Perspectives from Above the Noise – Week of October 27, 2014

The market rebound, which began with growing expectations that the Federal Reserve will maintain its zero-interest-rate policy into 2016 and the European Central Bank will expand its bond-buying program, received a boost last week from encouraging economic data. The risk that recent European weakness leads to slowing domestic growth remains an intermediate-term risk. However, the latest batch of data suggests the U.S. economy remains on firm footing in the near-term. As a result, U.S. stocks have rapidly recouped the majority of their losses for October through pockets of weakness.

Earnings results will also continue pouring in during the week and so far earnings season has been mixed. With around 15% of all companies reporting, 64.9% of firms have exceeded earnings-per-share estimates while only 49.3% have topped revenue estimates, according to data from Bespoke Investment Group. The less-than-stellar top-line results raise concerns about the quality of the earnings being reported. Broadly speaking, however, earnings results have been strong enough to soothe fears that weakness in Europe and a strengthening dollar would severely depress corporate results.

For the week, the S&P 500 rocketed +4.12%, the Dow Jones Industrial Average rose +2.59%, and the MSCI EAFE (developed international) gained +2.39%.

Here are the 3 stories this week that rose above the noise:
Today’s Deficit Is Not the Problem

The federal deficit for the 2014 fiscal year dropped to 2.8 percent of GDP, significantly below the 10 percent peak during the Great Recession. According to the Congressional Budget Office (CBO) projections, the federal deficit will remain below 3 percent of GDP through 2018. The CBO deficit forecast assumes that spending caps that were enacted in the Budget Control Act of 2011 will remain in place through 2021.

If the spending caps hold, Social Security, healthcare and debt interest payments will become a much larger percentage of overall government spending, which will reduce outlays on government programs that are investments in the future, mainly education, research and development, and infrastructure.

If the government spending caps do not hold and spending grows at the same pace as the overall economy without any tax increases or cuts in benefit programs, the federal deficit could increase ahead of baseline projections and reach 5 percent of GDP by 2021. As stated in the article, “today’s deficit is not the problem. Tomorrow’s looks bigger than the comforting projections suggest.”

The World’s Biggest Economic Problem

The Economist outlines the growing dangers of Eurozone deflation, which has played a major role in recent market volatility. The article takes the position that drastic actions are needed from the European Central Bank and political leaders in order to mitigate the risk of the region falling into a prolonged period of falling prices, similar to what Japan has experienced in the past two decades.

However, there does not seem to be much appetite for drastic action from either monetary or fiscal authorities and a true crisis may be required before an aggressive policy response is enacted. The article is sobering and pessimistic, but does a good job of presenting some of the risks in Europe that may continue to create market volatility for the foreseeable future.

Brazil Vote Highlights a Rift Linked to Economics

Brazilian voters re-elected Dilma Rousseff as president on Sunday, supporting a leader who has helped reduce poverty and kept unemployment low over a centrist challenger who criticized her government over a simmering bribery scandal and a sluggish economy. Rousseff took 51.64 percent, against 48.36 percent for her rival, Aécio Neves, the smallest margin of victory in any presidential election since democracy was re-established in the 1980s.

The election results highlighted widespread social and geographic divisions within the country. Rousseff won easily in the relatively poor northeast where recipients of social welfare programs broadly backed the incumbent, while Neves comfortably won in São Paulo, Brazil’s richest and most populous state. Brazil’s main stock index fell by 3.7 percent following the election, continuing a steep two-month decline which was largely attributable to the likely prospect of a Rousseff re-election.

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 October 20, 2014

After plunging to eight-month lows by Wednesday, stocks stabilized and staged a significant rally on Friday to close with only modest weekly losses. A number of factors converged for the volatile start to the week, which saw the CBOE Volatility Index hitting a two-year high, the 10-year Treasury yield briefly fall below 2% for the first time since June 2013, and the 10-year German Bund yield plunge to an all-time low of 0.72%. The S&P 500 broke below its closely watched 200-day moving average on Monday for the first time since 2012, adding to recent signs of deteriorating market momentum.

