Perspectives from Above the Noise – Week of May 26, 2014

Last week, economists, investors and homeowners welcomed the news that existing home sales improved 1.3% for April. Complementing that announcement from the National Association of Realtors, the Census Bureau said new home sales rose 6.4% in April. In annualized terms, the sales pace has flagged: new home sales have slowed 4.2% over the past 12 months, resales 6.8%.

April brought the fourth straight monthly gain for the Conference Board’s index of leading economic indicators. It rose 0.4% in April, and its March gain was revised up to 1.0% (its largest gain since last September). The index looks at 10 factors to project the health of the American economy 3-6 months ahead.

These concerns must be weighed though against generally stronger-than-expected recent U.S. economic data, including a strong ISM Non-Manufacturing (services) report, a resumption in falling initial jobless claims after a brief rise, and improved Chinese export data largely due to a weaker yuan currency. With earnings season more than 90% complete, three-fourths of reporting companies have topped consensus earnings-per-share estimates, according to Factset. Investors may also get a summer boost in the form of additional monetary stimulus from European and Japanese monetary authorities.

For the week, the S&P 500 rose +1.21%, the Dow added +0.70%, and the MSCI EAFE (developed international) gained +0.54%.

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

Are Emerging-market Equities Finally Catching Up?

Emerging-market equities experienced net inflows for the first time in over a year during April. Emerging-market performance significantly lagged developed markets in 2013, but they are outperforming in 2014.

Last year, investors began to pull money out of emerging markets when the Federal Reserve first discussed tapering its bond-buying program in May, which resulted in a sharp decline for many emerging-market currencies. Investor sentiment for emerging markets has improved in recent months, but emerging markets still face several headwinds including slower economic growth and elevated geopolitical risks in several regions.

E.C.B. Plots Strategy for Staving Off Deflation

European policy makers and economists met this week in Lisbon in advance of the formal June 5 governing council meeting to discuss the European economy, including the growing deflation concern. While the annual inflation rate of 0.7% is well below the European Central Bank’s (ECB) 2% target, the specter of deflation threatens to undermine the weak economic recovery in the Eurozone.

Most economists expect the ECB will take some form of action on June 5, however there are differing opinions as to what moves should and will occur. Among the policy options are ECB asset purchases (similar to U.S. quantitative easing), a reduction in the benchmark interest rate to 0.15 percent from 0.25 percent, and a negative deposit rate that would charge lenders for parking money at the central bank.

Bond Market to Fed: Your 4% Rate Forecast Is Way Too High

A Bloomberg article examines some implications of the strong start to the year for bond markets, which has resulted in the best year-to-date gains for long-term Treasuries since 1995. One implication of current market yields is that bond investors believe that the Fed will keep interest rates lower for longer than even the Fed’s own forecasts conclude. A further implication is that bond investors seem to be pricing in a prolonged period of subpar economic growth despite a growing consensus among economists that growth will accelerate over the remainder of the year.

Behavioral and technical factors may explain some of the bond market strength this year after a very volatile 2013, but additional declines in yields in the coming months would suggest the bond market is betting against a strong global economic recovery developing anytime soon.

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

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.

Perspectives from Above the Noise – Week of May 19, 2014

In the past week, U.S. markets made fresh all-time highs, while equity markets in Europe, and particularly the United Kingdom, have touched six and 14-year highs respectively. But stocks came under pressure last Thursday after Treasury yields sunk to fresh 2014 lows – taking out the important technical February low of 2.57% on the 10-year Treasury. The consensus expectation was that yields would rise this year as the economy picked up steam, and the U.S. Federal Reserve purchased fewer government and mortgage-backed bonds each month under its gradual taper strategy. But that has not yet come to pass.

Despite signs of slowing growth, Wednesday’s Producer Price Index provided some additional evidence that inflationary pressures may be quietly building in the U.S. economy, rising 0.6% in April. This represented the biggest monthly increase since January 2010.

For the week, the S&P 500 dropped -0.03%, the Dow lost -0.55%, and the MSCI EAFE (developed international) gained +0.35%.

