Emerging Market Worries Weigh on Global Markets
The Dow Jones Industrial Average (Dow) fell 3.52%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 2.52%, the Standard & Poor’s 500® Index (S&P 500) dipped 2.63% and the NASDAQ Composite Index (NASDAQ) finished off...
January 27, 2014
| By Mike Schwager
Performance for Week Ending 1/24/14:
The Dow Jones Industrial Average (Dow) fell 3.52%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 2.52%, the Standard & Poor’s 500® Index (S&P 500) dipped 2.63% and the NASDAQ Composite Index (NASDAQ) finished off 1.65%. Sector breadth was negative as all 10 of the S&P sector groups finished lower. The Materials sector (-4.51%) led the way lower followed by Industrials (-3.98%) and Financials (-3.75).
||Closing Price 1/24/2014
||Percentage Change for Week Ending 1/24/2014
||Year-to-Date Percentage Change Through 1/24/2014
*See below for Index Definitions
MARKET OBSERVATIONS: 1/20/14 - 1/24/14
The major market indices finished the holiday shortened week moderately lower reflecting growing fears of contagion in the emerging markets as well as technical considerations. The rout was global in nature with all the major European bourses closing off in excess of 2%. Most of the major Asian markets also closed in the red.
Growing fears surrounding the emerging markets were sparked after China’s manufacturing sector contracted for the first time in six months. The downtick suggests economic momentum in China has hit a near term speed bump. With China still considered to be a major growth engine for the global economy, hints of slowdown tend to ripple through the global markets. Adding fuel to the fire were growing fears of a credit crunch in China which in turn forced the People’s Bank of China to inject money into the banking system to ease liquidity conditions.
Growth concerns over China among other factors led to a major selloff in emerging market currencies. Russia’s ruble, India’s rupee, South Africa’s rand, and the Turkish lira all plunged. The flow out of emerging markets currencies reflects concerns about emerging market countries ability to jump start their economies, which in turn is being compounded by growing political and financial instability.
The growing uncertainty put a bid under gold and U.S. Treasuries – both of which are considered “safe havens” during time of uncertainty. The yield on the benchmark 10-year Treasury declined to 2.74% from 2.82% last Friday, and now stands at the lowest level since late-November (note: price and yield move in opposite directions). Gold gained over $13/ounce, finishing up 1.1% for the week.
Technicals were also likely at work last week. After testing the 50-day moving average twice on Friday, the S&P 500 broke through this key support level. The 50-day is closely watched by the trading community as it is considered to be a key indicator of the markets near term trend. Capitulation-like characteristics were also evident in late-week trading as traditional “fear fulcrums” appeared to signal growing levels of PANIC (these indicators also tend to be contrarian in nature). For example, at one point on Friday DOWN accounted for over 90% of total volume, the VIX (aka Fear Index) rose to the highest level since mid-October and market breadth on the NYSE was overwhelmingly skewed toward declining issues.
A potential silver lining to the recent market cloudiness is the fact that bullish sentiment has fallen from the “frothy” levels that existed at the start of the year. Last week the American Association of Individual Investors (AAII), reported that bullish sentiment -- or expectations stocks will rise over the next six months – fell for a fourth straight week and now stands at the lowest levels since late-November. 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 most fearful (bearish) at market bottoms. The current trend in bullish sentiment suggests that selling pressure may be reaching a near-term peak -- stay tuned.
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 Federal Reserve at the end of 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.
With valuation levels roughly in line with their longer-term averages, investors are looking for earnings growth (versus multiple expansion) to become the primary driver of stock prices over the coming year. While overall growth is running well ahead of expectations, the quality of those earnings and the forward guidance from company management is casting some doubt over whether this transition is beginning to take shape. In other words, companies really need to “stick the landing” even if their bottom lines are coming in ahead of forecasts.
Through Friday, 122 members of the S&P 500 have reported quarterly results with overall earnings up by 15.0%, solidly ahead of the 6.6% pace analysts are forecasting for the overall quarter. According to analysis by Bloomberg, of the 122 companies that have reported, 66.4% have exceeded expectations while 20.5% 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 the two-day Federal Open Market Committee (FOMC) meeting on Tuesday and Wednesday. Expectations are for the FOMC to announce another $10 billion reduction (to $65 billion per month) in their bond buying program. Earnings season will reach a peak with approximately 130 members of the S&P 500 expected to report results during the week. The economic calendar will pick up this week with the focus on December new homes on Monday. Tuesday brings reports on December durable goods orders, the Conference Board’s January consumer confidence survey and the October Case-Shiller Home Price Index. The first estimate of fourth-quarter GDP and December pending home sales will be released on Thursday. Friday will feature December personal income and spending, the University of Michigan’s final January consumer confidence survey and the January Chicago PMI. Also of interest in the upcoming week will be the Treasury Department’s sale of $15 billion two-year floating rate securities. The interest rate on these notes will reset daily. This is the first new product issued by the Treasury Department in 17 years. Treasury will also auction $32 million of traditional two-year notes on Tuesday, $35 billion of five-year notes on Thursday and $29 billion of seven-year notes on Thursday.
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.
VIX- CBOE Volatility Index is the ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge."
S&P/Case-Shiller Home Price Index is a group of indexes that tracks changes in home prices throughout the United States. The indexes are based on a constant level of data on properties that have undergone at least two arm's length transactions. Case-Shiller produces indexes representing certain metropolitan statistical areas (MSA) as well as a national index.
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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