Global Concerns have Investors Russian for the Exits

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March 17, 2014 | By Mike Schwager

Performance for Week Ending 3/14/14:

The Dow Jones Industrial Average (Dow) fell 2.35%, the Wilshire 5000 Total Market Index^SM (Wilshire 5000^SM) lost 1.90%, the Standard & Poor’s 500^® Index (S&P 500) dipped 1.97% and the NASDAQ Composite Index (NASDAQ) closed off 2.09%. Sector breadth was negative as 9 of the 10 S&P sector groups finished lower. The Industrials sector (-3.22%) led the way lower followed by Financials (-2.51%) and Consumer Discretionary (-2.42%).

Index*	Closing Price 3/14/2014	Percentage Change for Week Ending 3/14/2014	Year-to-Date Percentage Change Through 3/14/2014
Dow	16065.67	-2.35%	-3.08%
Wilshire 5000	19280.02	-1.90%	+0.13%
S&P 500	1841.13	-1.97%	-0.39%
NASDAQ	4245.40	-2.09%	+1.65%

*See below for Index Definitions

MARKET OBSERVATIONS 3/10/14 - 3/14/14

The major market indices finished the week lower as escalating tension surrounding Russia and the Ukraine coupled with worries over slowing economic growth in China overshadowed signs that the U.S. economy may have moved past the weather-induced slowdown.

The events in the Ukraine continued to weigh on investor sentiment last week as lack of any progress and ongoing saber-rattling from Russia had many investors moving to the safety of the sidelines. While until recently the events have mostly been shrugged off by the domestic markets and have been viewed as more a political event than an economic event, there certainly remains the risk of the situation morphing into the latter. While the Ukraine’s impact on global growth is miniscule, if the country’s financial situation results in a default, it could rattle the already fragile emerging markets. In turn, additional pressure on emerging market economies could ultimately bleed in both the European and U.S. markets. So far the biggest loser in the Russian led invasion of Crimea has been Russia itself, as its stock market has dropped by over 14% in the past two weeks.

The overseas events overshadowed several reports showing the U.S. economy may be moving past the weather related weakness that weighed on growth since the start of the year. Last week the Commerce Department reported that retail sales rose 0.3% during February, a solid snapback from the 0.6% decline posted during the prior month. The rebound in retail sales during February likely reflected pent-up demand resulting from poor weather conditions in January. Data also showed that progress in the labor markets continues. Following the recent rebound in monthly nonfarm payrolls, the Labor Department reported that initial weekly jobless claims fell to 315K, the lowest level since the end of November. The 4-week moving average—which tends to smooth the week to week volatility—fell to 330.5K, the lowest since early December.

While there are a variety of reasons the market is currently going through a choppy digestion phase – ultimately it is Fundamentals (the economy, earnings, interest rates) that drive the stock market – and in that regard, the macro environment – remains supportive of further gains.

U.S. economic growth seems to be in a “goldilocks” phase (not too hot, not too cold) with consensus forecasts for full year growth settling in at around 3%. This level should be strong enough to continue to drive labor market growth, but not too strong that the Federal Reserve (Fed) would consider hiking interest rates.
The Labor markets are moving forward. After disappointing labor market reports in both December and January, the February payroll data came in much better than expected. In addition, most other labor statistics (ADP, ISM, Initial claims) – all argue that the labor markets continues to gain momentum.
Corporate earnings continue to surprise to the upside. According to the Bloomberg consensus, earnings are likely to grow approximately 8-10% both this year and next.
Inflation remains low and is not likely to move much above 2% in the foreseeable future. Low levels of inflation should be supportive of the markets valuation due to the inverse relationship. In fact, by historical standards, when inflation has been below 2%, the price to earnings (P/E) multiple on the S&P 500 has averaged close to 18 times trailing earnings versus the current 17 multiple.
Monetary policy should remain favorable through 2015. Fed Chairwoman Yellen in recent speeches has had a dovish tone and appeared in no hurry to raise rates.

Midterm Election Years
2014 marks a mid-term election year. According to data from Strategas Research, midterm election years going back to 1930 are typically characterized by choppy sideways trades during the first nine months of the year followed by solid performance in the final few months. Political posturing and uncertainty going into the election usually keep investors close to the sidelines. Once the outcome to the election becomes clearer, investors are more likely to come back into the markets and position for the outcome. In other words, if history repeats itself, performance this year could be back end loaded.

The Week Ahead
The focal point in the upcoming week will be the two day Federal Open Market Committee (FOMC) meeting, which will also include the latest update to the Fed’s central tendency forecast. The meeting will be followed by the first press conference from new Fed chairwoman Janet Yellen. While no surprises are expected to emerge from the FOMC meeting, the committee is expected to reduce their bond buying activity by another $10B/month to $55 billion. The economic data cupboard will be full this week with reports due out on regional manufacturing, housing, inflation and employment. A handful of Fed heads will be out and about next week, with speeches scheduled for St. Louis Fed President Bullard, Dallas Fed President Fisher, Minneapolis Fed President Kocherlakota, and Fed Governor Jeremy Stein.

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 Index^SM 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.

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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