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

Mixed domestic data, further signs of weakness in Europe, and some encouraging data out of China headlined a week’s choppiness for asset markets. For the week, the S&P 500 was little changed, emerging markets outperformed, and small-caps continued a month-long trend of notable underperformance. The major indices have spent most of July searching for direction with a generally solid early earnings season offset by very mixed economic reports.

The labor market is a key economic component that continues to show its best momentum in years. The latest encouraging data was Thursday’s report on weekly initial jobless claims, which declined by 19,000 to a seasonally adjusted 284,000. This was the lowest weekly reading since February of 2006.

For the week, the S&P 500 gained +0.01%, the Dow Jones Industrial Average lost -0.82%, and the MSCI EAFE (developed international) rose +0.43%.

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

Geopolitical risks have been rising recently with the United Sates and Eurozone increasing sanctions on Russia and Israel escalating its military efforts in the Gaza strip. Positively, so far, increased geopolitical strife has yet to materially impact oil prices, which have actually fallen 3% over the past year.

As the geopolitical chess game plays out in the Ukraine, an article by Gerald Seib from The Wall Street Journal points out why Russian President Vladimir Putin is willing to take big risks in Ukraine and why the Unites States and its allies should see his power play as an effort to alter not just the arc of Ukraine but all of Europe. The article points out that Poland, the country that integrated itself into the Western economy, has growth almost twice as fast of Ukraine. Last year its growth rate was three times larger. This contrast between Poland and Ukraine represents a threat to Putin since emulating Poland would cause the Ukraine to pivot westward, ending his alleged near-term dreams of rebuilding the Russian empire.

Home Prices in 20 U.S. Cities Rose at Slower Pace in May

Recent data on housing-market activity has been very mixed, indicating a sluggish recovery that is unlikely to provide an economic tailwind in the near term. The latest reading on the S&P/Case-Shiller index of property values in 20 cities also suggests that price appreciation continues to slow. The index rose 9.3% year-over-year, which was the smallest gain since February 2013.

Moreover, the index actually showed a price decline versus the prior month’s reading for the first time in two years. The latest data on home prices confirms the sluggish growth seen in recent starts and sales data, suggesting economic growth may not receive the boost from housing many were hoping for in 2014.

IMF cuts global growth outlook as U.S. recovery falters

The International Monetary Fund (IMF) cut its 2014 global growth forecast because of weaker-than-expected growth in the first quarter and waning optimism for emerging-market growth for the remainder of the year. In its view, global growth will reach 3.4% in 2014, a drop of 0.3% from its outlook in April, but still ahead of 3.2% growth in 2013. The IMF also cut its 2014 U.S. economic growth forecast to 1.7%, well below its April prediction of 2.8% growth, following the 2.9% contraction in GDP growth in the first quarter.

However, the IMF raised its outlook for Japan. It predicts that economic growth will reach 1.6%, a 0.3% increase from its view in April, largely because of the positive effects that Abenomics (economic reform introduced by Prime Minister Shinzo Abe) is having on the Japanese economy.

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

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

Fed Chair Janet Yellen testified before lawmakers last Tuesday and, as expected, she was careful to emphasize that policy accommodation could be withdrawn more rapidly or more slowly than currently expected, depending on incoming data. Market participants looking for any clues that rate hikes could be brought forward in response to recently improved data were largely disappointed, even as several lawmakers focused their questions on the Fed’s exit strategy. Also of note, the Fed’s monetary policy report flagged lower-rated corporate debt as evidence investors may be reaching for yield, and in a very unusual move singled-out small-cap social media and biotech stocks as segments of the equity markets with “substantially stretched” valuations.

All in all, the week’s economic reports indicated some potential loss in momentum from May’s data and added to recent evidence that economic growth heading into the third quarter was steady but not spectacular. However, steady has been plenty good enough for the equity market bulls. The end of the week finally brought the return of some volatility to markets, with the S&P 500 ending its longest streak since 1995 without a 1% daily move by declining 1.18% on Thursday before subsequently recovering virtually all of its loses on Friday.

For the week, the S&P 500 increased +0.54%, the Dow Jones Industrial Average added +0.92%, and the MSCI EAFE (developed international) rose +0.94%.

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

Heading Off the Entitlement Meltdown

This year’s budget deficit of “only” $500 billion has brought some complacency on federal spending and deficits. We believe it shouldn’t. An article from Rob Portman in The Wall Street Journal points out that the Congressional Budget Office’s (CBO) long-term budget outlook released on July 15 shows a $40 trillion increase in debt over the next two decades. While a $500 billion deficit is welcome compared to the $1.4 trillion peak in 2009, the current decline may be only temporary.

The CBO projects new debt of $10 trillion over the next decade, followed by $100 trillion over the subsequent two decades. Consequently the CBO simply stops calculating the national debt after 36 years, as its models apparently cannot conceive of a functioning economy. While the projected ballooning deficits remain a longer-term concern for investors, the article points out that the longer we wait to enact reforms, the more abrupt and painful they may be.