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

Interest Rates: Low for Long

Despite the year-to-date decline in the yield of the 10-year Treasury, many pundits believe that interest rates are poised to reverse course and rise back above 3 percent based on the slowly improving U.S. economy. Oppenheimer provides a contrarian view that interest rates may remain low for much longer than anticipated based on their more muted growth outlook.

Historically, U.S. gross domestic product (GDP) and interest rates tend to track each other very closely. Oppenheimer notes that policy changes in China will likely lead to slower Chinese domestic consumption which will be a drag on global growth and they do not expect interest rates to rise until global GDP does.

Pinch Me! Europe Grew Faster than U.S.

The European economy grew at a faster pace than the United States’ for the first time in three years during the first quarter, as Europe experienced 0.9 percent annualized growth and the U.S. economy grew at a 0.1 percent annualized rate. European economic growth was below consensus expectations in the first quarter, however, it was the second consecutive quarter of positive economic growth in Europe and provided further evidence that Europe’s post-debt-crisis recovery remains on track.

Despite the strong start to 2014, growth in Europe is likely to trail the U.S. in the second quarter. Europe had a mild winter, which provided a boost to economic activity and that factor will likely fade in the second quarter. Conversely, U.S. economic activity is likely to rebound after a historically cold winter. Additionally, the crisis in Ukraine is likely to negatively impact consumer and business confidence throughout the Eurozone and negatively impact economic activity.

Lackluster Earnings Leave Stocks on Thin Ice

Behind the stock market’s anxious ups and downs of late lies the fear that a weakening U.S. and global economy could dash hopes for an uptick in corporate earnings. For the first quarter, earnings season is nearly done. More than 90 percent of big companies have reported results and they are lackluster. Profit gains for the S&P 500 were 2.1 percent overall compared with a year earlier, well below the previous quarter’s 8.5 percent rise, according to FactSet.

An article from The Wall Street Journal discusses some of the risks to earnings going forward, which include an uncertain economic backdrop due to recent soft reports on industrial production, housing starts, consumer sentiment and European economic growth.

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

Perspectives from Above the Noise – Week of May 12, 2014

The Dow Jones Industrial Average and the S&P 500 both continued to probe the upper end of their trading ranges, pressing against the resistance of previous all-time highs. Even recently weaker large-cap technology stocks attracted some buying interest. But below the surface of the large-cap indices, trouble has been brewing. Concerns of note include weakness in economically sensitive stocks, volatility readings again nearing readings associated with complacency, and the cautionary signal suggested by stubbornly low Treasury yields (often a warning signal of a slowing economy).

These concerns must be weighed though against generally stronger-than-expected recent U.S. economic data, including a strong ISM Non-Manufacturing (services) report, a resumption in falling initial jobless claims after a brief rise, and improved Chinese export data largely due to a weaker yuan currency. With earnings season more than 90% complete, three-fourths of reporting companies have topped consensus earnings-per-share estimates, according to Factset. Investors may also get a summer boost in the form of additional monetary stimulus from European and Japanese monetary authorities.

For the week, the S&P 500 dropped -0.14%, the Dow added +0.43%, and the MSCI EAFE (developed international) fell -0.29%.

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

Fear of Economic Blow as Births Drop Around World

Even before the global financial crisis, demographic headwinds were expected to be a major long-term issue for economic growth with important implications for asset allocation. A recent Associated Press article details how the global recession accelerated this concern, causing a sharp and so-far persistent drop in already declining birth rates.

A rapidly aging world population may weigh on global economic growth in the coming decades and provide some steady downward pull on interest rates. While we do think rates are likely to rise in the coming years as inflationary pressures build, demographics are one force that may help moderate the rise and keep yields lower than historical norms for a very long time.

Regional Fed Chairmen Still See US Economic Growth of 3%

First-quarter 2014 U.S. GDP growth plunged to just 0.1 percent, down from 2.6 percent in the fourth quarter of 2013. However, anemic growth over the last six months could be due to the severe winter weather throughout much of the U.S.

