· Correction in stocks

· Bonds have bottomed after 26 years
 

Market Synopsis

The herd instinct is wholly unavoidable when discussing stock market pricing and we got a taste of this when prices tumbled in the middle of the week. The majority of market analysts and talking heads suggested that we are on the cusp of a dramatic correction and while not denying that possibility exists, we consider that a smaller correction is more likely given that the S&P 500 had only managed to achieve its all time high last week. An historic occasion such as a new high could necessitate some backing and filling over an extended period of time however the conclusion is almost surely a continuation of the upward move.

The price of the 10-yr bond experienced a selling capitulation on Friday that likely laid the groundwork for a rebound from a low on a short term basis but, and this is an important “but”, this week the bond made it abundantly clear to technical analysts that the bottom has finally been put in for bond yields. After peaking in 1981 and sliding progressively lower since that time, interest rate yields developed a double-bottom in 2003 and 2005 and this week’s surge sent yields above the declining trendline that had thus far contained them. Much like the new high in the S&P 500, this transition from lower interest rates to higher is historically significant.

Despite the rise in bond yields, it would be premature to predict the immediate demise of equities as asset price inflation of all sorts continues unabated. However notwithstanding this asset inflation, there is certainly an argument to be made that liquidity at the margin could be drying up. Two central banks in particular, the European Central Bank and the Reserve Bank of New Zealand, decided to raise interest rates this week in their respective jurisdictions due to the threat of rising inflation. Undoubtedly, raising the interest rates will have the desired effect of beginning the process of mopping up the excess liquidity. The Federal Reserve will have its own opportunity to raise (or lower) interest rates at the end of this month but most analysts are in agreement that the Fed will remain on the sidelines. The key factor is that in a rising interest rate environment, purchases of risk-free bond investments will inevitably attract money from equities

The economy remains the key for any interest rate decision by the Fed and with a weak first quarter of growth combined with declining consumer inflation, the apparent rebound in economic activity is fraught with uncertainty. As we mentioned last week, employment numbers continue to be a concern and given the probable losses that are not currently recognized in the official statistics, the majority being in the housing and construction sectors, there is some doubt in the success of job creation.


Technically Speaking

After having achieved a new all-time high last week, the S&P 500 succumbed along with all other stock markets to a spate of selling this week. Certainly, the selling was widespread and affected equities of every kind but was this the beginning of a broad wave of selling? Unlikely is our answer as previous lows continue to hold firm. The stock markets have been rising steadily in a very powerful move that began last summer and only paused briefly in late winter before re-energizing.

Having reached a new high means the S&P could take some time to get accustomed to the new environment but ultimately the likelihood is that the index will rise further in response to this significant achievement.

Support for the DJ-30   lies near the low from Thursday around 13,250 with lower support around 12,750. Correspondingly, support for Nasdaq Composite is located near the lows from Friday at 2535 and for the S&P 500, at around 1475.


New Buy Recommendations (in order of preference):

Euroseas (ESEA)  This very profitable shipper has broken away from its largely $8-12 range and begun to commit to a more identifiable price rise helped enormously by its most recent quarterly results. A quick investigation has revealed that it has a significant dividend in addition to the strong upside potential for capital gain.

American Science and Engineering (ASEI)  We return to a previously recommended stock, which is now poised to rise. ASEI developed a double-bottom on the daily chart with its lows in April and May and last week crossed its 200-day moving average. The outside day higher on Friday emphasizes its intention to head toward the Feb highs near $60 having already surged well beyond the monthly highs from March through May.

New Short Sales  

None.

Stock Positions to Sell/Exit:

We were exited from Merck on our stop.

Portfolio Comments:

New stops have been added to the list while others have been modified. Those that have blanks are being carried unstopped for now. Please see our complete list of stops in the table below.

List of Current Stock Recommendations:

Action Ratings. The following is the legend for designating immediate action
for our stock recommendations. The first is B, meaning the stock is timely
to buy but the case for doing so right here is not overwhelming. Either the
stock may have gotten ahead of itself and may be vulnerable to a retracement or
else the stock has been performing disappointingly but may simply be
regrouping. B+ and B++ indicate stocks for which there is a technical case
to buy now, with plusses adding weight according to how many there are, up
to a maximum of two. Stocks rated H are ones to hold, awaiting confirmation
to buy more or to sell. SELL, of course, means what it says. It seldom pays
to override this designation. In the case of stocks held short, the rating is S where positions should be retained. S+ and S++ indicate stocks for which there is a technical case to add to the positions with plusses adding weight similar to long positions. The maximum number of plus signs is 2.

N.B. There are no longer restrictions on foreign stocks held in Canadian retirement savings accounts.