MARKET UPDATE AND COMMENTARY
September 28, 2014
I told myself that I was not going to do it, but I just can’t help myself: there are now just 88 days till Christmas! You may be asking yourselves why on earth is Paul bringing up the onset of the holiday season? I have two reasons. First, I am a very slow shopper so I need to start thinking about gifts now if I am going to meet the holiday deadline. Second, and what really matters, is that we are now three-quarters of the way through 2014 and rapidly closing in on 2015. I would like to offer a few thoughts about where we are and where we might be going over the next few months. Before I do, I will quickly summarize September’s actions.
September has two trading days left and the S&P 500 must rally 21 points (1%) to close out the month positive. For the year, however, the S&P 500 is up a respectable 7.3%. The Dow Jones Industrial Average (DJIA) is positive by 0.1% but lags the S&P 500 with a gain of just 3.2% for the year. The technology-heavy NASDAQ exchange is down 1.5% in September but is up 8.0% for the year. Smaller company stocks as measured by the Russell 2000 have had a tough month and year with this index falling 4.7% in September and losing 3.8% for the year.
Interest rate sensitive sectors have underperformed in September as interest rates have made their largest monthly increase in 2014. The US 10-year Treasury Yield has climbed 19 basis points (0.19%) to close Friday at 2.53%. The Real Estate and Utilities sectors have lost about 6% and 4% respectively for the month. The Energy sector has also been hit hard losing a little more than 6% as energy prices continue to pull back. Only Health Care and Consumer Staples have managed to post a positive month so far.
International regions are having a tough month as well. The Emerging Markets region has fallen 5.0% in September followed by the Asia/Pacific region with a 3.7% drop while the Developed Markets region is down 2.8% in September. For the year, the Emerging Markets region is up 4.3%, the Asia/Pacific region is up 1.7%, and the Developed Markets Region is up 2.4%.
The second estimate of the 2nd quarter Gross Domestic Product (GDP) was released on Friday showing an upward revision in real GDP from 4.2% to 4.6%--welcomed, but expected news. The GDP Price Deflator (a measure of inflation) remained unchanged at an annual rate of 2.1% continuing to give the Federal Reserve more latitude on when they may start raising interest rates.
THE YEAR SO FAR
Increasing geopolitical instability has been the overarching theme in the news this year. Ukraine fighting to retain its sovereignty from an expansionist Russia, the rise of ISIS and the increasing military involvement by the US in the Iraq/Syria region, and a more aggressive China are, in my opinion, the most significant challenges facing the US and investors today. Quietly, Argentina and Venezuela are suffering severe economic setbacks led by very socialistic governments, and Brazil finds itself in the midst of its own economic challenges. In addition to geopolitical concerns, investors remain fixated on parsing every word the Federal Reserve utters about the future of monetary policy.
This economic divergence between the United States and the rest of the world has the attention of international investors. Demand for the US Dollar has risen dramatically (foreign investors must convert their home currency into US Dollars to invest here). The Euro has fallen 9.4% to the US Dollar since May 8th and the US Dollar index has increased 8.5% over the same period. This is a seismic shift in terms of currency changes and I believe related, in a positive way, to the rise in interest rates. Let me explain.
While the Federal Reserve controls very short-term interest rates, the market sets longer rates. As Scott Grannis summed it up well this week in his blog, “10-year (Treasury) yields are largely driven by the market’s expectations for economic growth and inflation.” Watching the benchmark 10-year Treasury yield, rising rates indicates a positive growth outlook given the tempered rate of inflation. At the same time the European Central Bank (ECB) is getting ready to launch their own quantitative easing (QE) program to fight sagging economic growth in Europe while the Fed must address raising rates in response to stronger economic growth here. The Federal Reserve, I believe, will be forced to raise rates in response to these changes.
While I believe US markets are the place to be, this does not mean that going forward investors do not face some headwinds, we most certainly do. A rise in interest rates may result in a revaluation of interest rate sensitive stocks such as we have begun to see in the utility and real estate sectors. Additionally, demand for these same stocks may lessen as more conservative investors shift some of their investments back into higher yielding bonds. Greater supply implies lower prices.
So far in 2014 there has been a shift away from small-capitalization stocks. These stocks have underperformed large cap companies by nearly 10% on average. As the theory goes, when investors become nervous about the markets in general, small caps are sold first. I understand this theory, but I am tempered by the knowledge that this has happened several times over the past few years only to see the “riskier” part of the stock market rebound swiftly. As I said in my last Update and Commentary, if you are uncomfortable with your stock exposure, look to the small and mid-cap holdings to raise cash.
Going forward, I believe we will continue to see higher volatility and possible short-term disruptions in stock prices. I am firmly committed to overweighting US stocks over international stocks and bonds. The US economy, for many reasons, has the ability to adapt to the challenges that may lie ahead. US companies are extremely well run and have strong balance sheets. If Washington addresses some of the fiscal policies holding back our economy, we will see this plow horse economy start to gain momentum. Finally, the Federal Reserve must continue to manage monetary policy effectively. I believe the secular bull market will continue to run over the next year or two.
LOOKING AHEAD
September has been a lackluster month for stocks. If the month ended this past Friday, it would be the third weakest month (measured by the S&P 500) and one of four negative months for the year. January and July were worse.
Rising rates have put pressure on many bond sectors with high yield and extended duration among the weakest performers. This may continue if rates keep rising in the last quarter of the year.
The DorseyWright & Associates Money Market sector score currently stands at 1.65 (out of 6.00) up from 1.48 at the end of August. This sector’s overall ranking remains at 128 out of 134, and while this is a trend I generally do not like to see, I am not overly concerned with the sector ranking unchanged at 128.
The September Employment Situation report will be published on Friday. This monthly jobs report is closely watched by investors worried about an early increase in interest rates by the Federal Reserve. The August report surprised investors with a job increase of just 142,000, but consensus is expecting the August number to be adjusted significantly upward and for the September non-farm payroll to show an increase of 215,000 jobs. While the jobs report is very important to investors, it is hard to predict how investors will react to either an upside or downside surprise given the many Federal Reserve cross currents impacting investor decisions.
If you have any questions or comments, please reach out to me.
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 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.
