Market Update for the Month Ending January 31, 2014 Presented by Cynthia Doussard Markets consolidate to start the year After a 2013 with no major or even many minor declines, stock markets dropped across the board in January, as investors reassessed their risk tolerances. Driven by the Federal Reserve’s (Fed) tapering of its stimulus program, the MSCI Emerging Markets Index was down a steep 6.60 percent. Developed international markets, represented by the MSCI EAFE Index, got hit hard as well, with a decline of 4.03 percent, while the U.S. S&P 500 Index slipped 3.46 percent—somewhat less than the international markets, but still its largest drop in months. Declines in emerging markets drove increased uncertainty around the world. With the reduction in monetary stimulus in the U.S., as well as the perception of both political and economic risks rising in other countries, investors sold securities, driving values for equities and bonds down in emerging markets. The risk-off trade was reinforced by a collapse in the Argentine peso, a growing political scandal in Turkey that could threaten the government, and riots in Thailand. Emerging market woes were not the only reason for the sell-off here in the U.S. A contributing factor to the decline was concern about the future profitability of U.S. companies. Among the S&P 500 companies that have so far reported earnings for the fourth quarter of 2013, 44 guided down expectations, with only 10 guiding up for more optimistic growth. Fundamentals remain reasonably strong, but the prospects for future growth are becoming less certain. This was reinforced by several indicators of possible slowdowns in employment and economic growth. Fixed income assets benefited from the rising risk perceptions. The first month of the year started on a very positive note for duration-sensitive bonds. The Barclays Capital Aggregate Bond Index returned 1.48 percent, reversing in one month more than 70 percent of the losses it sustained during all of 2013. This improvement was linked to a decline in the U.S. 10-year Treasury yield, which closed out January at 2.64 percent, down from 3.03 percent at the start of the month. The rebound in traditional fixed income underlined the diversification benefits that bonds offer, even when rates are at historically low levels. The only fixed income sectors that struggled were global—and especially emerging market bonds. The J.P. Morgan EMBI Global Core Index slipped 0.85 percent, as nervous investors sold emerging market bonds and currencies and repatriated assets to developed markets. Concerns about slowing growth, higher interest rates, inflation, and Fed tapering were all factors that contributed to weakness in this asset class. U.S. economy shows signs of slowing growth Gross domestic product figures for the fourth quarter of 2013 were relatively robust—with initial estimates putting growth at 3.2 percent—but there were signs of a slowing recovery at year-end. The December employment growth figure was significantly below expectations, adding just 74,000 jobs instead of the 200,000 generally forecasted. Most analysts attributed this to severe weather, but it did introduce an element of uncertainty. Other disappointing data points were the most recent releases of auto sales data, building permits, and housing starts. The most recent releases of business capital expenditures were weak, too, as were new home sales and durable goods orders. Positive news included strong consumer spending data in December, which is important, given that the consumer has historically contributed more than two-thirds to overall economic growth. There was also a noticeable improvement in the U.S. trade balance, due largely to continued growth in domestic oil and gas production and a rebound in consumer confidence toward the end of December. Essentially, these were simply signs of potential future weakness, rather than of an imminent slowdown. The positive data still dominates the negative data, but the balance is getting somewhat closer, signaling possible slower but still positive growth in the first part of this year. Along with external negative developments, such as the weakness in emerging markets, which should hurt U.S. exports, investor expectations have taken a hit. At this point, we still expect growth in 2014 to average in the 2.5-percent range on a real basis, but we are keeping an eye on the data, with special attention to employment. Government a bright spot One of the principal positive differences between the start of 2014 and last year is the role of government. Unlike the beginning of 2013, we do not have to worry about a fiscal cliff deterring consumers and businesses; instead, we have the certainty of a two-year budget and spending deal. Also unlike 2013, we no longer have a large tax hike and pending spending cuts. We have an agreement that actually modestly expands spending at the federal level and increases the likelihood of spending growth at the state and local levels. Finally, unlike in 2013, government at all levels is no longer laying people off; government employment