Economic releases showed continued strength in the U.S. recovery, but softness in Europe. Alcoa reported better than expected earnings and that news leading-the-earnings-season gave Alcoa's stock a 5+% boost in an environment where equities were down on the week. High stock valuation, renewed concern about Portugal's debt, and confirmation that the U.S. Federal Reserve plans to end bond purchases in October all put a damper on equities and rallied bond markets. The "risk-off" week included a widening of credit spreads, especially those for high yield. The US dollar was mixed, energy prices were down, and metals prices were up on the week.

Perspective:

On weeks such as this when the equity markets sell off, my colleagues ask me if this is the start of a correction. Mark Hulbert's Wall Street Journal article, How Overvalued Markets Translate Into Lower Returns, referred to the work of Nobel laureate Robert Shiller to answer that question.

Professor Shiller uses six measures, all of which show that the U.S. equity market (ie S&P 500) is overvalued: Price/earnings ratio, Cyclically adjusted P/E ratio, Price/book ratio, Price/Sales ratio, Q ratio (company's market cap divided by the replacement cost of its assets), and Dividend yield. He compares those measures with the past 35 peaks. The current P/E ratio is higher than 69% of those peaks; the other valuations are higher than 82% to 89% of those peaks.

While high valuations do not have a high short term "correction" predictive value, Shiller's work shows that they do have a high correlation with lower returns over the next decade.

Therefore, going forward we are unlikely to match the 20+% post-great-recession returns or even the 10% long term average returns. Hulbert adds, "Unfortunately, none of the valuation ratios help us determine the path the market will take in producing these anemic returns. It could turn in low, but positive returns during the next 10 years, or it could soar first and then plummet, as it did in the late 1990s and early 2000s."

On the undervalued side of that balance sheet and likely to generate above average interest is U.S. soccer (or futbol as it is called in the rest of the world.) My first indication was when U.S. goalkeeper Tim Howard was briefly listed as "Secretary of Defense" by Wikipedia. My second indicator was the fact that my wife, not really a sports fan, wanted to watch the World Cup final between Argentina and Germany.

Economic Releases:

This week's Initial Claims data added evidence of an improving jobs picture in the U.S. following last week's June Employment Report. New Claims fell to 304,000 the week of July 5th. The four-week average of Claims (blue in the chart) fell to 311,500. Continuing Claims (red in the chart) rose 10,000 to 2.584. As shown in the chart, both data series fell to close to pre-great-recession levels. These series support the Fed's decision to end bond purchases (QE) in October if the Fed's forecast for the economy remains on track.

Other Economic Releases

German Industrial Production fell -1.8% in May. This data will be little noticed because the entire Country will be celebrating Germany's victory over Argentina in the World Cup. On the other hand, France's -1.7% Industrial Production in May added to the perceived weakness in the European recovery. In the UK, the Bank of England met and, as expected, kept interest rate unchanged at 0.5% and Asset Purchases unchanged at 375 billion Pounds. Industrial Production in the UK fell -0.7%; Manufacturing Output fell -1.3% in May.

Equities Markets:

Concerns about Portugal and high stock valuations contributed to the sell-off in stocks this week. The widening of high yield credit spreads generated a negative return for the High Yield Total Return Index on the week.

Bond Markets:

Bond yields and credit spreads widened fell as part of this week's "risk-off" trade.

Currencies & Commodities:

The U.S. dollar was mixed on the week, falling against the Yen and Euro and rising against the Pound and the Looney. Energy prices fell and metals commodity prices rose on the week.