Economic Update 10-13-2014

• It was a light week for domestic economic reports, generally focused on employment subtleties; however, global economic growth expectations were downgraded by the IMF, causing additional market tumult.
• Typical October volatility returned to markets as domestic stocks experienced some of the widest day-to-day swings of the year and ended sharply negative. Conversely, bonds gained as yields fell to their lowest levels in over a year.

Volatility is back from summer break.  U.S. stocks started the week off on a poor note, but gained strongly Wednesday as the FOMC meeting minutes were more dovish than anticipated, holding off fears of rising rates anytime soon; yet, Thursday and Friday saw a complete reversal of those gains as less-than-reassuring comments implied from Mario Draghi (Europe’s problems being structural, not cyclical) and Carl Icahn’s assessment that a market correction was inevitable (yet, at the same time, raving over Apple) and general worries about global growth, particularly regarding some poor German industrial numbers.  On the week, defensive segments utilities and consumer staples led, while energy and telecom suffered the worst declines (lower oil prices being the driver of the energy group).

Such is the story of October markets.  The VIX has moved from lows of around 10 in July to the low 20’s in recent days, and technical corrections occurring in several global markets, including Germany, the broader Eurozone, as well as U.S. small cap.  It doesn’t necessarily mean the world is falling apart, but a pullback always serves its purpose as a healthy ‘pause to refresh’ and prevent things from becoming too overheated on a short-term basis—just like in an economy.  The IMF hasn’t done the world any favors by again tempering predictions for global growth in an environment described by Christine Lagarde as ‘brittle, uneven and beset by risks.’  For 2015, estimates were lowered from 4.0% down to 3.8% (albeit better than this year’s 3.3% rate), and warned that the Eurozone faces a 40% chance of a third recession since the global financial crisis.

While overall global growth isn’t what many would like it to be, U.S. fundamentals have continued to strengthen.  Onto a somewhat more positive note, from a fundamental standpoint, what is the U.S. earnings picture looking like for this quarter?  Per FactSet, who tracks these things, a fewer number of companies have issued negative pre-announcements for the third quarter in a row.  The bulk of the improvement seems to have taken place in materials, industrials and technology.  For the year-over-year period ending in September, earnings growth is expected be to in the range of +5% (albeit down from +8-9% estimates earlier in the summer).  These estimates have been markedly downcast over the past several years, and generally, stocks have beaten them.  Telecom and health care are largely expected to fare best, as firms with U.S. revenue exposure are unsurprisingly anticipated to outperform those with significant overseas operations, due to foreign weakness and dollar strength.

Traditional bonds experienced an exceptionally good week, with the risk-off tendencies of equities—rates fell 10-20 basis points across the curve, as the 10-Year Treasury reached its lowest level since June of last year.  Long government bonds naturally led the way, gaining a few percent due to duration effect, while mortgages and investment-grade credit also fared positively.  Despite their strong fundamentals, high yield bonds were hit by a combination of factors, including widening spreads due to risk avoidance, fickle investor cash flows affected by ETF markets and a wider supply calendar, that has lowered prices in recent weeks.

Foreign bonds were theoretically aided by a weakening reversal in the dollar, but lack of further easing discussion in Europe and some risk-off tendencies in emerging markets led to little change on net.

The real estate sector was led by strong gains in residential REITs, which gained several percent upon continued strength and low vacancy conditions in apartments (to the detriment of home sales to some extent, witnessed by a poor week in the homebuilding sector), while retail and industrial/office also gained.  European REITs were the worst performing, in the negative by a few percent, as economic prospects continue to look dicey, which threatens tenant demand.

Commodities experienced a mixed week, although a weaker dollar last week helped their general prospects.  Soft commodities (coffee and sugar) experienced another strong period amidst supply concerns, while gold rallied with lower bond real yields and the general risk-off environment, bringing year-to-date returns to just barely positive.  Oil and natural gas lost up to -5%, with the West Texas Intermediate Crude contract falling into the range of the mid-$80’s.  This drop in price, as noted earlier, has been a significant headwind for energy equities but certainly a positive input cost for most other economic segments.

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.                                     

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.  FocusPoint Solutions, Inc. is a registered investment advisor.