Market Update Q3 2014

by Harrison C. Willner, C.C.O.
Investment Advisor Representative

The market trend over the first quarter of this year was flat and underwhelming at best.  This sluggish start led many, headline news reporters included, to cavalierly use words such as contraction and mini recession with excessive disregard.  Much of the lackluster performance was publicly attributed to the abnormally severe winter experienced by much of the country.  Given that the extent of the harsh winter was sufficient to provide fodder for much debate by pundits touting either a bull or a bear market, it follows that the data for the first few months of the year confirm the dampening effects of the years’ cold spell.  Fortunately, the nation’s accumulated snowfall wasn’t the only item heating up with the spring thaw as the latest jobs numbers, and by extension, company earnings, were up significantly in April and May over the first three months of 2014.  This has led to a net gain of 4.7% for the year on the S&P 500 despite being down as much as 4.9% in February.

Although a lagging indicator, the GDP data summarize the overall effect the cold weather had on the economy and sets the stage for what could be a very strong second half to 2014 given the stifled demand in the most recent two quarters as shown on the graph below.

GDP

GDP increased 3.4% over 2013, subsequently accompanying a 26.7% market gain[1].  In contrast, GDP during the first quarter of 2014 saw a revised decrease of 1% annually.  Not surprisingly, this coincided with a much more impuissant 5.6% annualized gain for markets.  For comparison, during a normal year, the U.S. economy experiences on average 3% growth, while two consecutive quarters of negative growth would be grounds for a recession.

durable goods

Manufacturers’ new orders of durable goods, a leading indicator in economic trends, dropped sharply in December of 2013 and continued to a 12 month low in January before finally creeping back up in February and March.  The winter seems to have had a negative impact on new orders, and by extension, production figures, as manifested in the decline of the index during the winter as well as the faltering of stock market momentum during the first quarter of the year.  However, the most recent positive trend indicates that manufactures expect a surge in pent up demand held over from prior months going into the second half of the year.  This is supported by the decreasing unemployment rate which now sits at 6.3%, down from 7.5% a year ago[2].  The ostensibly positive drop in the unemployment rate should; however, be tempered with the notion that many individuals remain underemployed and thus earn and contribute less than their potential allows.

Overall, we are optimistic about job creation for the second half of 2014 and expect this to be reflected in a healthier GDP for the remaining quarters of the year.

The less than inspiring 84 thousand jobs added in December set a negative tone for markets that pervaded through February and into much of March and April.  However, 282,000 jobs added at the end of April propelled markets forward in May with the S&P 500 gaining nearly 2% for the month.  Most recently, the May jobs report showed that 217,000 jobs were created during the month of May legitimizing April’s strong jobs numbers.  Moreover, it shows that the U.S. economy can in fact substantiate a verifiable recovery with reduced monetary stimulus from the Fed. If this positive trend in job creation continues through the summer, we expect markets to increase correspondingly insofar as equity market gains do not outpace the additional earning power provided by newly created jobs.

Turning now to fixed income markets, our previous market update issued in July of 2013 covered the fed’s announcement to change its current interest rate friendly policy in accordance with what they deemed to be a sustainable economic recovery.  This meant fewer bonds purchased in the open market by the fed, less demand for bonds in general, and an accompanying price decline. Initially, this knocked prices on the 20 year treasury down by nearly 18% from May 2013 highs before flattening out late last year.  Since the fed initiated the reduction in its bond buying program, we have seen a somewhat counterintuitive rise in bond prices and demand.  This continuous rise in price over the course of the year coupled with a positive market return points to a healthy economic environment capable of sustaining growth through the end of the year without artificial demand created by the fed.

iShares

That said, we view 2014 with cautious optimism in that many of the headline stocks that led equity indices last year are now too expensive at current levels.  We are currently positioned to take advantage of cheaper value stocks that yield healthy dividends as well as a few select industrial, tech, and financial holdings that have remained under the radar, and therefore, relatively cheap on an earnings basis.  Given that the current economic environment is one that favors value and product over promise in the face of a tepid recovery, we anticipate that all five of our risk profiles will modestly outperform their benchmark indices with careful asset selection.

 

[1] The S&P 500 index is used as a proxy in calculating market returns

[2] Although the unemployment rate has been decreasing, the number of people leaving the labor force are increasing (806,000 according to the April jobs report) meaning that some individuals have given up looking for work altogether.