Perspectives from Above the Noise – Week of April 20, 2015

We took a break last week for the final push through tax season, but we are back with our weekly commentary.

Last Wednesday, Mario Draghi, President of the European Central Bank (ECB), managed to sound increasingly bullish about Europe's improving economic outlook at his regular press conference. At the same time, he shot down recent rumors of an early exit from the quantitative easing (QE) program which the ECB launched in March. The speculation of an early end to the asset-purchase scheme has focused not only on a very weak euro currency, potentially creating an inflation overshoot, but just as importantly on concerns that the ECB will struggle to find enough eligible debt to complete the program.

Volatility returned to markets in a big way on Friday, as China's securities regulators announced new policies to allow the short-selling of stocks and to restrict the use of margin trading accounts. Fears that the odds of Greece exiting the Eurozone are rapidly increasing also contributed to Friday's swoon, which sent the major U.S. indices down more than 1% for the week.

For the week, the S&P 500 dropped -0.99%, the Dow Jones Industrial Average fell -1.28%, and the MSCI EAFE (developed international) decreased -0.22%.

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

Few Who Lost Homes in U.S. Will Make Purchases Again Soon

One potential tailwind for housing is the influx of former homeowners who previously lost their homes to foreclosure or distressed sales during the housing crash. A whopping total of 9.3 million homeowners either foreclosed or were forced to sell their homes at a loss since early 2007. Unfortunately, only 950,000 have bought again and only 1.5 million are likely to purchase a home in the next five years.

Tighter credit standards and affordability are the biggest impediments for this group to return to the housing market. The U.S. homeownership rate dropped to a two-decade low at the end of 2014 and is likely to remain low for the foreseeable future, according to the National Association of Realtors.

The Fed Still Wants Easy Money

While investors have been focused on the potential timing of the Fed’s first interest-rate hike, recent commentary by Fed officials suggests rate hikes are likely to be extremely gradual once the tightening cycle begins. A recent Bloomberg article summarizes some of the recent speeches by Fed Chair Yellen and her colleagues that have indicated a desire to keep monetary conditions very accommodative for the foreseeable future. As a result, the path of coming rate hikes could be among the most gradual in the Fed’s history, which may help to limit market volatility once the initial hike is done.

What U.S. Interest Rate Hikes Will Mean for China's Economy

With the Chinese equity markets among the top performers this year, is this market at high risk if and when the U.S. Federal Reserve raises interest rates as expected later this year? While an initial rate hike will likely bring uncertainty, many economists feel that China is well positioned to avert significant negative impact from a U.S. rate hike.

For one, the People's Bank of China has many dovish policy tools at its disposal – they could cut interest rates domestically and/or continue easing up banking regulations, similar to their recent bank reserve requirement reduction. China is also likely to staunchly guard against any depreciation in its currency (the Chinese yuan). However, economists hedge these arguments if the U.S. Fed embarks on an aggressive, rather than measured, pace of tightening.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team. First Allied Asset Management provides investment management and advisory services to a number of programs sponsored by First Allied Securities and First Allied Advisory Services. First Allied Asset Management individuals who provide investment management services are not associated persons with any broker-dealer.

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 April 6, 2015

The past week included another slew of evidence that the domestic economy continued to slow significantly in March. Wednesday’s ISM Manufacturing Index continued a recent trend of disappointing manufacturing data. At 51.5, it was the lowest reading for the index since May 2013 and it missed consensus expectations for the fourth straight month - the longest string of disappointments since August 2012. Among the headwinds cited by the survey’s respondents were references to the West Coast port shutdown, a harsh winter, and the strong U.S. dollar.

Despite generally disappointing domestic economic data in recent months, credit market metrics have yet to signal the type of stress typically seen heading into prolonged economic downturns. However, last week provided one of the first pieces of evidence that credit conditions may be deteriorating. The NACM’s Credit Manager’s Index indicated the amount of credit extended dropped by the most on record over the past two months and the rejections of credit applications also spiked to the highest level in the history of the data (dates back to 2002).

For the week, the S&P 500 added +0.53%, the Dow Jones Industrial Average ticked-up +0.48%, and the MSCI EAFE (developed international) gained +0.21%.

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

All 3 Preconditions for Active Outperformance Are Present

Over the last two years, we have often commented that diversification into global equities and alternatives has detracted from performance, as investing exclusively in U.S. equities would have been rewarded over being in a globally allocated strategy. Similarly, the recent market environment has led to relative underperformance from active mutual fund managers who have struggled to beat their benchmarks.

However, Josh Brown notes that three preconditions (cash not a drag, international and small-cap equity doing well) for active fund outperformance are now finally present. Additionally, dispersion (the degree of standard deviation between stocks from one another) has notably increased which historically bodes well for active managers who can demonstrate their asset allocation and/or stock picking skills.

