Perspectives from Above the Noise – Week of May 26, 2014

Last week, economists, investors and homeowners welcomed the news that existing home sales improved 1.3% for April. Complementing that announcement from the National Association of Realtors, the Census Bureau said new home sales rose 6.4% in April. In annualized terms, the sales pace has flagged: new home sales have slowed 4.2% over the past 12 months, resales 6.8%.

April brought the fourth straight monthly gain for the Conference Board’s index of leading economic indicators. It rose 0.4% in April, and its March gain was revised up to 1.0% (its largest gain since last September). The index looks at 10 factors to project the health of the American economy 3-6 months ahead.

These concerns must be weighed though against generally stronger-than-expected recent U.S. economic data, including a strong ISM Non-Manufacturing (services) report, a resumption in falling initial jobless claims after a brief rise, and improved Chinese export data largely due to a weaker yuan currency. With earnings season more than 90% complete, three-fourths of reporting companies have topped consensus earnings-per-share estimates, according to Factset. Investors may also get a summer boost in the form of additional monetary stimulus from European and Japanese monetary authorities.

For the week, the S&P 500 rose +1.21%, the Dow added +0.70%, and the MSCI EAFE (developed international) gained +0.54%.

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

Are Emerging-market Equities Finally Catching Up?

Emerging-market equities experienced net inflows for the first time in over a year during April. Emerging-market performance significantly lagged developed markets in 2013, but they are outperforming in 2014.

Last year, investors began to pull money out of emerging markets when the Federal Reserve first discussed tapering its bond-buying program in May, which resulted in a sharp decline for many emerging-market currencies. Investor sentiment for emerging markets has improved in recent months, but emerging markets still face several headwinds including slower economic growth and elevated geopolitical risks in several regions.

E.C.B. Plots Strategy for Staving Off Deflation

European policy makers and economists met this week in Lisbon in advance of the formal June 5 governing council meeting to discuss the European economy, including the growing deflation concern. While the annual inflation rate of 0.7% is well below the European Central Bank’s (ECB) 2% target, the specter of deflation threatens to undermine the weak economic recovery in the Eurozone.

Most economists expect the ECB will take some form of action on June 5, however there are differing opinions as to what moves should and will occur. Among the policy options are ECB asset purchases (similar to U.S. quantitative easing), a reduction in the benchmark interest rate to 0.15 percent from 0.25 percent, and a negative deposit rate that would charge lenders for parking money at the central bank.

Bond Market to Fed: Your 4% Rate Forecast Is Way Too High

A Bloomberg article examines some implications of the strong start to the year for bond markets, which has resulted in the best year-to-date gains for long-term Treasuries since 1995. One implication of current market yields is that bond investors believe that the Fed will keep interest rates lower for longer than even the Fed’s own forecasts conclude. A further implication is that bond investors seem to be pricing in a prolonged period of subpar economic growth despite a growing consensus among economists that growth will accelerate over the remainder of the year.

Behavioral and technical factors may explain some of the bond market strength this year after a very volatile 2013, but additional declines in yields in the coming months would suggest the bond market is betting against a strong global economic recovery developing anytime soon.

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 May 19, 2014

In the past week, U.S. markets made fresh all-time highs, while equity markets in Europe, and particularly the United Kingdom, have touched six and 14-year highs respectively. But stocks came under pressure last Thursday after Treasury yields sunk to fresh 2014 lows – taking out the important technical February low of 2.57% on the 10-year Treasury. The consensus expectation was that yields would rise this year as the economy picked up steam, and the U.S. Federal Reserve purchased fewer government and mortgage-backed bonds each month under its gradual taper strategy. But that has not yet come to pass.

Despite signs of slowing growth, Wednesday’s Producer Price Index provided some additional evidence that inflationary pressures may be quietly building in the U.S. economy, rising 0.6% in April. This represented the biggest monthly increase since January 2010.

For the week, the S&P 500 dropped -0.03%, the Dow lost -0.55%, and the MSCI EAFE (developed international) gained +0.35%.

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

Interest Rates: Low for Long

Despite the year-to-date decline in the yield of the 10-year Treasury, many pundits believe that interest rates are poised to reverse course and rise back above 3 percent based on the slowly improving U.S. economy. Oppenheimer provides a contrarian view that interest rates may remain low for much longer than anticipated based on their more muted growth outlook.

Historically, U.S. gross domestic product (GDP) and interest rates tend to track each other very closely. Oppenheimer notes that policy changes in China will likely lead to slower Chinese domestic consumption which will be a drag on global growth and they do not expect interest rates to rise until global GDP does.

