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Martket Update - October 13, 2014

Europe’s Cold Wind

 

If you’ve been reading the paper or been on the Internet, the bumpy ride in stocks hasn’t escaped your watchful gaze. Recognizing that a triple-digit move in the Dow today isn’t the same as when it hovered at much lower levels, we’ve witnessed 100 plus point changes in the Dow in of 13 the last 19 sessions (St. Louis Federal Reserve).

 

Index

Weekly Return %

thru Oct 10, 2014

YTD Return %

Dec 31, 2013 – Oct 10, 2014

DJIA1

-2.74

-0.20

NASDAQ Composite2

-4.45

+2.39

S&P 500 Index3

-3.14

+3.13

Bond Yields

Oct 10 Yield & Weekly Change

Yield - % a/o Dec 31, 2013

3-month T-bill

0.01       Unch

0.07

2-year Treasury

0.45       -0.12

0.38

10-year Treasury

2.31       -0.14

3.04

30-year Treasury

3.03       -0.10

3.96

Commodities

Oct 10 Price & Weekly Change

Year end 2013

Oil per barrel4

     $85.52            -4.19

   $98.42

Gold per ounce5

$1,219.00           +24.00

$1,201.50

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC, Energy Information Admin.

 

Six of those days were up and seven were down. This includes last week’s biggest advance, up 275 points on Wednesday, which was quickly followed by the biggest loss on Thursday – down 335 points (St. Louis Federal Reserve).

 

Some might be tempted to blame October for the weakness. The month has a spooky reputation, as market swoons in 1929 and 1987 happened in the month that claims Halloween.

 

However, a review of the data going back nearly 45 years helps dispel the myth that October is traditionally bad for stocks – see Figure 1. Fact: September has historically been an off month for stocks, not October.

 

But October can be volatile. Since 1929, there have been 91 times that the S&P 500 Index has been up or down at least 6% in one day. Of those, 49 were up and 42 were down. Interestingly, 23 of those daily swings occurred in October (S&P Dow Jones Indices, CNBC).

 

Note: Percent change from month end to month end; Oct, Nov, Dec data through 2013

 

Reasons for the recent weakness vary, and much is being blamed on poor economic data in Europe, especially the continent’s economic anchor and largest economy, Germany.

 

Let’s begin with the negatives and provide some context with positive forces that remain in place. With the exception of the global economic backdrop, the list is not in any particular order.

 

  1. Global economic worries, especially as it relates to Europe. Last week, German industrial production and exports fell at their fastest rate since January 2009 (Bloomberg, EU Observer). Always be cautious with one data point, but comparisons to early 2009 are never favorable.

 

  1. The International Monetary Fund downgraded the global outlook and significantly raised the odds Europe will enter a recession (IMF.org).

 

  1. Poor market internals – the S&P 500 Index has broken through its 50-day moving average and failed to hold after Wednesday's big rally (StockCharts).

 

While the S&P 500 Index is down just 5.3% from its closing peak on September 18, smaller company stocks have had a rougher ride. The Russell 2000 Index6, which is a gauge of smaller companies, is down nearly 13% since early July (Big Charts). Anything below 10% is what analysts call a correction.

 

Moreover, 79% of companies in the Russell 3000 Index7, which is a very broad measure of large and small company stocks, are down at least 10% from their highs as of the October 10th close (Bloomberg News). In other words, the current level of the S&P 500 Index, which is weighted to the largest companies, is masking recent market weakness.

 

  1. Fears the strong dollar will weigh on revenues of multinationals.

 

  1. Worries about an eventual rate increase next year by the Federal Reserve have beaten down junk bonds; problems in the junk bond market can seep into stocks.

 

  1. Commodities are falling; oil is practically in a free-fall. Like stocks, it's a riskier asset, and some of the selling in commodities, which is being pressured by weaker global demand, may be spilling over into stocks.