Weak Jobs Keeps Fed at Bay until Second Half

The US economy added just 126,000 jobs in March, the worst monthly gain since December 2013, and about one-half the 245,000 jobs expected to be added by economists. Despite the weak jobs report released last Friday, U.S. markets shrugged off the news on Monday as stocks rallied. The markets focused on the likelihood that the U.S. Federal Reserve will move more slowly than previously expected to raise interest rates with September being the earliest timeframe for the Fed to act in the minds of many traders.

Additionally, the weaker-than-expected March report is also only one disappointing month in a stretch of solid employment reports and it remains unclear how much severe winter weather, port strikes and slumping energy prices may have temporarily disrupted the strong recent trend of U.S labor markets.

The U.S. Oil Boom Is Moving to a Level Not Seen in 45 Years

U.S. oil production is on track to reach an all-time high later this year, despite a sharp contraction in oil prices since last summer, according to oil and gas consulting firm Rystad Energy. Crude inventories are currently at their highest level (471 million barrels) since at least the early 1970s and will likely increase further as production continues to climb. Rapid production increases from shale drilling and hydraulic fracturing in recent years have been blamed for the significant decline in oil prices. From Rystad Energy's perspective, oil prices will not begin to climb higher until oil supplies begin to shrink after peak production is reached. In their view, that could occur around September, based on their rig count assumptions.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team. First Allied Asset Management provides investment management and advisory services to a number of programs sponsored by First Allied Securities and First Allied Advisory Services. First Allied Asset Management individuals who provide investment management services are not associated persons with any broker-dealer.

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 March 30, 2015

More signs of a slowing U.S. economy have appeared in the past week. Durable goods orders, for example, fell 1.4% in February, the category's third decline in the past four months. The Kansas City Fed Index also fell to a two-year low, to readings last seen in Feb 2013. But most troubling, the new orders component dropped to the second-lowest level since the Lehman Brothers crisis, and future capital expenditures (capex) expectations fell to a five-year low. Clearly some of this weakness reflects poor weather and the West Coast port shutdown. But it also appears to reflect uncertainty about future demand which has been exacerbated by a strengthening U.S. dollar, a trend which has big implications for Q1 earnings.

European equities snapped a lengthy run of weekly gains, with the Stoxx 600 losing 2.1% for the week after seven straight weeks of gains. In addition to general overbought conditions, the pullback in European markets was likely influenced by some newfound strength in the euro currency, which is up more than 4% from its recent lows on the heels of a dovish statement from the U.S. Fed and some bourgeoning evidence that Europe's economic growth is stabilizing.

For the week, the S&P 500 dropped -2.23%, the Dow Jones Industrial Average fell -2.29%, and the MSCI EAFE (developed international) decreased -0.69%.

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

Yellen Makes Case for Slow, Cautious Rate Rises after Liftoff

U.S. Federal Reserve Chair Janet Yellen said interest rates will probably be raised in 2015 but made the case for a cautious approach to subsequent increases that will keep borrowing costs low for years to come. In a speech last week in San Francisco, she emphasized that the coming tightening cycle will be unlike any other in recent times, as the U.S. economy continues to heal from the worst recession since the Great Depression.

Despite considerable anxiety regarding the timing of the first rate hike, Yellen played down the importance of when the Fed finally raises rates for the first time. She said "what matters for financial conditions and the broader economy is the entire expected path of short-term interest rates and not the precise timing of the first rate increase."

Forecasters Shrug Off Winter Economic Blues

Several key economic indicators, including manufacturing activity and durable goods order, have been disappointing through the first few months of 2015. First-quarter GDP growth is also likely to disappoint, but according to a poll of 50 economists by the National Association for Business Economics (NABE), the U.S. economy will bounce back after a brief winter economic slowdown and grow at a 3.1% pace for 2015.

The U.S. economy has not experienced 3% GDP growth since 2005, but according to the NABE, may reach that level of growth this year because of "healthier consumer spending, housing investment, and government spending growth." In their view, improving labor market conditions and declining fuel prices will lead to a boost in consumer spending and help propel the U.S. economy to stronger economic growth.

China's stock market sure looks like a bubble

A recent article by Matt O'Brien of the The Washington Post examines some troubling evidence that the Chinese stock market has entered a new bubble. Although valuations do not appear to be in obvious bubble territory despite an 80% rise in stock prices over the past nine months, signs of froth are apparent.

For example, new stock trading accounts have surged in recent months and margin accounts more than doubled in 2014. With the Chinese economy slowing, real-estate prices falling, and overall debt continuing to grow at a potentially unsustainable pace, the possible unwinding of an equity market bubble adds to the growing risk associated with the world's second-largest economy.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team. First Allied Asset Management provides investment management and advisory services to a number of programs sponsored by First Allied Securities and First Allied Advisory Services. First Allied Asset Management individuals who provide investment management services are not associated persons with any broker-dealer.

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.