Yellen Wage Gauges Blurred by Boomer-Millennial Shift

A key justification from the Federal Reserve for maintaining its zero interest-rate policy for an extended period after quantitative easing ends has been data indicating very weak wage growth. To many economists, including Fed Chair Janet Yellen, this has been an indication that significant slack remains in the labor market and as a result inflationary pressures are unlikely to sharply increase.

However, a recent Bloomberg article has some interesting data that suggests much of the weakness in wage growth may be attributable to demographics, with high-earning older workers retiring and being replaced with younger workers who earn lower wages. As a result, the labor market may have less slack than the Fed believes and continued strong labor market gains could result in the Fed bringing forward its schedule for increasing rates.

The Single Best Predictor of Equity Returns in 2014?

Since the start of year there has been a significant relationship between a company’s market capitalization and year-to-date returns, as larger size stocks have easily outpaced smaller stocks. This relationship seems to be even more pronounced from the beginning of July, when the small-cap Russell 2000 Index peaked.

This trend represents a stark reversal from 2013 when smaller stocks outperformed. Many analysts point to excessive absolute and relative valuations to explain the recent rotation out of small and micro-cap. Pension Partners warns that this sign of defensive behavior will likely have long-term ramifications that impact the broader market.

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

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

European stocks started last week in the red after German industrial production was reported by the country’s statistics agency Destatis. Industrial production in the largest Eurozone economy dropped at the fastest pace in more than two years during May, falling at a 1.8% seasonally-adjusted clip vs. expectations for a flat reading.

The minutes from the June Fed meeting released on Wednesday revealed widespread agreement to end the quantitative easing (QE) bond-buying program in October. Under this approach, the Fed will scale back $10 billion per month for the next three months with a final $15 billion reduction in October. Perhaps most importantly, the minutes also provided little indication that the committee was preparing to increase rates ahead of mid-2015, despite improving economic data and both inflation and unemployment nearing the Fed’s stated targets.

For the week, the S&P 500 dropped -0.9%, the Dow Jones Industrial Average lost -0.73%, and the MSCI EAFE (developed international) fell -2.4%.

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

Retail Sales in U.S. Showed Broad-Based Increase in June

The Commerce Department reported that overall U.S. retail sales increased 0.2% in June down slightly from a 0.5% advance in May. The June reading came in below the 0.6% the median estimate of 83 economists surveyed by Bloomberg.

Core sales, the figures used to calculate gross domestic product and which exclude such categories as autos, gasoline stations and building materials, increased 0.6% last month, after rising by an upwardly revised 0.2% in May. Sales receipts at auto dealerships fell 0.3 % which is surprising given automakers recently reported a surge in motor vehicle sales in June (16.9 million annual pace, the strongest since July 2006). Overall, the report adds evidence that the economy may be continuing to recover pointing to stronger growth in the second half of the year.

Yellen Says Continued Easing Needed Amid Job-Market Slack

It is a newsworthy week for Fed watchers, with Fed Chair Janet Yellen testifying before lawmakers on Tuesday and Wednesday and a monetary policy report being released prior to her testimony. An article from Bloomberg provides a good summary of Yellen’s prepared remarks and the Fed’s policy report.

As expected, in her prepared remarks the Fed Chair was careful to emphasize that policy accommodation could be withdrawn more rapidly or more cautiously than currently expected based on incoming data. Market participants are monitoring Fed statements for any clues that rate hikes will be brought forward in response to recently improved data and lawmakers are likely to focus their questions on the Fed’s exit strategy. Also of note, the monetary policy report flagged lower-rated corporate debt for having stretched valuations but generally seemed comfortable that most asset prices remain in line with historical norms.

Budget Gap Shrinks to Narrowest Since 2008 So Far in Fiscal Year

The U.S. budget deficit continues to shrink and is now at the lowest level since 2008, according to the Treasury Department. The Federal government is getting a boost in tax revenue from an improving labor market and an uptick in corporate profits.

The budget deficit from October through June is nearly $145 billion lower compared to the same period last year. The Congressional Budget Office (CBO) projects the deficit at the end of the current fiscal year will drop to 2.8% of GDP from 4.1% in 2013. We believe this is an encouraging sign, especially in light of how far the deficit has shrunk since the depths the recession that ended in 2009.

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

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

After the S&P 500 rose 4.69% in the second quarter, we turned the page to a new month – and another record close for U.S. equities. Last week’s holiday-shortened trading schedule was packed full of data releases which generally pointed to a domestic economy with solid momentum heading into the third quarter. On Tuesday it was manufacturing data from the world’s two largest economies that helped boost the prospects for a second-half pickup in economic growth.

