The initial outlook for 2014 was based on an improving economy across the board. As we approach the middle of the year, despite a weather-weakened first quarter, those expectations are playing out.

• After a slow first quarter, economic growth should heat back up to between 3 percent and 4 percent for the remainder of the year.
• Continued growth should have the Federal Reserve (Fed) completing the tapering process by the end of the year.
• Employment and wage growth should continue to accelerate.
• Earnings growth will have trouble meeting expectations, as rising wage bills and slowing productivity hit profit margins.
• Equity market growth will be constrained by earnings weakness, with the market trading around current levels for the remainder of the year.

“Snowdown” turns to meltup
We started 2014 in a much better place than we did 2013. Employment, both current and trend, was much better. The housing market was much improved. The consumer was much stronger. The government was much more stable—and in a much better fiscal position. The stock market responded to this ongoing improvement by posting its best year since 1997.

Although the first quarter of the year was snowed out (hence the above moniker), the second quarter looks to fare much better, and there is the prospect of economic warming kicking in at the global level for the rest of the year. First-quarter economic growth of 0.1 percent—which is quite likely to be revised to a loss—was driven by record-setting snowstorms, leaving hundreds of thousands more workers than usual stuck at home in January and February. Improving weather in March and April sent those workers back in, along with many others, leading job figures to increase at their highest level in years and driving private employment to an all-time high.

As we look further into 2014, we can expect the underlying economic trends to continue. Growth in jobs has stabilized at around 200,000 per month, bringing unemployment down from 6.7 percent at the end of 2013 to 6.3 percent at the end of April 2014. House prices have continued to appreciate, and although the market appears to have slowed, it continues to improve. Business investment has remained at levels above those of recent years, while government spending and hiring has ceased to be a drag on the economy.

All things considered, I expect to see real economic growth of around 3 percent for the remainder of the year, with the possibility of stronger performance. With consumer spending growing at around 4 percent on a nominal basis, business investment growing at around 8 percent, and government spending essentially flat, 3 percent appears both reasonable and achievable. Combined with inflation of around 1.5 percent for the year, nominal growth should approach 4.5 percent—better than we have seen for some time.

The risks here are largely on the upside. If consumer borrowing were to pick up, spending could grow faster than wage growth. Business investment could finally respond to improving demand and rise more than expected. Local and state governments could increase investment and hiring more than expected.

Downside risks are more limited and primarily external, with Europe and China remaining as possible negative actors in the world economy and financial markets. The major domestic downside risk is of slowing employment growth, of which there are few signs. Should employment growth drop, the rest of the economy would also slow. Nonetheless, the most probable case remains continued economic expansion.

The stock market, on the other hand, will face larger challenges this year and may struggle. I expect the U.S. equity markets to end 2014 at about the same level as they are now—around 1,875 for the S&P 500. Although earnings will continue to grow, they will do so more slowly than expected, and valuations may be adjusted over the year as investors expect lower future growth—and accordingly pay less for stocks. That willingness to pay less will also come because interest rates will rise somewhat over the year, making bonds more attractive as an investment and lowering the present value of the slowly growing earnings stream even more. The lower valuations will offset the somewhat higher earnings, leaving the market essentially flat for the year.

Unlike the economy, I believe the risks to the market are mostly on the downside. Valuations remain at high levels—higher on some metrics than they were in 2007, for example. Profit margins are at historic highs, and the tailwinds that got them there are disappearing. Stock buybacks, which have been responsible for much of the growth in earnings per share, appear to have peaked—and, in any event, have become less effective for every dollar spent as prices increase. And unlike in the real economy, market-related debt has increased back to 2007 levels and above.

That said, there is also the possibility that retail investors could start to buy in to the market—which could drive prices even higher. This could be considered a “bubble effect” and would drive valuations even farther above historic norms. Although this could certainly happen in 2014, it would only set the stage for a more severe adjustment later on.

