/perspectives/weekly-viewpoint/emerging-market-worries-re-emerge

Emerging Market Worries Re-Emerge

The Dow Jones Industrial Average (Dow) fell 1.14%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 0.45%, the Standard & Poor’s 500® Index (S&P 500) dipped 0.43% and the NASDAQ Composite Index (NASDAQ) finished off...

February 03, 2014    |    By Mike Schwager

Performance for Week Ending 1/31/14:

The Dow Jones Industrial Average (Dow) fell 1.14%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 0.45%, the Standard & Poor’s 500® Index (S&P 500) dipped 0.43% and the NASDAQ Composite Index (NASDAQ) finished off 0.59%. Sector breadth was mixed with 5 of the S&P sector groups finishing higher while 5 finished lower. The best performer was the Utilities sector (+2.86%) while the Consumer Staples sector (-1.66%) was the laggard.

Index* Closing Price 1/31/2014 Percentage Change for Week Ending 1/31/2014 Year-to-Date Percentage Change Through 1/31/2014

Dow

15698.85

-1.14%

-5.30%

Wilshire 5000

18629.60

-0.45%

-3.24%

S&P 500

1782.59

-0.43%

-3.56%

NASDAQ

4103.88

-0.59%

-1.74%

*See below for Index Definitions
 

MARKET OBSERVATIONS: 1/27/14 - 1/31/14

The major market indices finished the week lower reflecting concerns over the stability of the emerging markets, signs of economic slowing in China and another round of tapering by the Federal Reserve. While the year-to-date sell-off in the market is disappointing, in a sense it should not come as a total surprise. Following an almost 10% surge in the S&P during the final quarter of 2013, the market had become overbought and appeared in need of a pause to refresh. As mentioned in these missives over the past few weeks, the market has likely transitioned to a period of ‘price discovery’ as investors try to gauge what has been discounted in the market and what is likely to come to fruition in the weeks/months ahead. We are also at a point where investors are looking for earnings growth (versus multiple expansion) to become the primary driver of stock prices. With about half of the S&P 500 companies reporting Q4 results, overall growth is running solidly ahead of expectations; however the quality of earnings and the forward guidance from company management has cast some doubt over whether this transition is actually beginning to take shape. In other words, good growth in and of itself is not good enough and companies really need to “stick the landing” to appease Wall Street analysts.

January Effect: The old market adage “as January goes, so goes the year” is less worrisome when looking at the actual results. According to a report from Credit Suisse, since 1928, when the S&P has finished lower in January the percent of time the full year finished lower was 45% - similar odds to a coin toss. One only has to look at recent years to see the spottiness. In 2009, the S&P fell 8.6% in January but finished the year up by over 23%.  In 2010, the S&P finished down 3.7% in January, but rallied the rest of the year to finish up 12.8%.  Ultimately it will be earnings, Federal Reserve (Fed) policy, and the overall tone of the economy that drives the market. While the market has gotten off to a lackluster start, the macro environment remains conducive of higher equity prices, although a little patience may be needed in the near term.

Investor Sentiment is Becoming More Supportive:  The American Association of Individual Investors (AAII) reported that bullish sentiment in the most recent period fell to 32.2%, the lowest level since late-August.  Bearish sentiment surged to 32.8%, the highest level in 16 weeks. The bull bear spread has now turned negative for the first time since August. A negative bull bear spread (i.e. a higher percentage of bears versus bulls) has often been a precursor to a near term market bottom. Monitoring the level of bullish and bearish sentiment in the marketplace tends to be a useful barometer to gauge the mood of investors.  Remember investment decisions, in their simplest form, are made with emotions – fear & greed. Sentiment also tends to be a contrarian indicator as investors tend to be the greediest (bullish) at market tops and the fearful (bearish) at market bottoms. The current sentiment readings suggest that the recent selling may be close to running its course --- stay tuned

Fed Tapers Again:  As expected, the Fed announced they will trim their monthly bond buying by $10 billion to $65 billion, sticking to the plan for a gradual withdrawal. The after meeting communiqué noted that “labor market indicators were mixed but on balance showed further improvement.” The Fed left unchanged its statement that it will probably hold its target interest rate near zero “well past the time” that unemployment falls below 6.5%, “especially if projected inflation” remains below the committee’s longer-run goal of 2 percent.  Bond purchases will be divided between $35 billion in Treasuries and $30 billion in mortgage debt beginning in February. The committee repeated that purchases are not “on a preset course.” 

The Fed also made some minor tweaks to the language of the statement that, on net, took on a more upbeat tone for the U.S. economy. Whereas the committee previously stated that it expected economic activity to accelerate, the January statement said that growth has picked up in recent quarters and “with appropriate policy accommodation, economic activity will expand at a moderate pace” in the coming months. While the changes seem minor; in Fed parlance this appears to be an effort to acknowledge the stronger growth environment that has warranted cutting back on quantitative easing.

