Market Insights: August 12, 2014
Economic Outlook: Green, Yellow and Red signals
- In light of the increased market volatility (mostly downward), the question on our clients’ minds seems to be: “Is this the beginning of some sort of broad-based downturn in the economy and the markets?” The U.S. data reads “Green” and does not seem to be saying that.
- There was strength last week showing in the ISM Services Index. It posted a reading of 58.7, strongly in the growth territory.
- The Second Quarter trade deficit numbers were released last week, and showed a narrowing deficit to $41.5 Billion. This narrowing suggests a possible boost to final second quarter GEP numbers.
- Job numbers also continue to improve. Last week’s initial jobless claims, released by the Department of Labor, were down to 289,000. The four week moving average now stands at 293,500. This is a level that formerly was considered indicative of a normal jobs economy.
- Internationally, the data is mixed, however. China’s PMI composite measurement for last month recorded at 51.6. This is the second straight month of expansion in the Chinese Manufacturing Index number.
- European economic readings reveal a contrary pattern however. The retail PMI measurement for the Euro-zone slipped to a negative level of 47.6, in July. Apparently the Russia – Ukraine tensions, are taking a toll on the economy. Italy’s numbers have been hit particularly hard.
- The recent economic data out of Germany (Europe’s largest economy) has been troublesome, however. Factory orders in June declined more than 3.0% from the May levels, and are now actually reduced from year-earlier levels. Germany’s PMI index for manufacturing has been flattening, although the PMI Services Index continues to post a strong reading at 60.8.
- The divergence in the manufacturing numbers out of the member countries of the ECB (France is in the contraction column) has prompted increased speculation that European monetary authorities will begin a program of asset purchases similar to those followed by the Fed.
- The mixed data from Europe suggests that we are, at least for the moment, in a risk off mode, where any positive news regarding corporate earnings is likely to be over shadowed by geo-political factors weighing upon the economy.
Equities Outlook: Back to normal – things are volatile
- We spoke in our August 4th Comments about our expectations for increased market volatility. Indeed, we saw some of that last week. These days of large point swings can be somewhat unnerving. However, as noted in the Economic Outlook points above, the U.S. data for the economy, jobs, and consumer confidence all are showing strong readings. If the economy is not heading into recession, a major market pullback is unlikely.
- Last week showed downward momentum in most all equity markets. Surprisingly, the Russell 2000 Small Cap Index posted a gain for the week. This reverses some of the recent weakness that had been showing in that particular market.
- The strong economic data noted above creates some concern around acceleration in timing of a policy shift by the Fed, but the risk of outright recession appears low. Hence the risk of a shift to a bear market (as opposed to something milder, like a correction) appears quite low in the U.S.
- However, the European data showing weakness is a cause of concern and is something actively on our radar screen in the L&W Investment Committee to determine if any change in tactical weighting for client portfolios is appropriate. The FTSE, stock index in the UK slipped to a four month low last week. This may be a leading indicator that, at a minimum, we are facing a pause in the recovery of the European market.
- The Investors Intelligence poll was updated last week. The bullishness reading dropped from 55.6% to 50.5%. This reading has shown significant decline since the levels that we’re posting back in mid-June when this indicator peaked. Those in the survey expecting a correction jumped to almost one-third of the respondents, the highest level in the last six months. This makes it more likely that we will not in fact obtain a full correction.
- If we are in the beginning of a market correction, history would suggest that is a non-recessionary correction. Usually, in these corrections, corporate earnings growth remains strong. 10.0% corrections within a bull market are generally brief and last only several months. They are distinguished from more serious situations like a recessionary bear market, which can extend from one to two years and involve a decline of 20.0% to 30.0% or more.
Fixed Income Markets: Competition on Rates
- The Ten-Year Treasury continues solidly below the psychological 2.5% level. It had closed the previous week at a yield of 2.48%, and declined further to end last week at the 2.42% level. Geopolitical tensions and the weakness in data from Europe seem to be strong contributors.
- The German 10-year Bund yield has declined to a record low yield of 1.06%. The low rates in Europe take some upward pressure off rates in the U.S. market as capital is free to flow globally.
The Week Ahead
- NFIB Small Business Optimism Index (NFIB)
- Retail Sales (Census, Dept of Commerce)
- Producer Price Index (Bureau of Labor Statistics)
- Industrial Production (Federal Reserve Board of Governors)
- Consumer Sentiment (University of Michigan)