Market Point. In This Issue - Economic And Market Update - Equity Market Update - Fixed Income Market Update
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1 Issue # 5 In This Issue - Economic And Market Update - Equity Market Update - Fixed Income Market Update Market Point An Economic & Market commentary from Trust Point w ww.trus tpoin tin c.com F ir s t Q ua rt e r
2 An Economic and Market Update from Trust Point An unusually harsh winter across the country resulted in US economic activity slowing down in the 1st Quarter which also caused global measures of economic activity to slightly disappoint. Global growth remains healthy, but political uncertainties have started to cloud the economic picture. Offsetting these headwinds, global central banks remain determined to defend growth as global unemployment remains stubbornly high and global inflation surprisingly low. Source : Bloomberg As of Actual 3 Mths Ago 1 Year Ago Dollar Index Level March US Economic Activity ISM Manufacturing (>50=Expansion) March ISM Non-Manufacturing (>50=Expansion) March Non-Farm Payrolls March 192k 84k 141k Unemployment Rate March 6.7% 7.0% 7.7% CPI Ex-Food & Energy (yoy) February 1.6% 1.7% 2.0% Global Economic Activity JP Morgan Global Manufacturing Index (>50=Expansion) March JP Morgan Global Non-Manufacturing Index (>50=Expansion) March Polar Vortex Chills US Economy It has been cold and snowy this winter, one of the coldest and snowiest winters in history. As a result, flights were cancelled, stores were forced to temporarily close and restaurants and car dealerships wondered where all their customers went. Across the US, a range of industries was affected. The winter was so bad that the latest Beige Book (a summary of economic activity and conditions across the US published by the Federal Reserve) mentioned the word weather 119 times and snow 24 times. Since nearly 70% of the US economy is driven by consumer spending (chart 1), the negative effect was harmful but likely temporary. In fact, recent reports on consumer confidence, employment and consumer finances suggest that as soon as the sun comes back out, consumer spending should rebound as many purchases have likely been postponed. While the US economy may be off to a slower start than expected because of bad weather, the diminishing impact of higher federal tax rates and government spending cuts implemented in early 2013 should prove sufficient to propel the US economy to a 3% growth rate in 2014 (vs 1.9% last year). Chart 1 : Personal Consumption Expenditures as a Percent of Real GDP (Bil. of $/Bil. of $) 0.70 PCE / GDP Q Q Q Q Q4 Source : Federal Reserve Bank of St. Louis
3 The West vs Russia After invading Crimea (an autonomous region handed over to Ukraine by Russia in 1954 and comprised of 60% ethnic Russians), Russia has now formally annexed it from Ukraine following a referendum considered illegal by Kiev and the West. The US and EU responded with sanctions that have already started to hurt the Russian economy but that have left Russian politicians relatively unfazed. Although a full-scale military conflict should be avoided, an escalation of sanctions and retaliations could affect the world economy through two main channels, Energy and Finance. Russia supplies over 30% of the EU s energy needs with a large portion of it flowing through Ukraine (chart 2). A severe disruption of energy supplies to Europe could lead to a spike in energy prices, hurting businesses and households globally. Alternatively, a deep recession in Russia would lead to a decline in asset values and business activities in the country, with European banks the most at risk. Our clients portfolios have very little exposure to the regions affected, but we continue to monitor the situation closely for any potential spillover effects. Chart 2 : Energy Transportation Infrastructure (from Russia to Europe) Gas travels into Ukraine from Russia and Belarus and leaves for Europe Gas fields SLOVAKIA HUNGARY POLAND ROMANIA BELARUS Kiev MOLDOVA Source : East European Gas Analysis, National Gas Union of Ukraine, BBC News UKRAINE RUSSIA Crimea Cautiously Optimistic on Equities Over the past three months, bond markets and equity markets were slightly up. Neither weaker than expected economic numbers nor political uncertainty had much of an impact on markets. Investors essentially concluded that both are temporary and unlikely