Globally, continued weak data from Germany, renewed turmoil in Greece, and wild moves in European bond markets weighed heavily on European stocks. Fears that the Ebola virus will rapidly spread, although arguably somewhat irrational, were also cited as a catalyst for the market’s volatility. Domestic data seemed to play a role in Wednesday’s sharp decline, with reports on retail spending and regional manufacturing sentiment pointing to a worrisome reversal in economic momentum.

However, Thursday’s reports on initial jobless claims and industrial production showed a level of strength that was inconsistent with a sharply slowing domestic economy and helped to put at least a short-term bottom in equity markets and Treasury yields. Some dovish comments from central bank officials citing concerns over falling inflation expectations also seemed to help lift investor sentiment.

For the week, the S&P 500 fell -1.02%, the Dow Jones Industrial Average lost -0.99%, and the MSCI EAFE (developed international) dropped -0.65%.

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

Reasons to Calm Down About Ebola

Fears of a global Ebola virus pandemic have impacted markets recently as investors have become concerned about the virus’s impact on the global economy and, in particular, travel-related industries. While much remains unknown about the ultimate severity of the Ebola virus, an article from The Wall Street Journal provides some encouraging perspective.

It points out that Ebola is not particularly successful in humans by viral standards. HIV, to take a familiar example, has been killing more than two million people per year for almost two decades. Ebola has hitherto caused only small, localized outbreaks. The Ebola virus is not highly transmissible through proximity or casual contact as the influenza virus is.

Additionally, its current spread has been largely a result of poor local government response and inadequate funding in several African countries where the epidemic started. Nigeria provides an encouraging example of a country that has averted disaster through a rapid, well-coordinated government response to the outbreak which has contained the spread of Ebola in that country.

Mixed Economic Signals from China

With growth slowing in Europe and Japan, many investors are looking at China as one of the most significant wild cards in the global economy. However, assessing the health of the Chinese economy is a difficult task given mixed signals in the data. Chinese GDP increased by 7.3 percent in the third quarter, the lowest quarterly growth since the financial crisis in 2009. But compared to the rest of the world, this level remains well above the other major global economies.

While job growth continues at a strong pace, a disparity exists between an expanding service sector and a contracting manufacturing space. Other conflicting signals are seen within retail sales and trade data which further cloud the economic climate.

American Consumers See Windfall from Lower Gasoline Costs

Gasoline prices have dropped significantly since June and are now at their lowest level since January 2011. The sharp drop in gas prices should provide a boost to consumer confidence and spending. Gasoline accounts for roughly 3 percent of overall consumer spending and the drop in fuel prices may free up as much as $50 billion for consumers and provide a 0.3 percent increase in GDP over the next year, according to Deutsche Bank’s Chief U.S. economist Joseph LaVorgna.

It’s difficult to project gasoline prices over the next 12 months, but the price of gas typically declines between the summer and early winter. If history is any guide, gasoline prices may continue to fall through year-end.

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 October 13, 2014

Concerns about global growth caused markets to hit the brakes last week in a cloud of smoke and volatility, giving the S&P 500 and Nasdaq their worst week since May 2012.

Earnings didn’t preoccupy investors last week; Europe did. The International Monetary Fund warned that the euro area could enter another recession; European Central Bank president Mario Draghi urged EU member nations to go in for quantitative easing, but German finance minister Wolfgang Schäuble disagreed. IMF and Federal Reserve officials noted the potential for Europe to slow global and U.S. growth.

Though markets slid last week, let's take a look at how far we've come since last year: As of last Friday, the S&P 500 has gained 12.62% since October 14, 2013. While these pullbacks are often frustrating, keep in mind that as goal-based investors, we are more focused on how long-term performance affects our personal financial goals and less focused on short-term market behavior.

For the week, the S&P 500 fell -3.14%, the Dow Jones Industrial Average lost -2.74%, and the MSCI EAFE (developed international) dropped -2.41%.