Pinch Me! Europe Grew Faster than U.S.

The European economy grew at a faster pace than the United States’ for the first time in three years during the first quarter, as Europe experienced 0.9 percent annualized growth and the U.S. economy grew at a 0.1 percent annualized rate. European economic growth was below consensus expectations in the first quarter, however, it was the second consecutive quarter of positive economic growth in Europe and provided further evidence that Europe’s post-debt-crisis recovery remains on track.

Despite the strong start to 2014, growth in Europe is likely to trail the U.S. in the second quarter. Europe had a mild winter, which provided a boost to economic activity and that factor will likely fade in the second quarter. Conversely, U.S. economic activity is likely to rebound after a historically cold winter. Additionally, the crisis in Ukraine is likely to negatively impact consumer and business confidence throughout the Eurozone and negatively impact economic activity.

Lackluster Earnings Leave Stocks on Thin Ice

Behind the stock market’s anxious ups and downs of late lies the fear that a weakening U.S. and global economy could dash hopes for an uptick in corporate earnings. For the first quarter, earnings season is nearly done. More than 90 percent of big companies have reported results and they are lackluster. Profit gains for the S&P 500 were 2.1 percent overall compared with a year earlier, well below the previous quarter’s 8.5 percent rise, according to FactSet.

An article from The Wall Street Journal discusses some of the risks to earnings going forward, which include an uncertain economic backdrop due to recent soft reports on industrial production, housing starts, consumer sentiment and European economic growth.

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

Perspectives from Above the Noise – Week of May 12, 2014

The Dow Jones Industrial Average and the S&P 500 both continued to probe the upper end of their trading ranges, pressing against the resistance of previous all-time highs. Even recently weaker large-cap technology stocks attracted some buying interest. But below the surface of the large-cap indices, trouble has been brewing. Concerns of note include weakness in economically sensitive stocks, volatility readings again nearing readings associated with complacency, and the cautionary signal suggested by stubbornly low Treasury yields (often a warning signal of a slowing economy).

These concerns must be weighed though against generally stronger-than-expected recent U.S. economic data, including a strong ISM Non-Manufacturing (services) report, a resumption in falling initial jobless claims after a brief rise, and improved Chinese export data largely due to a weaker yuan currency. With earnings season more than 90% complete, three-fourths of reporting companies have topped consensus earnings-per-share estimates, according to Factset. Investors may also get a summer boost in the form of additional monetary stimulus from European and Japanese monetary authorities.

For the week, the S&P 500 dropped -0.14%, the Dow added +0.43%, and the MSCI EAFE (developed international) fell -0.29%.

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

Fear of Economic Blow as Births Drop Around World

Even before the global financial crisis, demographic headwinds were expected to be a major long-term issue for economic growth with important implications for asset allocation. A recent Associated Press article details how the global recession accelerated this concern, causing a sharp and so-far persistent drop in already declining birth rates.

A rapidly aging world population may weigh on global economic growth in the coming decades and provide some steady downward pull on interest rates. While we do think rates are likely to rise in the coming years as inflationary pressures build, demographics are one force that may help moderate the rise and keep yields lower than historical norms for a very long time.

Regional Fed Chairmen Still See US Economic Growth of 3%

First-quarter 2014 U.S. GDP growth plunged to just 0.1 percent, down from 2.6 percent in the fourth quarter of 2013. However, anemic growth over the last six months could be due to the severe winter weather throughout much of the U.S.

Atlanta Fed Chairman Dennis Lockhart said last week that he expects second-quarter 2014 U.S. GDP to rebound to 3 percent while Philadelphia Fed Chairman Charles Plosser expects full year growth of 3 percent. They both indicated that they believe the U.S. economy is strong enough for the Fed to continue to wind down its bond buying by October or December of this year.

Anticipating Strong Mandate for Modi, India’s Stock Market Surges

India’s stock market surged to a record high on Monday on hopes for a new, pro-business Indian government led by the Bharatiya Janata Party’s Narendra Modi. The election in India, the world's largest democracy, began April 7 and was held in nine phases, with exit polls now suggesting that the B.J.P. coalition could receive more than 272 of the lower house’s 545 seats.

The Congress party and its allies, which have held power for 10 years, were projected to win 101 to 120 seats, according to Bloomberg. The Indian market is up 12 percent since last December following signs that a B.J.P. victory was likely. However, optimism must be tempered as India’s exit polls have previously been unreliable, incorrectly calling for a B.J.P. coalition victory in 2004.