to affect the global economic landscape. Our view is not materially different, so we maintained our positive view on equities and credit-sensitive fixed income sub asset classes throughout the quarter. Our indicators (we monitor over 150 of them monthly) continue to suggest that economic activity and earnings are improving, inflation is and should stay low (chart 3) and monetary policies and liquidity remain positive. On the flip side, equity valuations are more expensive, and complacency is slowly setting in. Our weight of evidence approach focuses on the hard data and should continue to provide us with insightful signals when a change in strategy may be warranted. Aligning your goals with vision for the future Chart 3 : Developed Markets Inflation % Change YOY 22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 est.'14 Source : International Monetary Fund, US Bureau of Labor Statistics, Eaton Vance Developed Markets Avg. Japan United States Eurozone United Kingdom
4 An Equity Market Update from Trust Point Major US Equity Index Level Quarter-End 3 Mths Ago 1 Year Ago 3 Years Ago 5 Years Ago Markets can definitely be unpredictable at times, as evidenced in the 1st Quarter. After the US market rallied over 30% last year, many were anticipating a significant correction. In the 1st Quarter, however, markets shook off worries related to fading global economic activity and Russia s aggressiveness in seizing control of Crimea. After a short-lived selloff in January, markets rebounded to end the quarter up nearly 2% for the S&P 500. S&P 500 1,872 1,848 1,569 1, Dow Jones Industrial Average 16,458 16,577 14,579 12,320 7,609 Nasdaq 4,199 4,177 3,268 2,781 1,529 Equity Returns (%) 3 Month YTD 1 Year 3 Year (Ann) 5 Year (Ann) US Large Cap Growth 1.1% 1.1% 23.2% 14.6% 21.7% US Large Cap Value 3.0% 3.0% 21.6% 14.8% 21.8% US Mid Cap Growth 2.0% 2.0% 24.2% 13.5% 24.7% US Mid Cap Value 5.2% 5.2% 23.0% 15.2% 26.4% US Small Cap Growth 0.5% 0.5% 27.2% 13.6% 25.2% US Small Cap Value 1.8% 1.8% 22.6% 12.7% 23.3% International Developed (US Dollar) 0.7% 0.7% 17.6% 7.2% 16.0% Emerging Market (US Dollar) -0.4% -0.4% -1.4% -2.9% 14.5% Source : Bloomberg, Morningstar Markets Focus on the Improving Economy Equity markets have become somewhat desensitized to geopolitical risks in recent quarters. Back in 2011, the market sold off nearly 20% due to geopolitical worries in Greece. Then in 2012, markets sold off nearly 10% when Spain was added to the mix of counties under political unrest. Now in 2014, after a year when markets essentially went straight up, Russia is flexing its guns and has seized control of Ukraine s Crimea, and the market reacted by selling off a mere 4% in January, quickly rebounding to a new all time high in February as if nothing even happened. Over the past 18 months, the S&P 500 has traded in a narrow window with peak to trough selloffs of only 5%-6% (Chart 4). For the first time since the financial crisis of , the US stock market is focusing on the improving US economy and ignoring the geopolitical unrest that is happening on the other side of the globe. Chart 4 : U.S. Markets Trading in Narrow Band Austerity measures placed on Greece and the eventual bailout by the ECB lead to protests that last over 5 weeks. Concerns heighten that Italy and Spain will follow suit. Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Source : Bloomberg Spain struggles to fix their failing banks while riots and protests break out on the streets. Concerns arise that the European Debt Crisis is spreading into the region s largest economies. S&P 500 Index - Last Price
5 Weather Affects Corporate Earnings Not only did the adverse weather contribute to the brief market selloff in January, its real economic effect is displayed in the estimates for 1st Quarter corporate earnings (chart 5). At the end of last year, estimates for 1st Quarter year over year growth of the S&P companies were at 4.4%. As of March 28th, the average analyst estimate was for a slight contraction in earnings with a growth rate of -0.4%. Interestingly, the utility sector of the market is the only sector to have its estimate increased during the quarter and was the best performing sector during the quarter. This isn t a surprise considering all of the excess electricity and gas that was used to heat homes over the past few months. All is not lost though; analysts are expecting a bounce