Dorsey, Wright & Associates.

Markets continued to climb in the second quarter. The S&P 500 was up for the 5th straight month. Equities had some volatility early on (especially in the high relative strength stocks we own), but volatility tapered off toward the end of the quarter. Other asset classes also fared well during the last three months. Commodities, real estate, fixed income, and international equities all posted positive returns.

Second quarter performance for the high relative strength securities we own was not as good as first quarter performance. The first few weeks of the quarter were characterized by a sharp pullback in high momentum stocks and asset classes. That pullback stabilized later in the quarter, but led to some changes in our portfolios. At the end of the first quarter, the best relative strength could be found in places like small cap stocks, biotechnology stocks, and growth oriented strategies. The changes, however, where not significant enough for us to change our overall asset mix significantly. We saw shifts from growth to value and from small to large capitalization stocks. We also saw increasing exposure to foreign equities. These types of shifts are normal and part of the process. Given all of the bad press in April surrounding momentum stocks you would have thought the world was coming to an end. In the end though, it seems the momentum pullback was a garden variety strength shift and only required subtle shifts in the portfolios.

Part of the reason for the early quarter volatility might have been the economic data that was affected by the unusually harsh winter. It was very difficult for investors to determine if the economy was really slowing as rapidly as the numbers suggested, or if the cold weather was really the culprit. As we now head into the summer months, it looks like the cold winter played a large part in the numbers and we are seeing a snap-back in a lot of the economic numbers coming out. The economy certainly isn’t growing as fast as some would like, but it appears the worries of a major slowdown have been have been alleviated for the time being.

Tom Dorsey President Dorse

Bonds have been quite a surprise so far this year. Most investors expected bond prices to fall (causing yields to rise) and had positioned their portfolios accordingly. But bond prices have risen this year despite the perceived headwinds. The Federal Reserve has continued to taper their bond purchases, which is a form of tightening. The bond market has absorbed this so far so we would expect to see the tapering continue as planned. We have also reached the point where some of the talk has shifted to actual tightening rather than tapering. Some economists are now talking about the possibility of the Federal Reserve raising the Fed Funds rate to 0.25% from the current target of 0%. The real central bank action came from Europe. The European Central Bank cut rates to negative levels on reserve deposits and promised further action if price levels don’t pick up. That might be part of the reason we are seeing stronger bond prices domestically despite the fed tapering their bond purchases.

There are also two flows of funds indicators that will bear watching in the coming months. First, companies have been repurchasing their own stock at a torrid rate. According to a recent study, corporations in aggregate are the largest net purchasers of stock right now. Whether this is good or bad is open to debate, but for now, they are tipping the balance of supply and demand for stock to the buyers. Mergers and acquisitions have also increased dramatically as year to date volumes reached a seven year high during the second quarter.

Although we have seen some shifts in leadership this year the major trends remain intact. We saw some underperformance in our strategies at the beginning of the quarter, but after we made shifts in allocations the portfolios recovered nicely. While there are always unforeseen events that can derail the market, we are quite optimistic for the second half of the year.

Dorsey, Wright & Associates (DWA) is an independent and privately owned registered investment advisory firm based in Richmond, Virginia. Our expertise is technical analysis based on Point and Figure Charting, Relative Strength Analysis, and other tools to analyze market data and deliver actionable insights.  For more information, visit www.DorseyWright.com to find out more information about Dorsey Wright & Associates’ research.