Perspectives from Above the Noise – Week of April 28, 2014

The U.S. market entered the heart of the earnings season this week with the busiest period for first-quarter results thus far. Over the past year, the market has shrugged off sluggish earnings results and downward revisions to future earnings to march steadily to new highs. The early portion of the current earnings season has been no exception to this trend. Stocks were poised to make another run at new all-time highs until the latest dust-up in the Russian-Ukrainian crisis dampened Friday’s trading. The bond market also continues to seemingly signal some caution, with Treasuries and investment-grade corporate bonds outperforming high-yield issues and the yield curve flattening (with the spread between 5- and 10-year Treasuries narrowing.).

Because of its taper strategy, the Federal Reserve has been buying fewer government and mortgage-backed bonds each month thus far in 2014. As a result, the yield on the 10- and 30-year Treasury bonds has actually fallen despite the partial exit of the market’s largest buyer – to the surprise of many experts.

For the week, the S&P 500 dropped -0.08%, the Dow lost -0.29%, and the MSCI EAFE (developed international) gained +0.30%.

Here are the 3 stories this week that rose above the noise:

Feeling Jittery? Read This

Investors have begun to feel jittery in recent weeks, mostly because of concerns over equity valuation, a perceived threat of rising inflation, the Ukraine crisis and Fed tapering. However, the biggest threat to the bull market, a recession, is unlikely in the near term according to a recent Wall Street Journal article.

No two recessions are exactly alike, but the last seven recessions were proceeded with warning signs in a few key economic indicators including an inverted yield curve, a sharp contraction in manufacturing, a spike in inflation, a severe downturn in housing starts, and a drop in average weekly hours. None of these indicators are currently “flashing red,” signaling the current bull market has a low probability of being derailed by a recession in the near term.

IMF Raises its Economic Growth Forecast for China

The International Monetary Fund (IMF) raised its growth forecast for China by 0.3 percent to 7.5 percent for 2014, which may reassure investors who worry that the world’s second-largest economy might be slowing too abruptly. The forecast is in line with the ruling Communist Party's official growth target for the year and would be the strongest for any major economy but is below the double-digit levels of the past decade and last year’s growth of 7.7 percent.

While 2014 growth was raised, the IMF warned of continued credit problems, noting recent defaults in trust products, or packages of credit card debt and other debt sold by banks to investors, as well as heavy debts owed by some local governments that borrowed to pay for roads and other projects.

Help Wanted Signs Are Popping up in U.S. Cities

A recent article from Businessweek provides a good summary of growing evidence that the U.S. labor market is tighter than generally believed, including regional evidence of labor shortages. The implications of a tighter-than-expected labor market would likely be rising wage pressures, which would likely lead to increased corporate revenues but also broad inflationary pressures which may eat into profit margins and could accelerate the Federal Reserve’s stimulus wind-down plan. The idea of a stronger-than-anticipated labor market is a theme that may receive growing attention in the coming months and has important market implications.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of April 21, 2014

Last week’s holiday-shortened week came to a close with four consecutive positive sessions for the S&P 500 that erased most of the recent losses. It has certainly been a volatile April causing a 5% upswing in the S&P 500, which has now settled back above the 1850 level – a level that has served as both key technical resistance and now again support. The recovery last week forced many short-sellers to cover their positions in some of the most beaten-down former momentum favorites. The bulls will now try re-test the all-time highs set in early April around the 1900 mark on the S&P 500.

U.S. economic data again showed modest but solid improvement. Retail sales also jumped in March by the most since September 2012, including a pickup in vehicle sales, demonstrating pent-up demand from the winter weather. That being said, looking at the first quarter as a whole, retail sales lagged far behind the activity in the fourth quarter and will likely be a material drag on Q1 U.S. GDP.

For the week, the S&P 500 was up +1.73%, the Dow gained +1.47%, and the MSCI EAFE (developed international) rose +1.17%.

Here are the 3 stories this week that rose above the noise:

Risk of Stock Pullback Continues

With last week’s market rebound, talk of a major correction has faded. However, many money managers believe that the risk of a sharp pullback has been delayed, not eliminated. Equity markets have been so strong in recent years that major indexes haven’t dropped 10 percent or more since September 2011, which is twice as long as the typical once every 16 months.

Additionally, the markets appear strained as the number of stocks trading at record highs is off significantly and volatility is on the rise. Positively, while valuation is becoming more extended we are not at levels seen during prior peaks.

Companies Are Beating Earnings Estimates—but Don’t Be Fooled

Alex Rosenberg summarizes the results of earnings season thus far on cnbc.com. As detailed in the article, although it remains early in earnings season with less than 20 percent of companies having reported first-quarter results, those that have reported are beating estimates for earnings and revenues at a lower rate than has been typical over the past four years.

