January 4, 2010

Market Commentary by: James Investment Research, Inc.

Stock Market Analysis

Conclusions: Stocks moved against traditional year-end strength and closed lower, almost every index declined in light volume. Transportation, utility, and industrial stocks were especially weak. For the past year, best sectors turned out to be technology, materials, and consumer oriented.

One of the earliest signs of the recession, the break in single family home prices, continues to encumber recovery. Government intervention has been ineffective. Polls say voters earlier offered a simple solution to those behind in mortgages: Sell the home and get something they can afford. This might be an improvement over federal intervention. The pollster Rasmussen finds 28% of homeowners now believe their mortgages are greater than home value, and experts concur. These are an overhang on the market as are the many homes in default and awaiting foreclosure.

Home values still aren't rising, according to the latest Case-Shiller statistic. Values are down 29% from the top, off 7.26% year over year, and stabilizing after bottoming in April. One statistic we monitor: Sheriff sales notices in our daily newspaper; seemed to be improving a few months ago as the page count declined from the mid-teens to ten or fewer. But the New Year brought bad news, 18 pages. Apparently, at least locally, things are not getting better. Commercial property losses are overwhelming, values down about 43% from the top, with $3 ¼ trillion in commercial mortgages due within next 60 months.

In an interesting interview, Richard Koo postulates the Japanese economy has stagnated for 20+ years because the government did not spend enough to overcome private investment. Actually, the market crashed because speculation in Japanese real estate was even more extreme than in America. Japanese stimulus has been applied more than 15 times, according to some observers, and government intervention in the markets has served to freeze the private investment which generates real jobs. America should recognize this syndrome, akin to events of the great depression of the 1930's.

Reviewing economic conditions, we are struck by sentiment readings. For example, the Conference Board reports an increase of confidence to 52.9 in December. But at the same time, present conditions are rated at the lowest level since 1983, at 18.8. The danger is that confidence based on hope for the future will be dashed should the future disappoint.

Epstein points out the importance of changes in inventories, which have declined for 13 consecutive months as manufacturers judge final demand to be wanting. About one-third of the 2.2% GDP increase in the third quarter is due to a slowing of liquidation of inventory stock. October saw an increase in business inventories. This could result in a strong GDP for the fourth quarter, but not a lasting recovery.

A number of indicators hint stocks are topping. In December, for the first time in many months, stock mutual funds were being purchased. The VIX fear indicator, over 55 near the market bottom, touched 19.25 last week, a sign of excessive confidence. Inv Intl bulls now outweigh bears by more than 35 points (51.1 – 15.6), a very rare occurrence, showing excessive confidence by advisers. Insiders are selling. Advances occur on lessening volume. The normal end of the year rally has so far been missing. Our Risk Exposure Ratio is reading 82, a high risk area. Most important, our James weekly leading indicators are negative. None of this means an immediate collapse, however the risks for the bulls are high and growing. We would continue to reduce equities in over invested accounts.

F James, Ph.D.

Bond Market Analysis

Conclusions: US Treasuries took another hit this past week along the short end of the yield curve as yields rose from the 2 year to the 7 year bonds. Yields on the 2 year US Treasuries saw an increase of 14 basis points to 1.14%, and the US Treasury 10 year bond rose 3 basis points to 3.85%. Overall, the Barclays US Intermediate Government Total Return Index fell 0.3% for the week. The only positive for the US Treasury market seemed to come from the 30 year bonds which saw yields fall 5 basis points as the bonds advanced 0.4% for the week.

A possible reason for the poor performance as we wrapped up 2009 can be tied to the shortened holiday week, as well as the Treasury auction of an addition $118 billion in debt. Over the past year we have seen the total US public debt increase from $5.8 trillion in Nov. 2008 to $7.17 trillion in Nov. 2009; an increase of nearly 23%. With an increase in supply of this magnitude, it is rather obvious why the Barclays US Treasury Intermediate Bond Index posted a negative return for the year, the first time since 1994.

There were a few sectors which performed very well in 2009. Corporate AA bonds were up 7.8%, while lower grade junk bonds or high yield bonds saw staggering returns of 58.2% for 2009. Treasury Inflation Protected Securities (TIPS) posted positive returns as they advanced 11.4%.

As we look ahead to 2010, a couple factors that may affect the bond market are the massive government deficits and the large increase in overall supply. With the Money Base increasing 40% over the past year, if it has not already done so, inflation may creep back into the system. The year over year numbers released in October of 2009 show inflation was at a negative 1.3%. The December 2009 release shows the year over year number now at 1.9%. If future inflation rises, TIPS may be a better opportunity than regular Treasuries as they give some additional protection as inflation increases.

Trent Dysert

Copyright © 2010 James Investment Research, Inc. James Investment Research James Advantage Funds James Capital Alliance

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