Monthly Financial Market Update

Transcription

1 Charles Sherry Director, Institutional Education Group Blue Ocean Global Wealth 6400 Goldsboro Road, Suite 550 Bethesda, MD Tel: Monthly Financial Market Update January 31, 2014 Deviating from the Script Last year s advance in the S&P 500 Index came up just shy of 30% (St. Louis Federal Reserve data) and investors were primed for a strong start to 2014, at least that s how the consensus read the tea leaves. Besides, the market experienced a strong start to 2013 (St Louis Fed data). Why wouldn t we get a repeat? Well, the market can be fickle. Sometimes, it just seems to have a mind of its own, doing what it can, at least in the short term, to confound and confuse. In a word or two, stocks tripped out the 2014 gates, snapping a four month winning streak (MarketWatch data). Index January Return % 2014 YTD Return - % DJIA NASDAQ Composite S&P 500 Index Bond Yields Yield* - % a/o Jan 31, 2014 Yield - % a/o Dec 31, month T-bill year Treasury year Treasury year Treasury Commodities Jan 31 price, monthly change Year end 2013 Oil per barrel 4 $ $98.42 Gold per ounce 5 $1, $1, Sources: MarketWatch, U.S. Treasury, CNBC, St. Louis Federal Reserve, Energy Information Administration *Includes quarterly change Let s look at the key themes that greeted investors in January. First of all, there weren t any strong catalysts to fuel the next leg of the bull market.

2 Last year s surge in stocks and relative weakness in bonds had left asset allocations out of alignment. We re in a new tax year and some folks may have locked in profits on stocks in order to get back within their recommended equity percentages. Cash proceeds some may be going into bonds, including Treasuries, which to the surprise of many have performed admirably in January. But the real culprit for the weak start originated overseas, and in particular, emerging markets. Emerging markets, sometimes called developing markets, exclude the U.S., Western Europe, Japan, Canada, and Australia. What it does include is Asia, South and Central America, and Asia-Pacific economies. Many developing nations around the world have plenty of long-term potential, but there is heightened risk when investing in emerging markets. They may play an important role in the international component of a portfolio, they reduce investment risk over the long-term, but these countries are subject to big swings. What happened? In addition to mismanaged (some, not all) economies around the world, there are three major themes that have buffeted emerging markets. The Federal Reserve the world s central banker Ok, there are plenty of central banks around the world, but the Fed is like the 800-pound gorilla in the room or the bull in a china shop. Fed policy can and does ripple around the globe. Last year, we heard a steady drumbeat of talk from Fed officials that policy makers were getting set to cut back on its $85 billion in monthly bond buys. The Fed made good on its threat in December, with a $10 billion reduction and continued with a second $10 billion cutback at the end of January. With the Fed cutting back on money creation, the flow of cash into emerging economies has begun to recede, and in some cases reverse. Look at Figure 1. As talk of a tapering in Fed bond buys weighed on Treasury bond prices (and by extension, lifted Treasury yields), emerging market currencies quickly retreated. Last date: January 23, 2014 Note: The JP Morgan Emerging Markets Currency Index is a broad-based index of currencies of developing countries, which cannot be invested into directly. Past performance does not guarantee future results.

3 Emerging market economies that are running large trade deficits have been particularly vulnerable because they are more dependent on foreign cash inflows. For example, Turkey has a current account deficit (the broadest measure of a country s trade balance) of 7.4% of its Gross Domestic Product (Wall Street Journal), or GDP (the largest measure of goods and services). That s unsustainable. In contrast, the U.S. current account deficit as a percent of GDP stands at a very manageable 2.2% (BEA), down from 2006 s high of 6.2%. Throw in a lingering political scandal and we watched the Turkish lira repeatedly hit record lows against the dollar in January (Wall Street Journal), which forced Turkey s central bank to hike a key one-week lending rate by a whopping 5.5 percentage points to 10.0% (Central Bank of Turkey website). The goal: attract foreign capital and stem the lira s slide. In the meantime, Argentina, which has been struggling, decided in late January not to defend its currency. The peso promptly fell 13.2% in one day (Fitch Ratings). We also saw surprise rate hikes in India (Wall Street Journal), which is dealing with inflation, and South Africa, which has seen its currency come under pressure (Wall Street Journal). Moreover, currency jitters began to nibble at eastern European economies as the month came to a close. China focus Woes in Turkey, Argentina, and South Africa, aren t enough, in my view, to force selling in the U.S., which leads to the second major theme China. China is the world s second largest economy behind the U.S. An investment boom last decade created an enormous surge in growth that supported developing economies around the world. Today, China s growth has slowed to single-digit rates, which has dulled emerging-market exports to the Asian giant. Notably, the latest bout of selling in U.S. markets can be traced to the January 23 release of the China Manufacturing Purchasing Manager s Index by Markit Economics, which saw the preliminary reading fall from 50.5 to 49.6 see Figure 2. Note: a reading above 50 suggests expansion; a reading below 50 suggests contraction Last date: January 2014

