Wednesday, June 25, 2014

Perspectives from Above the Noise – Week of June 23, 2014



A recent run of data suggesting that the U.S. economy rebounded strongly during the second quarter gained further confirmation last week. Inflation data for May also provided more evidence that inflationary pressures may be building. The Consumer Price Index (CPI) increased by 0.4%, which was the largest monthly increase since February 2013 and double what economists were expecting. Food prices jumped the most since March 2011 and energy prices rose by 0.9%. Even core CPI, which excludes food and energy, increased by 0.3% the most since October 2009.

With hotter-than-expected inflation data and a recent string of solid economic reports, all eyes turned to the Federal Reserve. However, last Wednesday’s release of the Federal Open Market Committee’s (FOMC) policy statement and subsequent press conference with Fed Chair Yellen offered no real surprises. As expected, the Fed continued its tapering strategy and reduced its asset purchases by another $10 billion to $35 billion per month.

For the week, the S&P 500 gained +1.38%, the Dow Jones Industrial Average added +1.02%, and the MSCI EAFE (developed international) rose +0.86%.

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

U.S. existing home sales, inventory surge in May

The U.S. housing market is beginning to show signs of strength following a weak start to 2014. Existing U.S. home sales grew by 4.9% in May, well ahead of the consensus expectation for 2.2% growth. May home sales growth was the strongest since August 2011 and the second consecutive monthly increase.

The inventory of existing homes for sales increase by 2.2% to reach 5.6 months of available supply, which resulted in housing prices experiencing the smallest year-over-year increase in over two years.

Merger Fever Can Be a Menace for Shareholders

A recent surge in mergers and acquisitions activity has been a factor in propelling U.S. equities to record highs. However, prior merger and acquisitions (M&A) booms have in aggregate resulted in wealth destruction for public shareholders and offer some reason for caution as detailed in a recent article from The New York Times.

Moreover, academic research by Matthew Rhodes-Kropf of Harvard Business School and numerous others has concluded that M&A booms have historically tended to end with significant declines in broad equity prices. However, timing the end of M&A booms is difficult if not impossible and other macro indicators on balance remain positive for equity markets at this point.

In Yellen We Trust Is Bond Mantra as Inflation Dismissed

Recent economic and inflation data appears to be at odds with continued low bond yields and a recent Bloomberg article attempts to reconcile these data points. Bond investors seem to be signaling a strong belief that the Federal Reserve will maintain exceptionally low rates for a prolonged period after quantitative easing ends despite the recently improved data.

While demand for risk-free assets and low yields globally are undoubtedly also keeping U.S. yields suppressed, implicit in the continued low yields on long-duration Treasuries is some belief that inflationary pressures will remain subdued. Incoming inflation data for the remainder of the year will likely have a growing impact on bond markets as the debate over the appropriate level for bond yields heats up.

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