Atlanta Fed Chairman Dennis Lockhart said last week that he expects second-quarter 2014 U.S. GDP to rebound to 3 percent while Philadelphia Fed Chairman Charles Plosser expects full year growth of 3 percent. They both indicated that they believe the U.S. economy is strong enough for the Fed to continue to wind down its bond buying by October or December of this year.

Anticipating Strong Mandate for Modi, India’s Stock Market Surges

India’s stock market surged to a record high on Monday on hopes for a new, pro-business Indian government led by the Bharatiya Janata Party’s Narendra Modi. The election in India, the world's largest democracy, began April 7 and was held in nine phases, with exit polls now suggesting that the B.J.P. coalition could receive more than 272 of the lower house’s 545 seats.

The Congress party and its allies, which have held power for 10 years, were projected to win 101 to 120 seats, according to Bloomberg. The Indian market is up 12 percent since last December following signs that a B.J.P. victory was likely. However, optimism must be tempered as India’s exit polls have previously been unreliable, incorrectly calling for a B.J.P. coalition victory in 2004.

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

Perspectives from Above the Noise – Week of May 5, 2014

Markets have remained in a trading range after mixed U.S. economic data failed to provide clarity. The Dow Jones Industrial Average climbed to yet another new all-time high on light volume. However, others saw continued weakness in the small-cap Russell 2000 index as a troublesome, early-warning signal. We learned last week that U.S. GDP growth flat-lined to an annualized pace of just 0.1% in the first quarter, its slowest pace since the fourth quarter of 2012.

The deluge of economic data reported over the past week largely came in better than expected, with the exception of first-quarter GDP, suggesting the U.S. economy has shaken off the impact of a severe winter. Many are now predicting a strong second-quarter rebound. One data point to watch is a recent uptick in weekly initial unemployment claims, which last week rose to the highest level since February, for an indication of whether the labor market momentum suggested by April’s headline jobs data is likely to persist into the summer.

For the week, the S&P 500 gained +0.93%, the Dow added +0.93%, and the MSCI EAFE (developed international) grew +1.25%.

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

About that jobs report...maybe it wasn't so great

On the surface, the April jobs report was very strong. Not only were 288,000 nonfarm payrolls added, but the unemployment rate dropped from 6.7% to 6.3%. But unfortunately, the sizeable drop in the unemployment rate was largely the result of 806,000 people dropping out of the labor force.

Additionally, the average length of unemployment remained above 35 weeks and no improvement occurred in April within the average work week or average hourly earnings, two closely watched labor market statistics. Furthermore, a large number of new jobs created in April were in low-paying industries including retail, restaurants, and hospitality. All of that said, despite some weakness within the details of the jobs report, the labor market continues to improve, albeit at a slower rate than prior post-World War 2 recoveries.

U.S. Manufacturers Gain Ground

After more than a decade of losing ground to China and other export powerhouses, U.S. manufacturers are finally showing signs of regaining their competitive edge. An article from The Wall Street Journal points out the recent improvements in the U.S. trade deficit and the Boston Consulting Group’s (BCG) forecast for further trade-deficit improvements due to a surge in U.S. exports.

BCG says rising exports and “reshoring” of production to the U.S. from China could create 2.5 million to 5 million American factory and service jobs associated with increased manufacturing by 2020 that could reduce the unemployment rate by as much as two to three percentage points.

Why Weather Could Determine Who Wins a Race to Measure Inflation

A post on the The Wall Street Journal’s economics blog discusses an interesting recent divergence between the government’s measure of inflation and the measure calculated by the PriceStats Index, which was first developed by economists at MIT to measure inflation using web-based data. The internet-based measure uses real-time pricing data and until recently generally predicted CPI very accurately.

However, in late 2013 and the early part of 2014 the two measures have diverged, with official CPI showing much lower inflation than the internet-based measure. The article contends that the official CPI measure has been depressed by weather-related effects and will converge toward the PriceStats Index, which implies inflationary pressures in the economy are higher than generally believed. This inflation debate has important implications for asset allocation decisions over the remainder of the year.

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