 

  1. The Fed’s bond-buying program is scheduled to end this month. It's a well-known fact, but nonetheless, the expected end of Fed liquidity may be creating volatility.

 

  1. As far as its monetary response, the European Central Bank remains behind the curve, even with some of its more recent measures.

 

  1. Geopolitical concerns – it's difficult to quantify, but when sentiment gets negative, let's blame Ukraine, Russia, and the Middle East.

 

  1. Ebola is a headwind that's hard to define. According to the Center for Disease Control, the Ebola virus “is not spread through the air or by water, or in general, by food.” But when market sentiment is negative, it gets thrown into the mix.

 

  1. It's been 3 years since a 10% correction in the S&P 500 Index (St. Louis Federal Reserve). The big run-up in stocks and current valuations provide just the right excuse to book profits.

 

But let’s not discount the positives—

 

  1. U.S. fundamentals are solid. Nowhere is this more evident than in the labor market, where a number of indicators (including the ramp-up in hiring; BLS – nonfarm payrolls data) are signaling further economic growth, which in turn supports corporate profits.

 

  1. Earnings season is upon us. It's very early, but estimates at this stage of the cycle are above recent estimates at similar stages (Thomson Reuters).

 

  1. Global economic concerns, especially in Europe, are creating anxieties. However, according to S&P Dow Jones Indices, European companies accounted for 9.7% of S&P 500 revenues in 2012; Goldman Sachs estimates 7% in 2013. Europe just isn’t that significant a source of revenue.

 

  1. The U.S. exported $262 billion in goods to Europe last year, but that compares to a $17 trillion U.S. economy (BEA). The 2012-13 euro-zone recession didn't cause a slump in the U.S. and the U.S., economy is stronger today. Therefore, it's unlikely another euro-zone slump will cause a U.S. contraction.

 

U.S. exports account for about 13% of GDP, almost double 25 years ago (BEA). Still, that’s a small percentage compared to consumer spending which make up nearly 70% of the GDP. The U.S. is not nearly as dependent on exports as a number of countries around the globe.

 

  1. Falling oil and commodity prices are a plus for U.S. manufacturers and consumers.

 

  1. The Fed isn’t expected to start raising interest rates until sometime next year. Even then, the general consensus suggests any rate hikes will be gradual. A more accommodative monetary policy has historically been a plus for stocks.

 

In conclusion, don’t be misled by the larger number of bullet points in the market negatives. Powerful supports remain in place.

 

A 10% or more correction in the S&P 500 Index (if it were to occur), in the context of a growing economy, would likely be healthy for the longer-term well-being of the market, as it mops up excess enthusiasm that can lead to unhealthy exuberance in stocks.

A look at the current economic state - October 10, 2014

Financial writer Charles Sherry has a very nice breakdown of the current state of the economy in his article below:

The Dow lost 335 points, or 1.97% yesterday.

Yet, the S&P 500 Index is down 4% from its peak, less than half of what might be considered a correction but the volatility is headline grabbing.

What's going on? A number of things:

The negatives--

  1. Global economic worries, especially as it relates to Europe. Germany, Europe's anchor, has posted terrible data recently. Earlier in the week, German industrial production and exports fell at their fastest rate since January 2009. Always be cautious with one data point, but comparisons to early 2009 are never favorable. Moreover, Germany is at risk of slipping into a recession.
  2. Poor technicals - the S&P has broken thru its 50-day moving avg. and failed to hold after Wednesday's big rally; many S&P stocks are well off their highs, as the level of the S&P has masked some of the technical damage.
  3. The strong dollar will weigh on revenues of multinationals.
  4. Weakness in small caps; the Russell 2000 in in a correction, and has experienced volatility.
  5. Worries about a rate hike have beaten down junk bonds; problems in junk can easily seep into stocks.
  6. Ebola - it's a headwind that's hard to get one's hands on; per the CDC, it's not a disease that easily transmits from person to person, but when market sentiment is negative, it gets thrown into the mix.
  7. Commodities are falling; oil is in a free-fall. Like stocks, it's a risk-on asset.
  8. QE is coming to an end. It's a well-known fact but nonetheless, the end of Fed liquidity may be creating volatility.
  9. The European Central Bank remains behind the curve, even with some of its more recent measures.
  10. Geopolitical - like Ebola, it's difficult to quantify, but when sentiment gets negative, let's blame Ukraine, Russia, and the Middle East.
  11. It's been over 3 years since a 10% correction; P/E’s suggest stocks are fairly valued, but the steep rise in stocks creates anxieties.