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

Fed Wary on Global Growth

Just weeks ago, investors fretted that an improving U.S. economy might cause the Fed to start raising interest rates sooner than consensus expectations for the middle of next year. However, the most recent Fed minutes show that Federal Reserve officials have become more concerned that weak overseas growth and a strengthening U.S. dollar will crimp the domestic economy and hold down inflation — an outlook that has made them more inclined to stick to low interest rates. This article highlights that the Fed decision on when to raise interest rates will be “data dependent” and also have an eye toward developments overseas.

BofA Merrill Lynch Fund Manager Survey Finds Investors Fretting Over Monetary Policy as End of U.S. QE Looms

One catalyst for the recent market correction has been a sharp reversal in investor sentiment toward the outlook for global growth. A recent article summarizes the latest results of the Bank of America Merrill Lynch Fund Manager Survey. In the latest polling, only a net 32 percent of respondents expect the global economy to strengthen over the next 12 months, which was down more than 20 percentage points from the prior month. 

The lowered expectations create the potential for a relief rally in risk assets should global economic data stabilize and the mounting pessimism among investors is one contrarian indicator that suggests the market may be close to putting in at least a short-term bottom.

Fed Can’t Keep Falling Short of Inflation Goals, Says Evans

The biggest risk to the U.S. economy is the Federal Reserve raising interest rates prematurely, according to Federal Reserve Bank of Chicago President Charles Evans. It is widely believed that the Federal Reserve will institute a rate hike as early as next summer. However, there is a small contingent of regional Fed leaders that believe the labor market has improved enough for the Federal Reserve to contemplate raising rates in early 2015.

From Evans’ perspective, the Federal Reserve should continue to stimulate the economy while inflation remains low and until the economy shows it has healed enough to withstand a hike in interest rates. Inflation has remained below the Fed’s target of 2 percent for over six years and won’t breach its target until at least 2017, according to Evans. In his view, the Fed should hold off on raising rates until early 2016.

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 October 6, 2014

Stocks got off to a volatile start in the first days of October with the S&P 500 down nearly 3% on the week by Thursday before recovering most of its losses by Friday afternoon. On Thursday, markets were disappointed that European Central Bank (ECB) President Mario Draghi failed to deliver more specifics on the size of its plan to buy asset-backed securities. Markets have been under pressure for the last couple of weeks from Europe’s weakening economic data and concerns over slowing global growth in general, and that has left some to wonder if the “buy the dips” psychology of the last few years was starting to change. But Friday’s stronger U.S. jobs data for September, and upward revisions for both the July and August jobs numbers, have turned the tide for U.S. equities. We’re coming into what is historically a strong seasonal period for U.S. stocks, and for some perspective, in January and July we experienced a 6% and a 4% selloff in the S&P 500 that lasted 13 and 11 days. Thursday was day 11 of the recent pullback in U.S. equities before the sharp reversal rally end the week.

For the week, the S&P 500 fell -0.75%, the Dow Jones Industrial Average lost -0.60%, and the MSCI EAFE (developed international) dropped -2.17%.

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

German Industrial Output Drops Most Since 2009 in August

Evidence of sagging momentum in Europe’s largest economy continues to mount, as detailed in a recent Bloomberg article. The latest disappointing data on the German economy is a report that industrial production dropped 4 percent in August, the biggest decline since January 2009. The slowdown in the German economy is being driven by a stalling recovery in the euro area and ongoing political tension with Russia.

 The European Central Bank (ECB) has enacted unprecedented steps in an attempt to revive economic momentum in the region, but growing signs of weakness are calling into question whether the ECB’s actions will be enough to revive growth in the region. The latest data indicates growth in Europe remains a potential headwind for the global recovery.

Stocks Typically Pop After Mid-Term Elections 

One reason for optimism over the outlook for equities into 2015 is the historical tendency for the market to do well in the six months after mid-term elections. This article has a concise summary of the historical data for this seasonal period and some theories on why equities have tended to perform well following the uncertainty associated with mid-term elections.