back in the 2nd Quarter from pent up demand, and full year 2014 earnings growth still remains near double digit territory. Chart 5 : Q Earnings Growth Estimates 27.5 % 25.0 % 22.5% 20.0% 17.5% 15.0% 12.5% 10.0% 7.5% 5.0% 2.5% 0.0% -2.5% -5.0% -7.5% -10.0% Today 31-Dec Telecom Utilities Consumer Consumer Health S&P 500 Info. Financials Materials Industrials Energy Services Disc. Staples Care Technology 23.8% 7.3% 4.4% 1.1% 0.4% -0.4% -1.1% -1.5% -1.6% -2.5% -7.5% 25.4% 6.4% 12.8% 6.8% 2.4% 4.4% 4.0% 3.8% 8.8% 2.2% -4.2% Source : FactSet Research As of 3/28/2014 The Bull Market Turns 5 Chart 6 : US Equity Bull Market Turns 5 Normal cyclical stock market cycles last about 4 years. In those four years, there is generally a 1-3 year bull market followed by a 1-3 year bear market. In March, the stock market reached the 5th year of its current bull market. Since the March 9, 2009 market bottom, the stock market has been moving up without a prolonged downtrend, and over the past 12 months, it has consistently set new all time highs. Is the equity bull market over-extended? Since 1949, there have been five bull markets that have lasted longer than the current one, and three of those five have produced higher returns than this current market to date (Chart 6). So what can push markets higher from here? The slow growth economy over the past 5 years is set to reaccelerate to above 3% GDP growth in the U.S. this year. As the economy improves, long-term prospects for corporate earnings growth should also improve. The financial condition of US corporations remains strong with high levels of cash and low levels of debt, positioning corporations for growth that can be sustained. Aligning your goals with vision for the future Nominal Return From Trough (Indexed at 100) 700 Bull Market Period Beginning: 600 6/13/49 10/3/ /12/82 10/11/ /9/02 Current (3/9/09) ,000 1,200 1,400 1,600 1,800 2,000 2,200 2,400 Number of Work Days Data as of December 31, Source : Goldman Sachs, Investment Strategy Group, Bloomberg
6 A Fixed Income Market Update from Trust Point Fixed income markets started the year much better than anticipated with the 10-Year Treasury Yield dropping from over 3% at the beginning of January to 2.71% on March 31st. This quarter has been a welcomed reprieve from a difficult 2013, but volatility in the fixed income market is expected to continue as stronger economic data and a heightened awareness of diminishing support from the Federal Reserve take center stage in the coming quarters. US Yields (%) Quarter-End 3 Mths Ago 1 Year Ago 3 Years Ago 5 Years Ago 3 Month T-Bill 0.0% 0.1% 0.1% 0.1% 0.2% 2 Yr US Treasury 0.4% 0.4% 0.2% 0.8% 0.8% 10 Yr US Treasury 2.7% 3.0% 1.9% 3.5% 2.7% Fixed Income Returns (%) 3 Month YTD 1 Year 3 Year (Ann) 5 Year (Ann) US TIPS 1.9% 1.9% -6.5% 3.5% 4.9% US Treasury 1.1% 1.1% -2.5% 3.8% 3.3% US Mortgage 1.6% 1.6% 0.2% 2.8% 3.6% US Municipal 1.1% 1.1% 1.1% 3.6% 4.0% US Corporate 1.7% 1.7% 1.2% 5.0% 8.5% US Floating Rate 1.2% 1.2% 4.3% 5.0% 12.5% US Convertible 4.3% 4.3% 22.6% 11.1% 18.1% US High Yield 3.0% 3.0% 7.5% 9.0% 18.2% Corporations Healthy Despite Slow Economic Growth During the 1st Quarter, the Federal Reserve continued to decrease the amount of bonds that it was purchasing on the open market. What was once an $85 billion per month purchase program is now a $55 billion per month program, and we expect this downward trend to continue throughout the year. It is important to note, however, that the Fed s balance sheet is still expanding. Highly accommodative monetary policy has increased liquidity and has helped to promote robust corporate health (chart 7). We are continuing to see credit quality improve, with ratings upgrades and default rates well below historical averages. Although yields rose in 2013, they are still at historic lows, and investors search for yields remains unabated. With the Fed continuing to support corporate health, investors have shown that they are more than willing to take on more risk in the corporate market to achieve the reward of higher yields. We are monitoring for signs of excess risk taking in certain segments of the bond market and remain prepared to make portfolio adjustments if necessary. Global Bond (Unhedged) 2.4% 2.4% 1.7% 2.9% 5.2% Global Bond (Hedged) 2.2% 2.2% 1.1% 4.2% 3.4% Emerging Market Debt (US Dollar) 3.5% 3.5% -1.1% 7.2% 11.5% Source : Bloomberg, Morningstar Chart 7 : Corporate Credit Quality Improving Moody s U.S. Corporate Credit Ratings (by Quarter) Total Changes Source : Neuberger Berman Downgrades Upgrades Up / Down Ratio Up/Down Ratio