In conclusion, despite the weak first quarter, the recovery continues and should strengthen through the remainder of 2014. And as the Fed winds down its stimulus, we may see moderate increases in interest rates toward the end of the year. I expect the financial markets, on the other hand, to close 2014 at around the same level at which they are right now—and the potential for a decline at some point during the year is very real.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. The S&P 500 is based on the average performance of the 500 industrial stocks monitored by Standard & Poor’s. Emerging market investments involve higher risks than investments from developed countries and also involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation.
© 2014 Commonwealth Financial Network®

Weekly Market Update, May 19, 2014                  

Mark R. Gallagher 

General market news

• Equity markets were mixed last week, with very few trends apparent. The S&P 500 stayed essentially flat while the Nasdaq gained 0.53 percent and the Dow lost 0.45 percent. Once again, the MSCI Emerging Markets Index was a top performer.
• After breaking through the key 2.60-percent level—the lower end of the channel we’ve seen over the last five months—the 10-year Treasury yield has remained below that mark for five days. The next strong support level is 2.50 percent, followed by 2.47 percent, which was tested on Thursday. A move below 2.47 percent would likely cause a flight-to-safety trade, pushing yields considerably lower.
• Meanwhile, the long end of the curve has seen strong performance since the beginning of the year. The yield on the 30-year Treasury has moved from almost 4 percent on January 1 to as low as 3.13 percent last week.
• Economic news continues to be strong, especially in regard to employment and a pickup in inflation—two of the Federal Reserve’s most closely watched data points.

Source: Bloomberg

Source: Bloomberg

What to look forward to

This should be an exceptionally quiet week on the economic front. The only reports of any real importance will be related to housing. Existing Home Sales are expected to have risen 2.2 percent in April, while New Home Sales might have been up as much as 10 percent, after having fallen 14.5 percent the previous month. Obviously, these data points are both somewhat volatile, but hopefully analysts are correct that sales volume may be making a rebound.

Leading Economic Indicators might have increased 0.3 percent in April. This report is unlikely to make a big impact unless it is surprisingly weak.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. 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 & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000^® Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Bank of America Merrill Lynch U.S. Broad Market Index tracks the performance of U.S. dollar-denominated investment-grade debt publicly issued in the U.S. domestic market, including U.S. Treasury, quasi-government, corporate, securitized, and collateralized securities. The Bank of America Merrill Lynch U.S. Treasury Index tracks the performance of U.S. dollar-denominated sovereign debt publicly issued by the U.S. government in its domestic market. The Bank of America Merrill Lynch U.S. Mortgage-Backed Securities Index tracks the performance of U.S. dollar-denominated fixed-rate and hybrid residential mortgage pass-through securities publicly issued by U.S. agencies in the U.S. domestic market. The Bank of America Merrill Lynch U.S. Municipal Securities Index tracks the performance of U.S. dollar-denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market.

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For IARs: (Advisor Name) is a financial advisor located at (DBA Name and Registered Branch Office Address). (He/She) offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network^®, Member FINRA/SIPC, a Registered Investment Adviser. (He/She) can be reached at (Advisor Phone Number) or at (Advisor E-Mail).

For Registered Representatives: (RR Name) is a financial consultant located at (DBA Name and Registered Branch Office Address). (He/She) offers securities as a Registered Representative of Commonwealth Financial Network^®, Member FINRA/SIPC. (He/She) can be reached at (RR Phone Number) or at (RR E-Mail).

Authored by the Investment Research team at Commonwealth Financial Network.

© 2014 Commonwealth Financial Network^®

Market Update for the Month Ending April 30, 2014

Mark R. Gallagher 

Markets bounce around as economy improves

Financial markets were volatile during April, even as most recovered to show little change. The Dow Jones Industrial Average was up 0.87 percent, and the S&P 500 Index gained 0.74 percent, while the Nasdaq dropped 2.01 percent. The small changes in the Dow and S&P 500 masked two intramonth declines of about 2 percent and 3 percent, respectively, driven by growth fears, which hit technology and momentum-oriented equities. This differential drove the Nasdaq, which has a higher population of these stocks, to a worse performance for the month and into negative territory for the year.