At this point, it looks like S&P 500 companies will report a year-over-year earnings decline for the first time since 2012 and overall revenue numbers have also been below expectations in aggregate. Nonetheless, investors appear to be looking past first-quarter earnings, which in some cases may have been impacted by severe weather, and continue to price in a rebound in earnings growth for the remainder of the year.

Economists Expect U.S. to Shake off Winter Slowdown

According to the latest National Association for Business Economics survey, economists are more upbeat about the economy now that we have escaped the brutally cold winter that negatively impacted economic activity during the first three months of the year.

Recent data ranging from retail sales to industrial production has pointed toward a rebound in economic growth. Overall, 72 percent of economists polled in the survey feel that U.S. GDP will grow by 2 percent to 3 percent in 2014, ahead of 1.9 percent GDP growth in 2013. Additionally, 80 percent of survey respondents expect the Federal Reserve to end its quantitative easing program by year end.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of April 14, 2014

A volatile week of whipsaw market action pushed all the major U.S. equity indices back into the red on a year-to-date basis. The S&P 500 sunk to a two-month low after making new all-time highs only a month ago. Market leadership has been undergoing a profound shift away from U.S. growth to defensive value and non-U.S. assets. Momentum has also been waning among last year’s standout small-cap issues, often an indication of a tired market.

In fact, equity investors have been aggressively selling previous winners for the last couple of weeks, shedding high momentum leaders in areas like biotechnology, social media and homebuilders. They have opted instead for defensive and value names in the staples, utilities, telecom and energy sectors while also rotating into unloved emerging-market stocks and bonds. After several years of underperformance and subsequent capital outflows, emerging markets have become increasingly under-owned by professional investors. However, money has been flowing back to emerging markets as investors search for valuation bargains in this beaten-down asset class. 

For the week, the S&P 500 dropped -2.65%, the Dow lost -2.35%, and the MSCI EAFE (developed international) fell -1.79%. 

Here are the 3 stories this week that rose above the noise: 

The Tide Is Turning for Greece – and the Eurozone 

While unrest in the Ukraine has caused volatility in global markets, steady improvement in the Eurozone’s sovereign debt crisis may have gone unnoticed. An article from The Wall Street Journal, points out that Greece returned to the bond markets last week, which was a symbolically important moment for the euro crisis. 

For the country at the center of the crisis to draw €20 billion ($27.77 billion) of foreign demand for a five-year bond yielding under 5% shows that the market now believes Greece will stay in the Eurozone. It also indicates the market thinks Greece won’t collapse into chaos and that any further debt relief will be provided by official rather than private lenders. A year ago, there were few takers for that bet. The tide of money flowing into the crisis-country assets comes amid growing evidence that Southern Europe has turned the corner. 

Here's the One Trend to Watch in Earnings Season 

The first-quarter earnings season has begun and consensus analyst expectation is for 3% revenue growth and a 0.13% decline in earnings for S&P 500 firms. The bar is low for first-quarter revenue and earnings growth, but revenue among S&P 500 firms is expected to increase by 4% this year, ahead of 1.1% revenue growth in 2013. 

It’s an encouraging sign that revenue growth is expected to increase and also exceed the growth rate of earnings, which signals that consumer demand is beginning to have a larger impact on corporate profits, following several quarters of corporate austerity. Additionally, revenue growth will be a lot more important in the coming quarters as corporations may not be able to access large levels of cheap debt to fund large-scale buyback programs to boost stock prices if interest rates increase as the Fed winds down its QE program. 

Value Is the New Momentum, in Three Charts 

Large-cap value stocks, as measured by the Russell 1000 Value Index, rose 2.2% in March, easilyoutperforming the Russell 1000 Growth index, which was down 1.1%. The performance reverses a trend seen in the second half of 2013 and the first two months of 2014. 

Morgan Stanley strategist Adam Parker notes that historically “value tends to continue its advantage over growth following strong value rallies.” Additionally, “following a strong value rally, on average, the market underperforms its historical average for the next 10 months.” Parker points out that energy and consumer-staples stocks typically lead in these environments, while technology and telecom stocks lag. 

Articles chosen & summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of April 7, 2014

The S&P 500 and Dow powered to fresh new all-time highs before selling off after last Friday’s jobs report. The bulls were comforted by an apparent growth revival as the U.S. economy awakens from its harsh winter slumber. Most of the March data released this week showed modest but consistent improvement from February’s lackluster numbers. That included improved ISM services and manufacturing data, vehicle sales and ADP employment report. European central banks left policy rates unchanged again, despite inflation measures in the euro area falling to the lowest levels in four years. And emerging market equities have been rallying since mid-March.

For the week, the S&P 500 added +0.40%, the Dow gained +0.55%, and the MSCI EAFE (developed international) was up +1.53%.

