For a better formatted version of the below commentary please click here Weekly Letter 11-24-2014

Commentary at a glance:

-Onward and upward go the markets.

-Abe dissolves parliament in Japan.

-SURPRISE! China cut interest rates.

-Immigration reform presents the latest friction in Washington DC.

-Economic news releases in aggregate came in slightly above market expectations.

 

Market Wrap-Up: The majority of the financial markets around the world increased in value over the course of the past week, thanks in large part to continued support from a few key central banks. Technically, all three indexes remain very bullish, but the general lack of high volume seen during the movement is giving some investors pause. The charts below are of the three major US indexes in green with their respective most recent technical support levels in red, as well as the VIX, with the average level of the VIX over the past one year draw with a red line on the lower right chart:

4 charts 11-24-14

Technically, all three of the indexes look very strong, but it has now been nearly a full month without much, if any, pullback to speak of. Rallies are nice because investors make a lot of money, but they are also notorious for making investors become complacent to the world around them and focus far too closely on the market moving higher, while missing the bigger picture of what could be coming. From a seasonality time of year we are for sure in the sweet spot for returns; November is nearly behind us and we begin to enter a time of year where Santa Rallies are commonly found. A Santa Rally is a rally in the financial markets around the holiday spending at retailers. Retailers derive a significant percentage of their annual income from the holiday shopping season, which officially starts on Black Friday. I use the term Black Friday loosely since it seems most stores have started their major sales about a week ago and will be running them for a full three weeks; the bleed over from just one day to multiple days seems to be in full force. During this time there are usually many reports about how strong sales are as Americans seem to spend more and more each year. This in turn leads to the thought that profits and earnings will be stronger than expected during the fourth quarter and thus investors bid up the prices of stocks. This mentality permeates through the entire retail sector and is the major catalyst to a Santa Rally. One of the biggest potential positives to the markets continuing to move higher is the time of year in which we currently find ourselves.

 

Not everything is positive, however. There are plenty of dark clouds on the horizon even if they seem very small and very far away. One of the biggest potential issues is the declining price of oil and the ramifications it could have on some key countries around the world. Russia, already feeling pinched by the international sanctions, surely needs prices well above $100 per barrel to keep its economy moving forward. Break Even with linesThe chart to the right from the International Monetary Fund (IMF) shows various Middle Eastern Countries and their respective breakeven points for Oil, looking at both fiscal and current account needs. The current price level of oil is signified by the two intersecting dotted blue lines. As you can see, many countries the US needs to keep as friends in the region are now struggling with oil prices that cannot sustain current government spending in the countries. Saudi Arabia, of course, is the key dot to look at on the chart as it controls the largest amount of oil that flows onto the world market and a significant percentage of oil production out of OPEC as well. If oil prices stay below $80 we could see political unrest kick up in yet another Arab Spring early next year. This time around it would involve countries the US and the rest of the world really have economic ties to, not countries like Libya. Falling oil prices is a big wild card. Another dark cloud on the horizon is the unknown endgame with Russia and the rest of the world as Russia slowly appears to be taking back regions that were once under the Kremlin during olden times.

 

The Russian advance into Crimea and then Ukraine was not random by any stretch of the imagination and neither is the response from the rest of the world. Russian President Putin knew he was risking his economy to go on a land grab and so far it seems to be working for him. Sure his economy is starting to feel the pinch and he is successfully isolating his country, much like the North Koreans, but he is gaining physical land with his actions. The bigger potential issue for the global financial markets is where does Putin stop? Does he move into NATO member countries and push toward the Baltic States? Or will he be content with what he has? It is unlikely he will be content with what he has so expansion, if not stopped, is his likely direction. The issue is not whether the rest of the world can beat the Russians in a war if it came down to it, but whether the rest of the world can afford a major fight with Russia. Europe is already very weak with the European Central Bank (ECB) stepping in just last week with bond buying in an attempt to shore up slowing economic growth and other countries in the region have their own issues and financial constraints. This issue could weigh heavily on the global economy if the situation deteriorates further in the coming months, something which seems likely to occur.

 

National News: National news last week was all about President Obama’s executive action taken on immigration reform. While the actions were seen by Republicans as a direct political shot at themselves, the actual legislation seems much weaker than first feared. The Republican response to the executive action is at best discombobulated as various sects within the Republican Party want to take different paths toward resolution. One thing the action did seem to do was dash whatever little hope there was between the President and the Republican Party, which means it will be a long and slow fight over the next two years to get much of anything done in Washington DC.  While feathers were being ruffled in DC last week, earnings season for the third quarter of 2014 all but officially came to an end.

 

The third quarter earnings season is quickly drawing to a close as we have now seen more than 97 percent of the companies in the S&P 500 report their results. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. Negative earnings surprises are highlighted in red, while positive surprises in excess of 10 percent are highlighted in green:

 

Agilent Technologies 76% Jack In The Box 2% Salesforce.com -100%
Best Buy 28% Jacobs Engineering 4% Sears pushed
Buckle -3% Kirkland’s 133% Splunk -11%
Dick’s Sporting Goods 3% La-Z-Boy 6% Staples 0%
Dollar Tree 6% Lowe’s Companies 2% Stein Mart 0%
Foot Locker 6% Medtronic 0% Target 15%
Gap -6% Michaels 19% TJX Companies 0%
Home Depot 2% PetSmart 7% Tyson Foods 13%
J M Smucker 0% Ross Stores 7% Williams-Sonoma 8%

 

In looking at the data above it is clear to see that retail by and large continued to turn in solid performance during the third quarter of 2014. This solid performance will hopefully flow over into the holiday earnings season as this would be a nice catalyst for the markets to continue to move higher in what is commonly known as a Santa Rally.