Earnings were also a concern. Early reports actually showed a decline in corporate earnings over the previous quarter. Although data from the end of April moved earnings back into growth territory, the numbers were below what had been initially expected. The uncertainty about earnings growth, combined with bad news about the Chinese economy and the Ukraine situation, made investors nervous. These mid-month losses were recovered, but they prevented further gains.

Technical factors also showed weakness during the month. Several technical support levels were violated, although only for a limited time. The averages remain well above the most worrisome levels, but some damage has been done, and this merits watching.

Developed international markets performed more strongly than U.S. markets, with the MSCI EAFE Index up 1.45 percent, although they continued to trail year-to-date. About half of this came from currency appreciation relative to the dollar. The strong month was in part a bounce back from previous underperformance and also reflected less exposure to technology and momentum stocks. The MSCI Emerging Markets Index was up less—0.06 percent—which reflected the uncertainty surrounding China’s economy.

Once again, longer-duration fixed income securities performed best. High-quality, longer-dated bonds and TIPS posted the strongest returns in April, because of investor demand for certainty and yield. The worst-performing area within bond markets was the floating-rate bank loan space, which was essentially flat for the month. Short-duration bonds also experienced lackluster performance. Overall, the Barclays Capital Aggregate Bond Index returned 0.84 percent.

Spring continues for U.S. economy

After the economic weakness of January and February, statistics for March showed the slowdown to be largely due to weather. The employment numbers for March highlighted much stronger job growth, which was confirmed by even better April employment data. Private jobs touched a new high, breaking the level from before the financial crisis, even as unemployment claims averaged at low levels, despite bouncing around. Overall demand for labor was strong, with the average hours per week at historically high levels.

Better employment led to increased consumer confidence and also to higher spending, a primary driver of the economy. Retail sales were up an unusually robust 1.1 percent, which probably partially reflected pent-up demand from the poor weather months but still was well above expectations. Personal consumption, a wider measure of economic activity, rose at a brisk pace.

The news was not all good. Economic growth was reported as 0.1 percent for the first quarter of 2014, but because this largely reflected bad weather in January and February, it was not a significant concern. More worrisome was an apparent slowdown in the housing recovery. Even as prices continued to increase, activity levels slowed, apparently due partially to the weather, but more due to a lack of supply. Although the slowdown is arguably good news, reflecting a more normal market, it remains an issue worth watching (see chart).

Consumption Was Strong, But Other Factors Slowed First-Quarter Growth

Source: BEA

The Federal Reserve continues to taper

As expected, the Federal Reserve (Fed) continued to reduce its bond-buying program by an additional $10 billion, to $45 billion per month. There was speculation that the weak first quarter might have led to a pause, but the Fed concluded that the economic recovery was strong enough to continue the pace of purchase reductions. Despite the continued taper, rates actually fell during April, which should help the housing market continue its growth, and illustrates that, despite the Fed’s reduction in stimulus, an increase in rates is by no means assured.

International uncertainty remains

There were two major worries from around the world for U.S. investors in April. The situation in Ukraine continued to simmer. Although the expectation was for an eventual resolution, investors still worried that tensions seemed to be escalating. There is a growing conflict between the U.S. and our European allies about how to address the situation; Germany in particular is strongly lobbying against increased sanctions.

The second area of concern is China, where signs of a significant slowdown continue to appear. Chinese manufacturing and exports are showing lower-than-expected growth, and there are hints that China’s leaders realize that slower growth may be necessary to unwind some of the country’s financial imbalances. Keep in mind that in this case, slow growth might mean a still healthy 6 percent or so, but this represents a significant change from recent history. Additionally, the potential for policy errors could damage the world economy, as well as China’s.

Spring is here

As we move into the second quarter, it seems clear that spring is here for the U.S. economy after the weather slowdown of the first quarter. Steady improvements in employment and consumer spending are clearly optimistic signs. Even though worries remain, especially about the pace of wage growth, the trends appear not only favorable but improving for the real economy.