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

Perspectives from Above the Noise – Week of May 5, 2014

Markets have remained in a trading range after mixed U.S. economic data failed to provide clarity. The Dow Jones Industrial Average climbed to yet another new all-time high on light volume. However, others saw continued weakness in the small-cap Russell 2000 index as a troublesome, early-warning signal. We learned last week that U.S. GDP growth flat-lined to an annualized pace of just 0.1% in the first quarter, its slowest pace since the fourth quarter of 2012.

The deluge of economic data reported over the past week largely came in better than expected, with the exception of first-quarter GDP, suggesting the U.S. economy has shaken off the impact of a severe winter. Many are now predicting a strong second-quarter rebound. One data point to watch is a recent uptick in weekly initial unemployment claims, which last week rose to the highest level since February, for an indication of whether the labor market momentum suggested by April’s headline jobs data is likely to persist into the summer.

For the week, the S&P 500 gained +0.93%, the Dow added +0.93%, and the MSCI EAFE (developed international) grew +1.25%.

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

About that jobs report...maybe it wasn't so great

On the surface, the April jobs report was very strong. Not only were 288,000 nonfarm payrolls added, but the unemployment rate dropped from 6.7% to 6.3%. But unfortunately, the sizeable drop in the unemployment rate was largely the result of 806,000 people dropping out of the labor force.

Additionally, the average length of unemployment remained above 35 weeks and no improvement occurred in April within the average work week or average hourly earnings, two closely watched labor market statistics. Furthermore, a large number of new jobs created in April were in low-paying industries including retail, restaurants, and hospitality. All of that said, despite some weakness within the details of the jobs report, the labor market continues to improve, albeit at a slower rate than prior post-World War 2 recoveries.

U.S. Manufacturers Gain Ground

After more than a decade of losing ground to China and other export powerhouses, U.S. manufacturers are finally showing signs of regaining their competitive edge. An article from The Wall Street Journal points out the recent improvements in the U.S. trade deficit and the Boston Consulting Group’s (BCG) forecast for further trade-deficit improvements due to a surge in U.S. exports.

BCG says rising exports and “reshoring” of production to the U.S. from China could create 2.5 million to 5 million American factory and service jobs associated with increased manufacturing by 2020 that could reduce the unemployment rate by as much as two to three percentage points.

Why Weather Could Determine Who Wins a Race to Measure Inflation

A post on the The Wall Street Journal’s economics blog discusses an interesting recent divergence between the government’s measure of inflation and the measure calculated by the PriceStats Index, which was first developed by economists at MIT to measure inflation using web-based data. The internet-based measure uses real-time pricing data and until recently generally predicted CPI very accurately.

However, in late 2013 and the early part of 2014 the two measures have diverged, with official CPI showing much lower inflation than the internet-based measure. The article contends that the official CPI measure has been depressed by weather-related effects and will converge toward the PriceStats Index, which implies inflationary pressures in the economy are higher than generally believed. This inflation debate has important implications for asset allocation decisions over the remainder of the year.

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

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.

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

Last week’s holiday-shortened week came to a close with four consecutive positive sessions for the S&P 500 that erased most of the recent losses. It has certainly been a volatile April causing a 5% upswing in the S&P 500, which has now settled back above the 1850 level – a level that has served as both key technical resistance and now again support. The recovery last week forced many short-sellers to cover their positions in some of the most beaten-down former momentum favorites. The bulls will now try re-test the all-time highs set in early April around the 1900 mark on the S&P 500.

U.S. economic data again showed modest but solid improvement. Retail sales also jumped in March by the most since September 2012, including a pickup in vehicle sales, demonstrating pent-up demand from the winter weather. That being said, looking at the first quarter as a whole, retail sales lagged far behind the activity in the fourth quarter and will likely be a material drag on Q1 U.S. GDP.

For the week, the S&P 500 was up +1.73%, the Dow gained +1.47%, and the MSCI EAFE (developed international) rose +1.17%.

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

Risk of Stock Pullback Continues

With last week’s market rebound, talk of a major correction has faded. However, many money managers believe that the risk of a sharp pullback has been delayed, not eliminated. Equity markets have been so strong in recent years that major indexes haven’t dropped 10 percent or more since September 2011, which is twice as long as the typical once every 16 months.

Additionally, the markets appear strained as the number of stocks trading at record highs is off significantly and volatility is on the rise. Positively, while valuation is becoming more extended we are not at levels seen during prior peaks.

