General market news • The S&P 500 Index gained 1.40 percent last week as investors continued to put money to work in the equity markets. This marks the third straight week of gains greater than 1 percent for the S&P 500. Meanwhile, the VIX closed out the week at 10.73, indicating that investor fear is at a multiyear low. • Last week’s economic reports were modestly positive, showing that the U.S. economy continues to recover after weather-related weakness in the first quarter. • Treasury rates rose again last week after bouncing off of a 52-week low in late May. The benchmark 10-year Treasury ended the week with a yield of 2.60 percent. • At its meeting next week, the Federal Open Market Committee is expected to taper its asset purchasing program by another $10 billion, reducing monthly bond purchases to $35 billion.

Equity Index Week-to-Date % Month-to-Date % Year-to-Date % 12-Month % S&P 500 1.40% 1.40% 6.44% 22.67% Nasdaq Composite 1.89% 1.89% 4.05% 27.90% DJIA 1.28% 1.28% 3.22% 15.24% MSCI EAFE 0.92% 0.92% 5.17% 22.23% MSCI Emerging Markets  1.76% 1.76% 5.17% 8.91% Russell 2000 2.74% 2.74% 0.66% 20.54% Source: Bloomberg

Fixed Income Index Month-to-Date % Year-to-Date % 12-Month % U.S. Broad Market −0.54% 3.50% 2.06% U.S. Treasury −0.66% 2.69% 0.14% U.S. Mortgages −0.39% 3.36% 3.11% Municipal Bond −0.38% 6.19% 3.02% Source: Bloomberg

What to look forward to A number of retail-focused data points will be released this week. On Wednesday, data for Retail Sales and Retail Sales ex Auto and Gas is expected to show moderate growth over the previous period. Consumer spending indicators are an important factor, given their significant impact on gross domestic product.

On Friday, we expect the Producer Price Index (PPI) to show a smaller increase on a month-over-month basis, while year-over-year growth is expected to accelerate. In addition, the University of Michigan Consumer Sentiment indicator is expected to rise from 81.9 to 83.0.

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 Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities with maturities of at least one year. The U.S. Treasury Index is based on the auctions of U.S. Treasury bills, or on the U.S. Treasury’s daily yield curve. The Barclays Capital Mortgage-Backed Securities (MBS) Index is an unmanaged market value-weighted index of 15- and 30-year fixed-rate securities backed by mortgage pools of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC), and balloon mortgages with fixed-rate coupons. The Barclays Capital Municipal Bond Index includes investment-grade, tax-exempt, and fixed-rate bonds with long-term maturities (greater than 2 years) selected from issues larger than $50 million. The Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index measures the performance of intermediate (1- to 10-year) U.S. TIPS.

Authored by the Investment Research team at Commonwealth Financial Network.

© 2014 Commonwealth Financial Network®

A strong close to a quiet month U.S. financial markets had a relatively quiet month, except for the Nasdaq, which was down close to 2 percent mid-month. Still, all U.S. equity markets finished May strongly, with the Dow Jones Industrial Average up 1.19 percent, the S&P 500 Index up 2.35 percent, and the Nasdaq up 3.11 percent, despite its mid-month drop.

The weak start to May was driven largely by earnings growth, which was down significantly from fourth-quarter 2013. In addition, guidance from companies for the second quarter was much more negative than usual. On top of these factors, the economy suffered from severe weather. The strong close for the month owed a lot to much stronger economic reports, available toward the end of the period.

The MSCI EAFE Index, reflecting developed international markets, was up 1.62 percent in May, and the MSCI Emerging Markets Index gained 3.26 percent for the month. Fixed income markets showed surprising strength at month’s end. Yields on 10-year U.S. Treasury bonds, dropped from 2.63 percent at the start of May to 2.48 percent at the end, with the Barclays Capital Aggregate Bond Index gaining 1.14 percent for the month.

Winter’s last gasp as U.S. economy thaws Although the economy suffered from severe weather in the first quarter, shrinking 1 percent, more recent numbers have been substantially better. April showed a gain of 288,000 jobs, much higher than expected. Initial unemployment claims dropped to a seven-year low in April—another good sign—and average hours worked recovered to normal levels. Housing prices continued to increase at double-digit rates. Consumer confidence also improved, leading to gains in consumer spending and increases in lending. Because of these factors, most economists expect second-quarter growth to be quite strong—and to accelerate for the rest of 2014.

The Federal Reserve and interest rates The Federal Reserve (Fed) reportedly remains confident about a strengthening recovery. A surprising drop in interest rates at the end of May could call that view into question, but analysis of the supply-and-demand balance for Treasury securities suggests that the drop is market-driven. The reduction in the federal deficit means that, even with the taper, the Fed is buying a large proportion of the total debt issuance—and that sustained Fed purchasing, combined with growing demand from other buyers, is pushing rates down.

International risk remains Recent elections for the European parliament resulted in a much higher number of parliamentarians representing anti-European Union parties, indicating that Europeans are running out of patience with austerity policies. Expect to see more uncertainty around Europe through year-end.

China has become much more aggressive with respect to other countries. This is leading Japan, for example, to consider a more aggressive defensive stance, raising the geopolitical risk level.

Finally, even as Russia has seemed to pull back on Ukraine, it signed a multibillion dollar natural gas supply deal with China. This should benefit both sides but was designed to strengthen both countries in dealings with the West.

Back to the old normal With the U.S. economy continuing to mend, and because the bulk of the risk is in international issues, it seems as if we’re moving back to the old normal. Could the markets become complacent?

It would be a mistake to take the current improvement in the real economy and appreciating financial markets as a sign that risk has disappeared. Though we expect the recovery to continue, markets remain richly valued and subject to correction. Further, Europe and China retain the ability to generate negative surprises. And, although the U.S. recovery seems strong, it could weaken.

We certainly acknowledge the positive changes, but we aren’t complacent and remain on the lookout for risk. With that said, we believe that a properly diversified portfolio should allow investors to achieve their goals over time.

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.

Authored by Brad McMillan, vice president, chief investment officer, at Commonwealth Financial Network.

© 2014 Commonwealth Financial Network®

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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Authored by the Investment Research team at Commonwealth Financial Network.

© 2014 Commonwealth Financial Network^®