Wednesday, April 30, 2014

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.