Companies Are Beating Earnings Estimates—but Don’t Be Fooled

Alex Rosenberg summarizes the results of earnings season thus far on cnbc.com. As detailed in the article, although it remains early in earnings season with less than 20 percent of companies having reported first-quarter results, those that have reported are beating estimates for earnings and revenues at a lower rate than has been typical over the past four years.

At this point, it looks like S&P 500 companies will report a year-over-year earnings decline for the first time since 2012 and overall revenue numbers have also been below expectations in aggregate. Nonetheless, investors appear to be looking past first-quarter earnings, which in some cases may have been impacted by severe weather, and continue to price in a rebound in earnings growth for the remainder of the year.

Economists Expect U.S. to Shake off Winter Slowdown

According to the latest National Association for Business Economics survey, economists are more upbeat about the economy now that we have escaped the brutally cold winter that negatively impacted economic activity during the first three months of the year.

Recent data ranging from retail sales to industrial production has pointed toward a rebound in economic growth. Overall, 72 percent of economists polled in the survey feel that U.S. GDP will grow by 2 percent to 3 percent in 2014, ahead of 1.9 percent GDP growth in 2013. Additionally, 80 percent of survey respondents expect the Federal Reserve to end its quantitative easing program by year end.

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

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

A volatile week of whipsaw market action pushed all the major U.S. equity indices back into the red on a year-to-date basis. The S&P 500 sunk to a two-month low after making new all-time highs only a month ago. Market leadership has been undergoing a profound shift away from U.S. growth to defensive value and non-U.S. assets. Momentum has also been waning among last year’s standout small-cap issues, often an indication of a tired market.

In fact, equity investors have been aggressively selling previous winners for the last couple of weeks, shedding high momentum leaders in areas like biotechnology, social media and homebuilders. They have opted instead for defensive and value names in the staples, utilities, telecom and energy sectors while also rotating into unloved emerging-market stocks and bonds. After several years of underperformance and subsequent capital outflows, emerging markets have become increasingly under-owned by professional investors. However, money has been flowing back to emerging markets as investors search for valuation bargains in this beaten-down asset class. 

For the week, the S&P 500 dropped -2.65%, the Dow lost -2.35%, and the MSCI EAFE (developed international) fell -1.79%. 

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

The Tide Is Turning for Greece – and the Eurozone 

While unrest in the Ukraine has caused volatility in global markets, steady improvement in the Eurozone’s sovereign debt crisis may have gone unnoticed. An article from The Wall Street Journal, points out that Greece returned to the bond markets last week, which was a symbolically important moment for the euro crisis. 

For the country at the center of the crisis to draw €20 billion ($27.77 billion) of foreign demand for a five-year bond yielding under 5% shows that the market now believes Greece will stay in the Eurozone. It also indicates the market thinks Greece won’t collapse into chaos and that any further debt relief will be provided by official rather than private lenders. A year ago, there were few takers for that bet. The tide of money flowing into the crisis-country assets comes amid growing evidence that Southern Europe has turned the corner. 

Here's the One Trend to Watch in Earnings Season 

The first-quarter earnings season has begun and consensus analyst expectation is for 3% revenue growth and a 0.13% decline in earnings for S&P 500 firms. The bar is low for first-quarter revenue and earnings growth, but revenue among S&P 500 firms is expected to increase by 4% this year, ahead of 1.1% revenue growth in 2013. 

It’s an encouraging sign that revenue growth is expected to increase and also exceed the growth rate of earnings, which signals that consumer demand is beginning to have a larger impact on corporate profits, following several quarters of corporate austerity. Additionally, revenue growth will be a lot more important in the coming quarters as corporations may not be able to access large levels of cheap debt to fund large-scale buyback programs to boost stock prices if interest rates increase as the Fed winds down its QE program. 

Value Is the New Momentum, in Three Charts 

Large-cap value stocks, as measured by the Russell 1000 Value Index, rose 2.2% in March, easilyoutperforming the Russell 1000 Growth index, which was down 1.1%. The performance reverses a trend seen in the second half of 2013 and the first two months of 2014. 

Morgan Stanley strategist Adam Parker notes that historically “value tends to continue its advantage over growth following strong value rallies.” Additionally, “following a strong value rally, on average, the market underperforms its historical average for the next 10 months.” Parker points out that energy and consumer-staples stocks typically lead in these environments, while technology and telecom stocks lag. 

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