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Weekly Review - April 7, 2014

Guest Post - Monday, April 07, 2014

Summary

  • Domestic markets continued higher, with additional Fed promises of more accommodative policy, but were outshined by many foreign names. Several more speculative areas that performed well last year, such as biotech and social media, have experienced negative results as of late.
  • The Friday jobs report was decent—neither exciting nor disappointing, so market reaction was tempered. Other economic data was similarly mixed, as poor winter results are being sloughed off.

Economic Notes

(-) The ISM Manufacturing Index for March rose a bit less than expected, from last month's 53.2 to 53.7 (expectations called for 54.0). Regardless, the over-50 reading implies expansion, and, considering the challenging winter (weather and otherwise), that is not a bad outcome. In the underlying stats, production rose almost 8 pts., new orders rose just a partial point, while employment measures fell a point. Supplier deliveries recovered from a few poor weather months, and anecdotal commentary pointed to additional recovery as spring begins.
(0) The ISM Non-Manufacturing Index came in just a few tenths of a point shy of expectations, rising from February's 51.6 to 53.1 for March. The employment portion of this index rose by 6 pts., the largest change for the month, while new orders rose a few points but overall business activity fell by a point. The anecdotal portion of the survey mentioned weather impact, but was optimistic overall.
(-) The Chicago PMI for March came in weaker than expected, falling from 59.8 last month to 55.9 (a flat reading of 59.8 was expected). New orders and employment fell several points, while production increased. Again, it's worth reminding about making too much from a single month measure, as readings near 60 are difficult to sustain and anything over 50 represents growth—a good thing, considering the difficult winter.
(0) The final Markit PMI report for March came in at an unchanged 55.5, just under the forecasted 56.0. New orders, output and employment all fell slightly, but as all measures remain above 50, they're considered in growth territory—a good place to be.
(+) Construction spending for February gained +0.1%, which surprised versus consensus calling expectations calling for a flat reading. However, January's spending figure was revised down three-tenths into negative territory at -0.2%, but December's was revised up five-tenths. Residential spending fell -0.7% while non-residential construction spending rose +0.6%—but the bulk of this being from power and communications structures (wireless towers, etc.).
(+) Factory orders for February rose +1.6%, which surpassed expectations of a +1.2% increase; however, January's order numbers were revised down by three-tenths. Total manufacturing inventories rose +0.7% on the month, which was mostly in the durable vs. non-durable inventory category.
(-) The February trade balance widened about -$4 bil. more than expected to -$42.3 bil., due to a -1.1% drop in exports (mostly industrial supplies) while imports rose +0.4% (both in petroleum and non-petroleum goods). This might adversely affect GDP by a few tenths, based on some estimates.
(+) Total vehicle sales for March rose quite a bit more than expected, to 16.3 mil. annualized units, up 1 mil. from last month and outperforming consensus by 0.5 mil. The domestic component of this was the bulk of the gain, at 12.8 mil. annualized units. Several U.S. automaker stocks, such as Ford and GM, rose dramatically on the news.
(0) The ADP employment report for March was almost in line with expectations, rising +191k compared to consensus estimates of +195k in addition to an upward revision of February's figures by 39k to 178k (similar to the government's private job number). Last month, professional/business services jobs grew by 33k, leading the group, and construction jobs rose by 20k.
(0) The big government employment report appeared decent for March. Nonfarm payrolls rose +192k, which just missed the target of an expected +200k. On the more positive side, the February number was revised up from an initial +175k to +197k, and January's from +129k to +144k, so those months were much better than first thought. For March, the big highlight was a gain of over +20k retail jobs, which bucked the trend of several months of losses, and construction added just under +20k as weather improved nationwide. The unemployment rate was unchanged at 6.7%, although forecasters expected a drop to 6.6%. Labor force participation rose two-tenths to 63.2%, continuing an uptrend in that metric. In other stats, average hourly earnings were flat, despite expectations for a gain of two-tenths of a percent, and average weekly hours matched a post-recession high of 34.5.

While neither a blockbuster or bust, this report largely met investor and economist expectations of steady, slow improvement. The unemployment number didn't move, but participation grew somewhat. Over the past year, the broader measures and more subtle measures have generally all improved, but remain over where they typically might be at this point in the recovery cycle and over 'ideal' based on the Fed's variety of measures.

Question of the Week

That 60 Minutes segment last week about high-frequency trading was scary. Is it really that bad?

Our server rooms aren't large enough and attention spans not short enough around here for us to engage in anything close to high-frequency trading, so we don't claim to be as deeply entrenched into the operations of it as other folks. But no doubt, dramatic 60 Minutes stories about financial issues have a tendency to generate client questions, even if the topics covered are reported some time after the peak of the problem and don't offer easy solutions (financial market participant subtleties are more multi-faceted than can be captured in fifteen minutes). No doubt Michael Lewis (whose new book the segment was centered around) is a knowledgeable and compelling author, and we've enjoyed several of his financially- (and sports-) oriented writings in the past.