Economic Roundup: Last week’s batch of economic data was mixed; however, the data still suggests the U.S. economy continues to move in the right direction. The Commerce Department reported that the preliminary reading on fourth quarter GDP showed the economy expanded at a 3.2% rate, down from the 4.1% annualized rate observed in the third quarter but on target with economists’ expectations. On a six month basis (Q3 + Q4) growth was the strongest second half since 2003. Personal Consumption rose by a solid 3.3% during the quarter outpacing the 2.0% rate observed during the third quarter.  On the housing front, new home sales in December fell 7.0% on a month-over-month basis to an annualized pace of 414K units. Despite the weak finish, for all of 2013, new home sales rose 16.4% - the best showing in five years. Durable goods orders—goods meant to last at least three years--dropped 4.3% during the month of December, the biggest decline in five months. However when the volatile transportation components of the report are excluded, durables were off just 0.6%.

Quarterly Earnings Summary:  Through Friday, 250 members of the S&P 500 have reported quarterly results with overall earnings up by 10.5%, solidly ahead of the 8.3% pace analysts are currently forecasting for the overall quarter and well ahead of the 5.2% estimate at the end of December. According to analysis by Bloomberg, of the 250 companies that have reported, 71.6% have exceeded expectations while 16.8% have fallen short. The current beat rate is moderately ahead of the long-term average of 61%.

The Week Ahead:  The focal point of the upcoming week will be Friday’s monthly payroll report for January. Following last month’s disappointing report, investors will be looking to see if this was just a one off report that was skewed by weather and statistical noise or the start of a weaker period for the labor markets. As was the case last month, weather could become a factor as the “polar vortex” continued to punish a large swath of the U.S. with record cold temperatures during January. According to Bloomberg, nonfarm payrolls are expected to rise by 180K and the unemployment rate is forecast to hang steady at 6.7%.  Private payrolls—which filter out government hiring/firing—are expected to expand by 190K.  Other economic data of interest include the ISM January manufacturing survey, December construction spending, December factory orders, the ISM’s non-manufacturing (services) survey, and the January ADP Employment Report. The earnings calendar will be busy with approximately 100 members of the S&P 500 scheduled to report results.  Fed Heads will be out and about during the week with five Fed officials slated to make appearances. With the Fed chairmanship reins being handed over to Janet Yellen, investors will monitor Fed appearances closely for insight into any “new” developments at the Fed in terms of their efforts to reduce their quantitative easing program.

 

MARKET VIEW:
Despite a lackluster start for the U.S. markets, I continue to believe they remain poised to move higher during the course of the year, although the pace of gains is likely to be more muted relative to 2013. While a setback could occur along the way, the stage appears set for the market to deliver solid performance reflecting a combination of multiple expansion and corporate profit growth, as well as an expected increase in equity portfolio flows.

The U.S. economy is expected to continue to gain traction, reflecting the ongoing gradual recovery in the housing sector, falling energy prices and reduced fiscal headwinds. While consensus expectations are for near 3% GDP growth in 2014, the risk appears to be skewed to the upside. Pent-up demand resulting from the huge gap in household formation over the prior several years should continue to buoy the housing market. The sector may also benefit from the rising cost of renting and the still-attractive level of mortgage rates. Gradual loosening of lending standards could also become a tailwind. A pickup in global demand would bode well for the U.S. manufacturing sector. While the sector has been shrinking since the mid-1960s and currently accounts for only about 12% of U.S. GDP, it is well positioned to expand as a result of lower operating costs due to improvements in productivity, new investments and declining energy and commodity prices. In addition, U.S. corporations are bringing jobs back home as rising overseas labor costs, a more competitive U.S. labor force and the expense of shipping have all diminished the economic benefits of outsourcing. The consumer segment of the economy should continue to benefit from an increase in net worth resulting from the rebound in housing and asset prices. This increase in “wealth” has recently boosted retail sales and consumer sentiment measures, suggesting consumers could continue to ramp up their consumption during 2014.

While monetary policy will gradually tighten over the course of the year; short-term interest rates are expected to remain pegged at low levels and therefore, policy should remain supportive of risk assets. Janet Yellen will become Chairman of the Fed this month and will be responsible for the gradual winding down of quantitative easing. Investors will intensely focus on how Yellen handles this extremely complex and potentially fragile situation, which could determine her credibility with investors early in her term.

While the outlook for the domestic markets remains favorable, attractive relative valuation and improving macro conditions should set the stage for even higher returns out of the Eurozone. European risk assets should also benefit from reduced fiscal headwinds, supportive monetary policy and an uptick in economic growth. With the prospect of better economic growth, the diminishing threat of a Eurozone debt crisis, and the investor-friendly European Central Bank, patient investors are likely to be rewarded over the coming years.

Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm’s headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500© Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

American Association of Individual Investors – AAII is a non-profit, membership-driven investor education organization. The American Association of Individual Investors (AAII) was founded in 1978 by James Cloonan. The AAII's mission is to teach individuals to manage their own portfolios and to beat average S&P 500 returns, while taking on lower-than-average levels of risk. AAII also publishes the results of its weekly investor confidence surveys that are based on its members' feelings about where the stock market is headed.

ISM Manufacturing Index is an index based on surveys of more than 300 manufacturing firms by the Institute of Supply Management. The ISM Manufacturing Index monitors employment, production inventories, new orders and supplier deliveries. A composite diffusion index is created that monitors conditions in national manufacturing based on the data from these surveys. 



Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

Past performance is no guarantee of future results. Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no gua rantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.


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