The positives--

  1. U.S. fundamentals are solid.
  2. Earnings season is upon us; it's very early but Alcoa, the unofficial start to earnings season, blew past earnings.
  3. Yet, at less than 10%, it's not that significant.
  4. The U.S. exported $270 billion in goods to Europe last year; but that compares to a $17 trillion U.S. economy. The 2012-13 euro-zone recession didn't cause a slump in the U.S. The U.S. economy is stronger today, and it's highly unlikely another euro-zone slump will cause a U.S. contraction.
  5. Falling oil and commodity prices are a plus for U.S. manufacturers and consumers.
  6. The Fed won't be raising rates still sometime next year; the FOMC minutes from the latest meeting were dovish.

Summary - historically, bull markets end from recessions. Odds of a U.S. recession are very low. A 10%+ correction, if it occurs, would be healthy for the stock market (in the context of an improving economy).

 

Market Update - October 9, 2014

The rollercoaster ride continues for the markets today with all three major indexes showing weakness. Earning season kicked off this week, and will continue to have an impact on daily market fluctuations. Despite some strong earnings from companies such as Alcoa (AA) & Pepsico (PEP) and lower numbers in jobless claims, the markets are continuing to show volatility. Factors such as global economic worries, continuing concerns about Ebola and uncertainty about the Federal Reserve’s pullback of the Quantitative Easing program can influence the market on any given day. This is a good reminder that although these events are all important factors, you should be able to utilize current information to see a broader long-term perspective of your investments over time. While fluctuating markets can cause investors stress, it is also a good reminder to review your risk tolerance from time to time. Perhaps your investment goals have changed, or your financial situation has caused you to become more risk averse or risk tolerant. Just as people change with age, so does your investment philosophy.

Locally we are seeing some beautiful colors around our region. From the leaves changing on the trees, the blood moon early yesterday morning, and some spectacular sunrises, there is plenty of beauty for all this time of year.

(Disclaimer: Any individual stocks mentioned in this article are not to be viewed as recommendations. They are simply sampled reporting of market updates and news.)

Market Update - October 6, 2014

Firming Economy Keeps Job Growth Intact

 

Before we review September’s employment report released on Friday, I wanted to spend a brief moment discussing some of the recent volatility we’ve seen in stocks, particularly the Dow Jones Industrials.

 

Index

Weekly Return %

thru Oct 3, 2014

YTD Return %

Dec 31, 2013 – Oct 3, 2014

DJIA1

-0.60

+2.61

NASDAQ Composite2

-0.81

+7.16

S&P 500 Index3

-0.75

+6.47

Bond Yields

Oct 3 Yield & Weekly Change

Yield - % a/o Dec 31, 2013

3-month T-bill

0.01           Unch

0.07

2-year Treasury

               0.57           -0.02

0.38

10-year Treasury

2.45           -0.09

3.04

30-year Treasury

3.13           -0.09

3.96

Commodities

Oct 3 Price & Weekly Change

Year end 2013

Oil per barrel4

       $89.71             -3.64

    $98.42

Gold per ounce5

$1,195.00           -18.75

$1,201.50

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC, Energy Information Admin.

 

It’s the best known and oldest of the major market indexes, and its gets the most attention even though it covers only 30 stocks. Yes, they are 30 well-known firms, but still, it’s just 30 companies.