Here are the 3 stories this week that rose above the noise:

What the Jobs Report Means for Housing

Housing data has weakened over the last few months, but a recent The Wall Street Journal Real Time Economics article paints a brighter outlook for the housing recovery. The article indicates rising interest rates and rising home prices coupled with unseasonably cold weather put a pause in the housing recovery this winter. However, the latest employment data offers a few signs that things will improve.

First, employment for 25-34 year-olds, a key group for first-time home buyers, is steadily improving and approaching pre-crisis levels. Additionally, the unemployment rate for construction workers continues to fall and is at its lowest level since 2008. And residential construction employment is 30,800 workers higher than three months ago, signaling optimism within the industry for improved housing demand in the coming months.

IMF Says U.S. Drives Growth as Russia, Brazil Weaken

A Bloomberg article summarizes the latest International Monetary Fund (IMF) projections for global growth. Not surprisingly, the IMF expects the United States, Germany and the U.K. to be bright spots in the global economy for the remainder of the year and emerging markets to continue to exhibit disappointing growth.

The IMF’s reduced growth expectations for emerging-market economies reflects what are now widely held concerns, and the recently strong price action in emerging equities in spite of growing pessimism may suggest economists have become overly pessimistic in their outlook.

Quack Quack: Demand, Meet Supply

An article by columnist Josh Brown reviews the torrid IPO market since 2011, raising a cautionary flag as a white-hot IPO market coupled with sky-high valuations is often seen at market tops. 2013 was a banner year for IPOs, the best one since 2000. A total of 222 companies went public last year raising $55 billion. Fast forward to 2014 and, even before this week, the “ducks” have been exceptionally well fed.

The sixty-plus IPOs of Q1 2014 represented a 100 percent jump over what we saw in the first quarter of last year. Total dollars raised also jumped by 40 percent to $10.6 billion, and 70 percent of this quarter’s new issues were highly speculative companies losing money over the prior year. Given the rout of many recent IPOs, and many pricier technology and biotechnology shares over the past two weeks, signs have started to appear that indicate the “ducks” are close to satiated, if not fully stuffed.

International investing involves additional risk, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of March 31, 2014

U.S. stocks have been stuck in a six-week trading range as investors struggle to digest the effects of changes in Federal Reserve policy and the drag of winter weather on the U.S. economy. While U.S. markets continued to struggle for direction, emerging markets rallied – an unfamiliar condition in recent years. Commodities, which are closely tied to emerging economies, also staged a rally. Emerging-markets strength continues to come from India, where hope that a new government will spur economic growth has pushed equities to record highs. It’s unclear, though, whether last week’s emerging-markets strength was simply an oversold rally or the early indications of a new “risk-on” phase in the global equity markets.

For the week, the S&P 500 dropped -0.48%, the Dow gained +0.12%, and the MSCI EAFE (developed international) rose +2.15%.

Here are the 3 stories this week that rose above the noise:

Here Comes $75 Oil

Gene Epstein of The Wall Street Journal details the case for a very prolonged bear market in oil prices driven by surging production from deep water, shale and oil sands. These relatively new sources are providing a huge boost to previously estimated reserves and, coupled with slowing demand growth, could set the stage for much lower oil prices in real terms over the next decade.

The implications for this are likely positive for consumer spending and real economic growth, and extremely negative for countries such as Russia that are highly reliant on oil-and-gas revenues. While in the short-term oil prices may have some upward pressure from geopolitical concerns, longer-term the fundamentals seem to point to declining prices.

Yellen Assures Markets on Interest Rates

Janet Yellen, the new U.S. Federal Reserve Chairwoman, rattled markets less than two weeks ago by implying a sooner-than-expected rise in interest rates after a Fed policy meeting. However, yesterday, she made clear at a speech in Chicago that the Fed intends to keep interest rates low until the market is much stronger.

She said “while there has been steady progress, there is also no doubt that the economy and the job market are not back to normal health.” She went on to list five reasons that she sees continuing slack in the U.S. economy, including seven million part-time workers that would prefer to be in full-time jobs. Ms. Yellen’s quick re-messaging of her previous comments implies that she wants capital markets to continue to view the Fed as being unusually accommodative.

Emerging Markets Are Attractive

A recent article, based on a recent Merrill Lynch Fund Manager Survey, highlights a few interesting points on emerging market sentiment. Fund managers are currently extremely underweight emerging markets as seen by reporting of their largest underweight position in the asset class since the survey began in 2007.

Additionally, cash levels have increased and show a high correlation with the performance of the emerging markets equity. However, the asset class is starting to look extremely attractive from a long-term valuation standpoint with the overall MSCI Emerging Markets Index trading at 1.4 price to book value, and certain countries already trading close to or even below book value.

The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. It is a float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey. International investing involves additional risk, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.