appears to have at least stabilized—and may increase. The only real pending governmental risk factor is the debt ceiling negotiations in February, which have the potential to create the same sort of uncertainty and drama we have seen before. But the politics appear to have shifted enough that it seems unlikely that we will have a major problem. Overall, and with that exception, it appears that we can remove government as a risk factor for at least the near term. The effects of this are significant, as the private economy has been showing strong growth, despite being slowed by cuts in government spending and hiring. With government stabilizing as both a political influence and an economic actor, the strength of the private sector should become more apparent. Emerging markets and the fragile five A principal external risk factor is the slowdown in emerging markets. Although the reduction in stimulus by the Fed is often blamed for this—and is in fact a contributory factor—the real causes are the economic imbalances that the availability of cheap capital allowed to develop in those markets. The growth of imports and consequent build-up of debt in many countries will now have to be corrected during a period of slower growth. The nations that appear to be affected most are what we are calling the “fragile five”: Brazil, South Africa, Indonesia, Turkey, and India. All of these countries suffer from high current-account deficits. On the surface, conditions appear similar to 1998, which led to a crisis, but in fact conditions are much better now. Most of the affected countries have both floating exchange rates and extensive foreign currency reserves, which should allow them to adjust their monetary policies. Therefore, even though investors have pulled back, the rebalance so far has been smooth. Good fundamentals still in place, but valuations higher As we move through 2014, the economy should continue its recovery, with growth in employment and income across the board supporting continued progress in other areas. Strong fundamental factors, including the housing market, the oil and gas boom, recovering business investment, and slow-but-steady income and spending growth, should support a healthy economic environment. At the same time, the weak performance of stock markets around the world in January suggests that investors are reassessing their willingness to take risk and put capital to work at current valuations. While the long-term prospects for stocks remain potentially strong, it appears very possible that short-term weakness will continue. Offsetting this is the strong performance of traditional fixed income assets, as interest rates have declined. January’s events underline the need for a diversified portfolio, as well as a long-term perspective aligned with an investor’s goals. The ongoing growth of the economy, which now appears to be back on track, should provide a cushion for any market adjustments in the short term, and proper diversification should further limit their effects on your portfolio. Longer term, cautious optimism remains the appropriate stance, as history has shown us that markets and economies have always returned to a growth path. All information according to Bloomberg, unless stated otherwise. Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The J.P. Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets and is an expanded version of the J.P. Morgan EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans, and eurobonds with an outstanding face value of at least $500 million. It covers more of the eligible instruments than the EMBI+ by relaxing somewhat the strict EMBI+ limits on secondary market trading liquidity. ### Authored by Brad McMillan, vice president, chief investment officer, and Sean Fullerton, investment research analyst, at Commonwealth Financial Network. Cynthia Doussard is a financial advisor located at 325 E. Rio Vista Ave., Burlington, WA. She offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. She can be reached at 360-755-0344 or at cynthia@doussardfinancial. Dont keep me a secret! Referrals are appreciated! Cynthia Doussard Doussard Financial 325 E. Rio Vista Ave. Burlington, WA 98233 Phone (360) 755-0344 Fax (360) 755-2158 cynthia@doussardfinancial Securities and Advisory Services offered through Commonwealth Financial Network, Member FINRA/SIPC a Registered Investment Adviser. Notice: All e-mail sent to or from this address will be recorded by our record-keeping system and is subject to monitoring or review by and/or disclosure to, someone other than the recipient. By industry regulation, we cannot accept orders to execute trades by e-mail. In addition, we cannot accept time-sensitive information by e-mail. Important communications should be completed by telephone at (360) 755-0344. Thank you. This e-mail is an advertisement and you may opt out of receiving further e-mails. To opt out, please respond to this e-mail with Opt Out in the subject field. © 2014 Commonwealth Financial Network®
Posted on: Thu, 06 Feb 2014 18:58:59 +0000
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