 

We’ve witnessed 100+ point moves in seven of the last ten trading days. Four were negative and three were positive (St. Louis Federal Reserve data).

 

With the Dow residing near 17,000, a triple-digit move means much less than when the Dow was at a level of 5,000 or 6,000. For example, a 150-point change in the Dow at 17,000 amounts to 0.88%, versus 2.50% at 6,000. It is a good idea to keep that in perspective when you see the headlines.

 

Separately, Friday’s employment report strongly suggested the economy continues to firm, and the upward revisions to August helped alleviate worries that growth might be poised to slow.

 

Nonfarm payrolls grew by 248,000 in September, while August’s lackluster reading was revised to 180,000 from the initial report of 142,000 (BLS). July was revised to 243,000 from 212,000.

 

Including the upward revisions, September’s better-than-forecast increase of 248,000 beat the Bloomberg consensus of 215,000 by an impressive 102,000.

 

If you take a step back and filter out some of the monthly volatility, you’ll note in the chart below that momentum has been building. It’s not that the labor market has completely recovered from the deep wounds inflicted by the Great Recession. It hasn’t. But there has been notable progress.

 

 

Payroll growth signals stronger economy

 

In general, companies increase payrolls when they have a need for employees, and that usually doesn’t occur unless business is improving. In addition, increased employment helps to support overall demand for goods and services, which helps fuel economic growth.

 

It doesn’t stop there. From an investor’s viewpoint, stronger economic growth aids corporate profits, which creates a stronger tailwind for stock prices.

 

The missing ingredient – wage growth

 

We always feel better when we’ve received news that an unemployed family member, colleague, or friend lands a new position that fits their respective skillset. The same holds true when we see an increased number of job openings in the industry we work.

 

But one thing that has been holding back the economy and limiting gains in consumer confidence has been the lack of wage growth. Yes, we can always find anecdotal examples of rising wages in high-demand fields, but overall, salaries aren’t rising very quickly.

 

Included in Friday’s nonfarm payroll report, the Bureau of Labor Statistics reported that average hourly earnings in September was unchanged from the month before.

 

Year-over-year, growth slowed from 2.1% in August to 2.0% in September.

 

Eventually, increased job growth and a falling unemployment rate (down to 5.9% in September from August’s reading of 6.1% - BLS) should encourage faster wage growth, which in turn would likely provide added support for consumer spending.

 

Nonetheless, much of the recent data, including faster employment growth, is good sign the economy has probably exited the low-growth orbit it’s been stuck in since the start of the decade.

Market Update - September 29, 2014

Recently, the dollar has been surging against a number of major currencies. As the week came to a close, the Dollar Index6, which is a weighted average of the currencies of major U.S. trading partners, rose to its highest level since July 2010 – see chart below.

 

 

Unlike the 2009 surge in the dollar, which was aided by the global financial implosion and the dollar’s status as a safe-haven currency, the recent strength is tied more closely to the economic fundamentals.

 

For the most part, U.S. economic data have firmed and commentary coming out of the Federal Reserve suggests the long-awaited series of rate hikes may finally begin sometime next year.

 

An improving U.S. economy can be a magnet for foreign cash because profitable opportunities to invest expand.

 

Moreover, rising interest rates relative to other currencies may also attract funds, as foreign investors seek out higher returns. The Fed has yet to lift the fed funds rate, but the difference between the 10-year Treasury yield and its German counterpart is at its highest level in 15 years (Reuters).

 

In the meantime, economic growth in Europe has languished (Bloomberg, Eurostat, Wall Street Journal), adding to the divergence in economic activity and the relative attractiveness of the dollar. That has led to an increasingly accommodative stance from the European Central Bank, as it hopes to stave off deflation and support growth – another plus for the dollar.

 

We’re also seeing uneven economic activity in Japan, which has led to increased talk from economists that the Bank of Japan could expand its massive stimulus program (Wall Street Journal). That would be an added headwind for Japan’s currency, the yen. All in all it supports the dollar.

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