Financial markets are less certain. U.S. market results for the month, while not a concern, showed signs of potential weakness. Company earnings, though beating current expectations, are not particularly impressive. Technical damage was also done to the major indices in April, and therefore markets bear watching.

Overall, our stance remains optimistic, but with elements of concern about the financial markets, which remain vulnerable to uncertainty. As always, a diversified portfolio constructed around an investor’s own risk tolerance and time frame should help achieve goals, regardless of what happens in the interim.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.

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For IARs: (Advisor Name) is a financial advisor located at (DBA Name and Registered Branch Office Address). (He/She) offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network^®, Member FINRA/SIPC, a Registered Investment Adviser. (He/She) can be reached at (Advisor Phone Number) or at (Advisor E-Mail).

For Registered Representatives: (RR Name) is a financial consultant located at (DBA Name and Registered Branch Office Address). (He/She) offers securities as a Registered Representative of Commonwealth Financial Network^®, Member FINRA/SIPC. (He/She) can be reached at (RR Phone Number) or at (RR E-Mail).

Authored by Brad McMillan, vice president, chief investment officer, and Sean Fullerton, investment research analyst, at Commonwealth Financial Network.

© 2014 Commonwealth Financial Network^®

General market news

• Still firmly within the range we’ve been discussing, the yield on the 10-year Treasury bounced off 2.80 percent last Monday and up off 2.60 percent late Friday. Last week’s move was the strongest one-week performance in more than two months. Treasuries sold off early Monday morning, with the 10-year standing at 2.67 percent, in anticipation of the Federal Reserve’s meeting this week.
• International headlines were on investors’ minds last week. Uncertainty over the situation in Ukraine and fear of escalating tension grew throughout the week as a referendum vote approached over the weekend. In addition, weaker-than-expected economic reports from China put further pressure on equity prices.
• The Fed is expected to continue its tapering program at its meeting this week. The announcement will come on Wednesday, and markets seem to be in a “wait and see” mode as economic numbers below Fed targets and events in Crimea raise questions.
• Equity markets slid lower last week, with major indices posting losses between 1.75 percent and 2.50 percent. The S&P 500 split the middle with a drop of 1.91 percent. The best performance was a loss of 1.76 percent for the Russell 1000 Value, while the worst performer for the week was the MSCI Emerging Markets Index, which lost 2.40 percent.

What to look forward to

This week will start off with the release of Industrial Production data. The consensus estimate is an increase of 0.2 percent, which would be quite the rebound from last month’s 0.3-percent decline.

In terms of housing data, we will see the release of Housing Starts and Existing Home Sales. Both data points are expected to have positive results compared with the disappointing results in January.

Finally, the Consumer Price Index will be released on Tuesday, providing some insight into inflation, which is expected to remain under control.

Disclosures: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. 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 & Poor’s. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Dow Jones Industrial Average is computed by summing the prices of the stocks of 30 large companies and then dividing that total by an adjusted value, one which has been adjusted over the years to account for the effects of stock splits on the prices of the 30 companies. Dividends are reinvested to reflect the actual performance of the underlying securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. The Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Bank of America Merrill Lynch U.S. Broad Market Index tracks the performance of U.S. dollar-denominated investment-grade debt publicly issued in the U.S. domestic market, including U.S. Treasury, quasi-government, corporate, securitized, and collateralized securities. The Bank of America Merrill Lynch U.S. Treasury Index tracks the performance of U.S. dollar-denominated sovereign debt publicly issued by the U.S. government in its domestic market. The Bank of America Merrill Lynch U.S. Mortgage-Backed Securities Index tracks the performance of U.S. dollar-denominated fixed-rate and hybrid residential mortgage pass-through securities publicly issued by U.S. agencies in the U.S. domestic market. The Bank of America Merrill Lynch U.S. Municipal Securities Index tracks the performance of U.S. dollar-denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions, in the U.S. domestic market.