for the year. The ECRI Weekly Leading Index fell this week and is forecasting healthy, but decelerating, US economic activity.
*5-day % Change
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