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Time Will Tell

While the stock market continues to remain orderly, there have been some recent changes. The prices of many of the momentum stocks, which are long on promise and short on earnings, are down 50% or more so far this year. The iron law of valuation always wins. Fortunately, the stock prices of large traditional companies are holding (keeping many stock index returns slightly positive for the year). This could be a return of rationality, which bodes well going forward. While the valuation of the broad market is still rich, it is still well below previous extremes. It looks like it is headed higher.

Recent numbers on the state of the economy are mixed at best. The early report on first quarter GDP came in flat. The unemployment rate has improved substantially, but this is due to a decline in the U.S. labor-force participation rate. The stock market advance continues without much support from the economic fundamentals. Perhaps stock investors are looking ahead, optimistic about what they anticipate. For example, new technologies in natural gas production are boosting the oil & gas industry. These technologies are increasing domestic supplies, dramatically lowering energy costs and therefore potentially igniting a domestic manufacturing renaissance. Other technologies, too numerous to itemize, are also changing the world for the better. Innovations have become commonplace and, in past, solutions from seemingly nowhere have solved the challenges we faced. Why not this time, again.

Then there are bonds. Last year the interest rate on the 10-year Treasury spiked to 3% at year-end from an epic low of 1.75%. This left the Bloomberg U.S. Treasury Bond Index with a loss of 3.4% and the Barclays U.S. Treasury Inflation Protected Securities Index with a loss of 8.6%. So far this year, the interest rate of the 10-year Treasury has dropped back down to about 2.6%, resulting in higher year-to-date bond prices. The Bloomberg U.S. Treasury Bond Index is up about 2.6% and Barclays U.S. Treasury Inflation Protected Securities Index is up almost 3.8% this year. This is not something that normally happens in an improving economy. Rates should be going up and bond prices down; especially with the Fed’s Quantitative Easing bond buying program pulling back. However, rates are so far stable to down and bond prices are up. Perhaps higher bond prices are the result of the shortage caused by the years of the Fed’s bond buying. Or perhaps it is because our bonds look attractive relative to those globally. U.S. Treasuries are still seen by the world as a safe haven. Therefore, bonds look attractive for now despite interest rates remaining near historic lows.

The markets remain orderly. However, as always, participate with caution.