4 The unexpected drop below 50 sparked new worries about China; yet, as the Figure 2 reflects, the current level remains in the middle of the range it s been in over the last three years. Potentially more concerning China s unofficial Beige Book, which is a quarterly review of business conditions, contained a comment that the credit transmission is broken (Wall Street Journal). That s jargon for liquidity issues in the banking system beyond what we normally might see heading into the Chinese New Year. It s something that bears watching. Falling commodity prices China s slowdown leads us directly to the third theme that s pressuring emerging markets falling commodity prices. The boom in China led to a spike in raw material prices in the last decade, which directly benefited developing economies that are dependent on commodity prices. Take a look at Figure 3. The latest cyclical peak in commodity prices, as measured by the Thomson Reuters/Core Commodity CRB Index, occurred in April 2011, which coincides with the peak in the MSCI Emerging Markets Index (see disclosure below Figure 3). Emerging Market Stocks and Commodity Prices MSCI Emerging Markets Index 1,400 1,300 1,200 1,100 1, Figure 3 CRB Index MSCI Emerging Markets Index (LHS) Thomson Reuters/Core Commodity CRB Index (RHS) /1/2007 9/1/2008 3/1/2010 9/1/2011 3/1/2013 Data Source: FreeStockCharts, StockCharts Last Date: January 31, 2014 Note: The MSCI Emerging Market Index covers securities across 21 markets. It cannot be invested into directly. Past performance does not guarantee future results. The Thomson Reuters/Core Commodity CRB Index is a broad-based measure of commodity prices, which cannot be invested into directly. Past performance does not guarantee future results. Moreover, commodity prices and the performance of emerging market stocks have been closely correlated over the last seven years, as reflected in Figure 3.

5 Bottom line So let s try to put all of this in perspective. We can t lay all of the blame on the Fed, China, and falling commodity prices. Mismanagement of various emerging market economies has to share some of the blame. Ironically, emerging markets complained when the Fed first opened up the monetary floodgates, especially Brazil (Bloomberg). Sure, if the Fed wasn t tapering bond buys, China was still growing at a fast clip, and commodity prices were at new highs, we would be having a different discussion today. Nonetheless, our three main themes have exposed weakness, reminding me of Warren Buffet s famous comment when the tide goes out, you discover who s been swimming without clothes. Besides, following sharp U.S. gains last year, it s the perfect excuse for some traders to move to the sidelines. Peering into the crystal ball are we set to repeat the currency crisis of ? 1-We don t have the currency pegs that suddenly snap as we saw in the late 1990s; free-floating currencies adjust over longer periods and act as a cushion. 2-Troubled economies have foreign reserves ($7.7 trillion) they can bank on, and debt levels are far smaller, relative to reserves (The Economist). But reserves are spread out unevenly. Brazil holds over $300 billion (IMF), while Argentina has $28 billion (Wall Street Journal). 3-Falling currencies may increase inflation in their respective countries, but they also create a more competitive environment for exports, which could set the stage for an eventual recovery. 4-U.S. fundamentals are still solid, with the economy expanding at a moderate 3.2% annualized pace in the fourth quarter (BEA data). 5-Commodity prices remain in a downward trend but are not in a free-fall. The same holds true for the global benchmark for oil, Brent crude. In both cases, sharply lower prices would be signaling deteriorating demand around the world. That s not happening right now. 6-The International Monetary Fund believes Latin America as a whole is better prepared to deal with global market turbulence than it used to be (Reuters). 7-The Fed is withdrawing monetary accommodation, but the pace is extremely gradual. International jitters have cropped up before and there is always the outside chance of a major disruption in overseas markets. Risk cannot be completely eliminated but it can be managed. It s why your portfolio is crafted in a manner that takes into account your various objectives, including your tolerance for risk. Every situation has its own unique attributes. From a historical perspective, anxieties that originate from abroad have not had a long-lasting impact at home.

6 1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results. 2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly. Past performance does not guarantee future results. 3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results. 5 New York Mercantile Exchange front-month contract; Prices can and do vary; past performance does not guarantee future results. 6 London Bullion Market Association; gold fixing pricing at 3 p.m. London time; 2012/2013 year-end price fixing at 10:30 a.m. London time; Prices can and do vary; past performance does not guarantee future results.

7 It is important that you do not use this publication to request or authorize the purchase or sale of any security or commodity, or to request any other transactions. Any such request, orders or instructions will not be accepted and will not be processed. All items discussed in this report are for informational purposes only, are not advice of any kind, and are not intended as a solicitation to buy, hold, or sell any securities. Nothing contained herein constitutes tax, legal, insurance, or investment advice. DISCLOSURE: Investing involves risk including the potential loss of principal. No strategy can assure success or protects against loss. Past performance is no guarantee of future results. Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Please note that rebalancing investments may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events will be created that may increase your tax liability. Rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. Non-U.S. securities markets involve possibly greater risk of political instability and greater currency risk in addition to having been more volatile. These risks can be accentuated in emerging markets. Commodities investments are speculative and involve special risks related to weather and international political and economic developments. Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity. Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the portfolio. Tactical allocation may involve more frequent buying and selling of assets and will tend to general higher transaction cost. Investors should consider the tax consequences of moving positions more frequently. Beta measures a portfolio s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggests the portfolio has historically been less volatile than its benchmark. Past performance is not a guarantee of future performance. Different investments involve different degrees of risk, and there can be no assurance that the future performance of any investment, security, commodity or investment strategy that is referenced will be profitable or be suitable for your portfolio. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Before making any investments or making any type of investment decision, please consult with your financial advisor and determine how a security may fit into your investment portfolio, how a decision may affect your financial position and how it may impact your financial goals. All opinions are subject to change without notice in response to changing market and/or economic conditions Copyright 2014 Financial Jumble, LLC Blue Ocean Global Wealth All rights reserved.