Wednesday’s private employment report from Automated Data Processing (ADP) raised the bar for Thursday’s Bureau of Labor Statistics (BLS) nonfarm payrolls data, which was released a day earlier than normal because of the 4th of July holiday. The ADP report of 281,000 jobs added in June was the biggest gain in private-sector jobs since November 2012 and well above the consensus expectation of 205,000.

For the week, the S&P 500 gained +1.44%, the Dow Jones Industrial Average added +1.32%, and the MSCI EAFE (developed international) rose +1.39%.

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

5 Takeaways from the June Employment Rate

The U.S. economy added 288,000 non-farm jobs in June. The unemployment rate dropped to 6.1 percent, while the labor-force participation rate remained steady at 62.8 percent, indicating the drop in the unemployment rate was caused by more people finding work than people giving up on looking for jobs.

Another positive in the employment report was the rise in factory payrolls. Manufacturing jobs have increased for 11 consecutive months and may help spur wage inflation because manufacturing jobs typically pay above-average wages.

Yellen’s Economy Echoes Burns’s More than Greenspan’s

A recent Bloomberg article details an important dilemma potentially facing Fed policy makers in the coming years, which is slow productivity gains continuing to weigh on economic growth even as the labor market normalizes and inflation picks up steam. This article discusses the period when Arthur Burns was Fed Chairman in the 1970s for comparison, during which inflation rocketed higher while the economy stagnated.

The current backdrop appears very mild by comparison, however unless productivity growth suddenly increases, the Fed’s job is likely to be somewhat more complicated than during the Greenspan years. This potentially increases the risk of a monetary policy misstep and may at some point force the Fed to raise rates more aggressively than is currently reflected in investor expectations.

A Future Where the Internet is Available to All

Mark Zuckerberg, the creator of Facebook, recaps the remaining growth potential of connecting the portion of the global population that remains unconnected to the Internet in an article from The Wall Street Journal. According to the article, only a little more than one-third of the world is connected – about 2.7 billion people.

He cites research from McKinsey & Co. that shows the Internet already accounts for a larger share of economic activity in many developed countries than agriculture and energy and, over the previous five years, created 21 percent of GDP growth. A recent study by Deloitte found that expanding Internet access in developing countries would create 140 million jobs and lift 160 million people out of poverty.

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

Perspectives from Above the Noise – Week of June 30, 2014

A relatively quiet week for economic data ended with equity markets little changed. Perhaps the most notable characteristic of the week’s market action was a continued absence of volatility, with the S&P 500 now having gone 49 straight trading days without a 1% gain or loss – the longest such period since 1995. That this highly unusual lack of equity market volatility is occurring despite ongoing geopolitical unrest in the Ukraine and Iraq and a very steep selloff in the Dubai equity market makes it even more remarkable. Many commentators have pointed to Fed policy as the driving force behind the vanquishing of volatility.

While U.S. economic data has recently become more mixed, a better-than-expected reading for the HSBC Chinese manufacturing flash PMI has sparked some renewed optimism for a second-half pick up in the world’s second-largest economy. That would be consistent with the last three years in which Chinese growth has accelerated in the second half of each year.

For the week, the S&P 500 lost -0.10%, the Dow Jones Industrial Average fell -0.56%, and the MSCI EAFE (developed international) dropped -0.82%.

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

San Francisco Fed: U.S. Inflation Will Likely Remain Low Through 2015

A new research paper from economists Yifan Cao and Adam Shapiro of the Federal Reserve Bank of San Francisco predicts that U.S. inflation may remain “well below” the Fed’s 2 percent target through next year. The research paper also predicts unemployment will decline to 5.5 percent by the end of 2015.

Inflation has increased in recent months to reach an 18-month high, but still remains below the Fed’s target. If inflation continues to accelerate and advance past 2 percent, the Federal Reserve may increase short-term rates sooner than expected.

Pending Sales of U.S. Existing Homes Rise Most in Four Years

The number of contracts to purchase previously owned U.S. homes jumped in May by the most in more than four years, a sign the residential real-estate market is rebounding after a slow start to the year. The pending home sales index climbed 6.1 percent in May, the biggest advance since April 2010. The gain exceeded the most optimistic estimate in a Bloomberg survey of economists, whose median forecast called for a 1.5 percent gain.

The report on pending home sales followed a report yesterday from the Commerce Department that showed sales of new homes soared 18.6 percent in May to their highest level in six years. The combined reports suggest the economically important U.S. residential housing market has begun to regain its footing this spring after a sluggish first quarter.

Mid-Year Emerging Markets Update: ‘Recovery Phase’

Mark Mobius, executive chairman of Templeton Emerging Markets Group, provides his narrative for an emerging-market recovery, with a number frontier markets offering “some of the most exciting opportunities.”

Mobius notes that investor sentiment has improved, global liquidity fears have subsided, and upcoming emerging market elections (including Brazil) could prove to be positive market catalysts. Furthermore, the use of smartphones and the internet revolution have the potential to accelerate growth in many countries.

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