February 17, 2014
Last week’s market action gave stocks their first good weekly performance in 2014. The Dow Jones Industrial Average (DJIA) and the S&P 500 gained 2.3%, while the Russell 2000 and the NASDAQ Composite each added 2.9%. For the year, the DJIA remains down by 2.6%, the Russell 2000 is off 1.2%, the S&P 500 has dropped 0.5%, while the NASDAQ has added 1.6%.
International markets were also positive last week with most regions posting returns similar to the US. While the Developed Markets region of the world continues to perform reasonably well (-0.6%) in 2014, the Emerging Markets region remains a laggard. For the year, the Dow Jones Emerging Markets Region TSM index is down 4.2% hurt by the Asian/Pacific Region which is down 3.7%.
I believe markets have struggled to get started this year for a couple of reasons. First, markets had an incredibly strong 4th Quarter 2013 to cap off a stellar year. It would be perfectly normal for investors to take a breather at some point. Second, the weather has really hit most of the US hard this winter and with it—business. While I believe that bad weather has been used as an excuse for one bad economic data point or another in the past, I do think that this time weather will legitimately be to blame for lackluster economic data as the year gets started.
Other concerns that may have affected markets include fears in the emerging market region and the start of the Federal Reserve’s policy to reduce the amount of bond purchases (aka Tapering). As I have written previously, I do not believe either of these issues have had a major impact on our markets; however, I keep such worries under scrutiny.
Finally, corporate earnings are always under the microscope each quarter when companies announce their previous quarter’s results. We are nearly finished with the 4th Quarter 2013 reporting period where, according to the Wall Street Journal, 80% of companies in the S&P 500 have announced earnings and two-thirds have exceeded analyst expectations—in line with the past four quarters exceeding the post-1994 average of 63%. Profits drive markets and profits are still climbing.
WORRY AND THE MEDIA
I had lunch today with my corporate attorney and our conversation turned to the markets and the inherent fear many investors have. Part of this fear is a residual from the Great Recession of 2008. However, he pointed out, correctly I might add, that the first inclination of the financial media before, during and after a market like 2013 is to scare investors and convince them another market meltdown is just around the corner. Why? Because fear sells.
How many of you have seen the stories bouncing around the internet about how similar the chart of the DJIA today is to 1929? In case you have not seen the chart, here it is (top chart). The chart looks as if the markets today are tracking the 1929 markets with eerie similarity. However, what the fear mongers do not tell you is how the scale of the two periods are highly different in order to provide the similarity. If you scale the charts in the same manner (bottom chart) you will see a far different chart and most likely draw a very different view of today compared to 1929.
Source: The Wall Street Journal
Another topic I want to discuss is the importance of putting corrections into context. Again, the news media seem to hype every pullback as the coming of the next Great Depression fanning the fears of many investors. To help offer some perspective, I addressed this subject in the first Market Update and Commentary (January 2, 2014) of the year where I reviewed market corrections of the S&P 500 from March 2009 until the end of 2012, and then for 2013. Looking at the first years of this current bull market, I noted that the S&P 500 suffered 3.8 corrections between 5% and 10% every year and one correction greater than 10% every two years. I then noted that 2013 had no corrections of 5% or greater which made 2013 an unusually quiet year. Since my evaluation covered just the most recent five years of data, I was curious to see what a longer-term perspective might offer so I found a report that looked at S&P 500 corrections since this index’s inception.
Ned Davis Research reviewed every correction of the S&P 500 from January 1928 through April 2012. Their research found that there has been an average of 3.5 corrections of 5% or greater every year and on average one of those corrections was grew into a correction of at least 10%. The first part of the current bull market acted similarly to the overall market average, while 2013 did not. The S&P 500 had its first 5% correction of 2014 losing 5.8% between January 15th and February 9th. If history is any indication, we are likely to have more corrections this year, and that would be perfectly normal.
I have included a chart from Ned Davis Research that gives you greater insight into US stock market corrections:
I am not trying to make statisticians out of everyone, but I do think it is important for you to have some context of what is possible, even probable, when investing in the stock market. Volatility is an unpleasant fact of investing. How you react to this volatility has much to do with your success as an investor, and having some perspective about market corrections will hopefully enable you to make better investment decisions.