7 How Far and How Fast Many fixed income investors have legitimate concerns of how far and how fast interest rates are going to rise in the coming years. There are many variables which will come into play with inflation, economic growth and Fed policy being a few key catalysts. Throw in unknown factors like the Russia-Ukraine conflict, and the task of predicting how far and how fast becomes a difficult prediction to make. As we saw last summer, the market has a tendency to overreact or undershoot market expectations. The market is currently pricing in an increase of 50 basis points in the 10- year range, with steeper increases on the shorter end of the yield curve (chart 8). There are many variables, some of which will come to light in the coming months, which may disrupt these market expectations. We do feel that yields will eventually rise but are not willing to make bets on how far or how fast. We believe it is more prudent to take a diversified approach and optimize our fixed income portfolios to protect against a rising rate environment that could span over a few years. The best performing asset classes of 2013 will likely continue to outperform again in Chart 8 : Market Expectations of Rate Increases 1.00 Treasury 1-Year Forward Rates less Current Yields (%) year 2-year 3-year 5-year 10-year 30-year Source : Bloomberg Finance, Fidelity Investments Time to Think Globally The worst of the Euro crisis is clearly behind us. Yields across the region have been on a downward trend since the peak of the banking crisis in 2012 due to a more proactive European central bank and better growth expectations (chart 9). Europe has made significant progress and is on its way out of recession with the support of the European Central Bank which has bought the debt of troubled nations, cut borrowing rates to record lows and provided liquidity to the banking system. The benefits of international investing through equities are already well known, but many investors fail to realize the benefits of global bonds in a diversified portfolio. We have been positioned with an allocation to global bonds outside of the US to take advantage of this recovery in the Eurozone, and the allocation provided positive returns through a difficult 2013 for US bonds. The Fed is likely going to be the first major Central Bank to begin tightening. In this US rising interest rate environment, investors should be thinking globally, and global bonds should be a key component of a diversified fixed income portfolio. Aligning your goals with vision for the future Chart 9 : Eurozone Bond Yields European Sovereign Funding Costs 10-year benchmark bond yield 35% EURO LAUNCH 30% 25% 20% 15% 10% 5% 0% Source : Tullett Prebon, FactSet, J.P. Morgan Asset Management 12/31/13 Greece 8.26% Portugal 6.00% Spain 4.18% Italy 4.11% Ireland 3.44% Germany 1.94% LTRO OMT
8 Copyright Trust Point Inc., La Crosse, WI, All Rights Reserved. Market Point Market Point is a quarterly market commentary designed to provide you with an overview of economic conditions, as well as equity and fixed income market summaries for the quarter. This commentary is offered by the Investment management team. The individuals contributing to Market Point are Randy Van Rooyen, CFA, Yan Arsenault, CFA, CAIA SM, Brandon Hellenbrand, Steve Brudos, and Joseph Zeck, CFA. Please feel free to contact any team member with questions. 230 Front Street North I PO Box 489 I La Crosse, WI PH I FX I Pictured: Left to right; Randy Van Rooyen, Yan Arsenault, Brandon Hellenbrand, Steve Brudos, Joseph Zeck. The opinions expressed here reflect our judgment at this date and are subject to change. Trust Point uses its best efforts to compile its data from reliable sources, however, it does not warrant the accuracy, completeness or timeliness of any of the information provided. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Investors should seek advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk, Market conditions and trends will fluctuate. Past performance is no guarantee of future returns. 230 Front Street North I PO Box 489 La Crosse, WI Standard U.S. Postage PAID Mailed from Zip Code Permit No. 125
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