 It is important not to overemphasize the explanatory power of the election cycle given a limited sample size, but equities are entering a period in which normal seasonality and the political cycle have historically tended to be a net positive.*
*Past performance is no indication of future results.

I.M.F. Lowers World Growth Forecast, Pointing to U.S. as a Bright Spot 

The International Monetary Fund (IMF) cut its forecast for 2014 global growth down to 3.3 percent from 3.7 percent, and reduced its forecast for 2015 to 3.8 percent. The IMF pointed to weaker growth in China, Europe, Japan and Latin America (Brazil in particular) as the main drivers of the decline.

The possibility that the euro area could fall back into recession and the slowdown in large, emerging-market economies like China and Brazil were issues of primary concern. In contrast, the outlook for the U.S. economy was revised sharply upward, to 2.2 percent this year from 1.7 percent as the United States economy was set to outpace many large economies, not just in terms of growth, but also in corporate profitability and international competitiveness.

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 September 29, 2014

Last week was a volatile one for U.S. stocks with the S&P 500 slipping by 1.6% on Thursday before stabilizing heading into the weekend. There was no single clear-cut catalyst for Thursday’s volatility, with geopolitical risks, the persistent strength of the U.S. dollar, hawkish Fed commentary, and general technical factors all cited as potential contributing factors. Fears of a deeper correction in risk assets heading into the fourth quarter were also exacerbated by continued weakness in small-cap equities and high-yield bonds. To put the selloff in context, however, most major global equity indices remain above rising 200-day moving averages, an indication that the uptrend in risk assets that has been in place since 2012 has yet to exhibit significant deterioration.

Economic data will move back to the forefront in the coming week headlined by the ISM Manufacturing Index on Wednesday and nonfarm payrolls on Friday.

For the week, the S&P 500 fell -1.37%, the Dow Jones Industrial Average lost -0.96%, and the MSCI EAFE (developed international) dropped -2.18%.

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

The U.S. Dollar is Top of the World

Heading into this week’s Fed policy statement, speculation has been high that a change in the statement’s language will signal a more hawkish stance. Although some recent economic data has been surprisingly strong, some moderation in the closely watched labor market and inflation data does not create a clear-cut case for a more hawkish Fed. If there is a change in Fed language, the motivation may be due to concerns over signs of excessive risk taking in financial markets.

An article from Institutional Investor summarizes a recent warning from the Bank of International Settlements, regarded by many as the central bank for central banks, that there are many signs of investors reaching for yield and becoming overly complacent about the path of future interest rates. If the Fed does shift to a somewhat more hawkish tone in the coming months, concerns such as those mentioned in the article, are likely to be the motivation.

Home Prices Rise at Slow Pace

Further evidence that the U.S. housing recovery has lost some steam in recent months was provided by this week’s S&P/Case-Shiller 20-city index of property values. The widely followed index showed a 6.7% year-over-year increase for the three months ending in July, which was the smallest gain since November 2012. The price increases came in well below the median projection of analysts and is the latest in a string of generally disappointing housing data reported during the third quarter.

However, as noted in the article, continued double-digit price increases are probably not sustainable and the current low inventory of available homes helps mitigate the risk of a broad decline in property values.

Americans’ Views of the Labor Market Deteriorates

Confidence among U.S. consumers unexpectedly declined in September to a four-month low, as the Conference Board’s Consumer Confidence Index decreased to 86.0 from 93.4 in August. The current reading fell short of the median Bloomberg consensus expectation of 92.5, representing the largest miss since January 2012.

The Conference Board’s Present Conditions and Expectation Indices both posted month-over-month declines. Concerns over the current labor market helped drive the reduction in confidence, as the share of respondents who said jobs were currently plentiful dropped from 17.6% to 15.1%, the weakest in three months. Additionally, fewer consumers expected more jobs to become available in the next six months.

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.