There are two schools of thought on the high-frequency trading issue: (1) that the practice represents an outright manipulation of the financial system or, on the other hand, (2) serves to promote increasingly efficient markets by providing additional volume, liquidity and 'price discovery' ('price discovery' is the important non-transactional quality that markets also provide...what an asset's market value is, even if you're not currently trying to sell it). Naturally, the reality might lie somewhere in the middle of these two extremes. There are no current laws against stationing oneself a few miles/city blocks/feet closer to an exchange than someone else, or equipping oneself with high-speed equipment to relay trades as fast as possible.

On the regulatory side, there has been a long-standing prohibitionagainst 'front-running' based on non-public information, against doing so when it adversely affects one's own clients, and/or if the activity moves into the realm of market manipulation/fraud—such as placing orders that unfairly squeeze others into inopportune positions. However, trading that may look like front-running hasn't been frowned upon historically when based on 'public' information or when it affects other people's clients. The line between 'public' and 'private' has become increasingly gray, as it has in other industries. Just this morning, the U.S. Attorney General's Office told a congressional panel that HFT is under investigation by the Justice Department, as is the SEC and Commodity Future Trading Commission, so we may find out sooner than later.

Below are links to a few reviews we found interesting and add additional color to the TV segment. Perhaps clients may find these useful as well.

A higher-level view of this issue brings up the question of what it means to 'invest.' The classic view of putting investment funds to work in the equity capital markets involves buying fractional ownership pieces of quality businesses that benefit from the long-term earning of profits and being an eventual (hopefully) recipient of beneficial cash flows such as dividends, share buybacks, etc. Another method is the value-based philosophy of buying ownership stakes in assets trading at prices less than their calculated 'fair value'—on the idea that the difference between the two will eventually converge over time (often thought of as happening from several months to several years in the future).

However, today's extremely short holding periods don't allow normal business cycle dynamics to play themselves out. What economic value does such market behavior bring to the investing public? No doubt a focus on the shorter term. The evolution from person-to-person open-outcry exchanges to electronic ones has improved efficiency and made investing much more accessible to the retail public (in no small part by lowering trading costs dramatically—imagine a full-service broker charging $500 for a 100-share stock trade decades ago before leaving for the golf course versus a current ticket charge of <$5 with no human interaction). At the same time, 'assets' like the S&P 500 have become tradable chunks of exposure that many obsess over the standard deviation and Sharpe Ratio of, as opposed to seeing them as baskets of real companies. The proliferation of efficiency may well continue, if it's measured by fast speed and low cost, but there must be a natural limit at some point as to how much of this we really need.

Market Notes

Period ending 4/4/2014

1 Week (%)

YTD (%)

DJIA

0.58

-0.39

S&P 500

0.44

1.44

Russell 2000

.15

-0.56

MSCI-EAFE

1.52

1.57

MSCI-EM

1.74

-0.06

BarCap U.S. Aggregate

0.10

1.97


U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2013

0.07

0.38

1.75

3.04

3.96

3/28/2014

0.04

0.45

1.74

2.73

3.55

4/4/2014

0.03

0.43

1.71

2.74

3.59

Markets were generally higher on the week, led by additional Janet Yellen comments committing to a continued easy policy. In the S&P, industrial, energy and materials stocks led, while technology lagged with negative returns on the week. We've certainly seen additional weakness from some of the market's highest beta sectors, such as biotech and social media, which performed so well in 2013 and now seem to be coming back to earth a bit. This is also seen in recent strength in large-cap versus small-cap.

Outside the U.S., European markets were calmed by Mario Draghi's promise to keep accommodation intact, gaining the most by region, with the U.K. and Japan just positive. With growth remaining quite slow in the Eurozone, it wouldn't be surprising to see pressure for additional accommodation this year due to fears of too much disinflation on the opposite end. Japanese industrial production numbers were down sizably in February, and this week the 8% sales tax rolls out. Emerging markets were the clear winners on the week, with recovery performances from Turkey, Russia and Brazil. China was flat to a bit negative, with decent banking sector earnings.

Bond markets were mixed with yield curve steepening being the story—lower yields in the intermediate area and slightly higher yields on the long end. In the U.S., high yield bonds and intermediate-term credit led, while long bonds lagged despite the small yield change. Internationally, emerging market bonds performed best of all, upwards of +1%

All real estate segments were positive on the week, led by Asian markets with a multiple-percent gain, followed by U.S. residential and retail.

The first quarter of 2014 was a decent one for investors—the back-and-forth risk-on/risk-off dynamic surfaced again in Jan. and Feb., which resulted in relatively even results for stock and bond investors. Real estate and commodity owners were no doubt pleasantly surprised by some of the strongest asset class returns for the quarter. Bond returns were positive, but a bit weak against the broader BarCap Aggregate, due to falling rates over the period and a lack of portfolio duration exposure. Small-caps were the worst-performing, which reinforced our continued recommendation for an underweight due to valuation.

FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger's, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder's, Standard & Poor's, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.  FocusPoint Solutions, Inc. is a registered investment advisor.

Notes key:  (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.

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