LOOKING AHEAD
There has been no change to my key market fundamentals nor has there been any significant deterioration of the data. US stocks are favored along with International stocks. Bonds remain in the #3 position among my six major asset classes followed by Foreign Currencies, Money Market funds, and Commodities. While I have been avoiding the Commodity asset class, it is important to note that Gold has risen 9.7% in 2014 and the Dow Jones UBS Commodity index has risen 3.9%. There may be life in commodities, but for now I am still avoiding or minimizing my exposure.
Small capitalization US stocks remain favored and Growth is favored over Value stocks. On a relative strength basis, Consumer Discretionary, Health Care, and Industrials remain the favored sectors; however, on a performance basis, Real Estate, Health Care, and Utilities have been the best performing sectors in 2014. Please keep in mind that the relative strength relationships I discuss in this section of my Update are long-term in nature to avoid constant turbulence in portfolios.
Developed International markets remain favored over Emerging markets, and I continue to prefer the High Yield and Bank Loan bond sectors. With the drop in interest rates so far in 2014, more interest rate sensitive bond sectors like Long Government and Preferred Stock have outperformed, however, I believe as interest rates begin rising again, these interest rate sensitive bond sectors are likely to pull back.
There are no major economic reports due out over the next couple of weeks. However, there are a couple of key reports such as Housing Starts, Consumer Price Index, and Initial Jobless Claims that will be published. As I noted earlier, I would expect these reports to be below consensus due to the weather impact on the economy.
My next Update and Commentary will be published around March 3rd.
Paul L. Merritt, MBA, C(k)P®, AIF®, CRPC®
Principal
NTrust Wealth Management
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Past performance is not indicative of future results and there is no assurance that any forecasts mentioned in this report will be obtained. Technical analysis is just one form of analysis. You may also want to consider quantitative and fundamental analysis before making any investment decisions.
Information in this update has been obtained from and is based upon sources that NTrust Wealth Management (NTWM) believes to be reliable; however, NTWM does not guarantee its accuracy. All opinions and estimates constitute NTWM's judgment as of the date the update was created and are subject to change without notice. This update is for informational purposes only and is not intended as an offer or solicitation for the purchase or sale of a security. Any decision to purchase securities must take into account existing public information on such security or any registered prospectus.
Emerging market investments involve higher risks than investments from developed countries and involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The main risks of international investing are currency fluctuations, differences in accounting methods, foreign taxation, economic, political, or financial instability, and lack of timely or reliable information or unfavorable political or legal developments. The Dow Jones Emerging Markets TSM Index is produced by S&P Dow Jones Indices and represents 21 of the largest emerging market economies led by China, South Korea, Taiwan, Brazil, India, South Africa, and Russia.
The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Past performance is no guarantee of future results. These investments may not be suitable for all investors, and there is no guarantee that any investment will be able to sell for a profit in the future. The Dow Jones UBS Commodities Index is composed of futures contracts on physical commodities. This index aims to provide a broadly diversified representation of commodity markets as an asset class. The index represents 19 commodities, which are weighted to account for economic significance and market liquidity. This index cannot be traded directly. The CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.
TIPS are U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.
The NYCE US Dollar Index is a measure that calculates the value of the US dollar through a basket of six currencies, the Euro, the Japanese Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss franc. The Euro is the predominant currency making up about 57% of the basket.Currencies and futures generally are volatile and are not suitable for all investors. Investment in foreign exchange related products is subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and foreign interest rates, and investors’ expectations concerning interest rates, currency exchange rates and global or regional political, economic or financial events and situations.
Corporate bonds contain elements of both interest rate risk and credit risk. Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. U.S. Treasury bills do not eliminate market risk. The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.
The bullish percent indicator (BPI) is a market breath indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is that when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey.
All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poors and is a capitalization-weighted index meaning the larger companies have a larger weighting of the index. The S&P 500 Equal Weighted Index is determined by giving each company in the index an equal weighting to each of the 500 companies that comprise the index. The Dow Jones Industrial Average is based on the average performance of 30 large U.S. companies monitored by Dow Jones & Company. The Russell 2000 Index Is comprised of the 2000 smallest companies of the Russell 3000 Index, which is comprised of the 3000 biggest companies in the US. The NASDAQ Composite Index (NASDAQ) is an index representing the securities traded on the NASDAQ stock market and is comprised of over 3000 issues. It has a heavy bias towards technology and growth stocks. The STOXX® Europe 600 is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 represents large, mid, and small capitalization countries of the European region. The Dow Jones Global ex-US index represents 77 countries and covers more than 98% of the world's market capitalization. A full complement of subindices, measuring both sectors and stock-size segments, are calculated for each country and region.