 

According to Factset Research, we have now seen 487 (97 percent) of the S&P 500 companies release their results. Of the 487 that have released, 77 percent of them have met or beaten earnings estimates, while 23 percent have fallen short of expectations. This 77 percent of companies beating on earnings represents the highest percentage of companies beating expectations since the third quarter of 2010. When looking at revenue we saw no change in the percentage of companies that have beaten estimates with the figure holding firm at 59 percent having reported beating estimates on a revenue basis, while 41 percent have fallen short. At this point the figures are the final numbers for the quarter as it has become all but impossible for the remaining 13 companies that have yet to report earnings to actually push the needle even one percentage point in any direction from the current figures.

 

This week is the last of the stragglers as far as major companies announcing earnings for the third quarter of 2014. Most of the companies announcing this week are retail centric companies that have very large operations and it takes a large amount of time to tabulate all of their quarterly figures from the end of a quarter. Below is a table of the better known companies that are releasing earnings with the potentially most impactful releases highlighted in green:

 

Big Lots
Campbell Soup
Deere & Co
DSW
Hewlett-Packard
Hormel Foods
Sears
Tiffany & Co

 

Hormel will be closely watched this week to see if they announce any new price increases as the prices of raw materials in many of their products have been doing nothing but increase so far during 2014. While big companies such as Hormel typically hedge out some of their costs with derivative financial instruments on their underlying raw materials, this slow but steady increase in prices will start having a noticeable impact on the company in the future. Tiffany & Co will also be closely watched as it is one of the premier high end retailers going into a holiday season and typically has a very good read on the higher end consumer and their spending patterns for the rest of the year.

 

International News: International news was hopping last week as there were several key developments that pushed the global financial markets around. China made the biggest splash with several key moves on interest rates that took the financial markets by surprise on Friday. The first move on Friday in China was to cut the 1-year benchmark loan rate by 0.4 percent from 6 percent down to 5.6 percent. China has also lowered its deposit rate with banks from 3 percent down to 2.75 percent. China’s final move was to increase the amount it is willing to pay savers through the deposit rate up to as high as 3.3 percent. In simple terms, the People’s Bank of China (PBOC) cut the interest rates that small businesses and people pay for loans, while increasing the amount of interest a saver gets at the bank. This was done in an attempt to get growth to pick back up in China as it has gone from double digit annual growth rates in the past to a paltry 7.6 percent now. There are very few places in the world that would fear a 7.6 percent growth rate in their economy, but China is one such place. Sticking with Asia, Japan made headlines early last week as Prime Minister Shinzo Abe officially dissolved parliament and called for new elections in December.

 

Dissolving parliament may seem like a big deal to someone not familiar with the political process in Japan, but it was not that big of a deal and more procedural than anything else in Japan. In calling for election on December 14th, President Abe is pretty much holding a vote two years earlier than planned to see if the people of Japan will back the radical economic reforms his government is undertaking as it tries to get Japan on steady economic footing. One of the main topics of the upcoming election is the sales tax increase, which was scheduled for October of 2015, but has already been kicked out until April of 2017 at this point. It is thought that Abe will easily win reelection as there is little time for candidates against him to mobilize enough votes or formulate a plan to mount a reasonable challenge and that once he and his party are reelected, they will have the “will of the people” behind them in the economic actions in the future. Abe would not have called for snap elections if he did not think he would easily win them.

 

The other major story of the week last week came out of Europe and did not have to do with Russia in Ukraine, but rather with ECB Executive Board member Benoit Coeure announcing that the ECB was starting to buy bonds. In a speech on Friday, Coeure outlined the plans for the asset-buying purchase program, which will start this week. In total, the ECB expects to expand its balance sheet by 1 trillion Euros, but that may not be enough. Earlier last week, ECB President Draghi said in a speech that the ECB would do all that it could to get Europe growing and inflation returning, but he warned that the ECB may not be able to do enough on its own. Countries will need to come together and formulate a plan for becoming more competitive in the global economy if Europe is going to pull out of the current mess it find itself in. This whole situation with the major economies of Europe slowing down to a near stall speed will be a big concern during 2015 as the actions taken by governments in the region could stem or accelerate problems that could spread globally if not correctly dealt with.

 

Market Statistics: All three of the major US indexes made it five weeks in a row last week for gains. We are really starting to see a weekly trend going here. When looking at volume overall for the three indexes, it boils down to an average week for volume with the S&P 500 seeing the best volume of the three:

 

Index Change Volume
S&P 500 1.16% Above Average
Dow 0.99% Average
NASDAQ 0.52% Below Average

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Oil & Gas Exploration 3.88% Broker Dealers -1.37%
Home Construction 2.95% Telecommunications -1.20%
Semiconductors 2.83% Software -0.75%
Energy 2.81% Regional Banks -0.64%
Natural resources 2.79% Financial Services 0.19%

The most interesting aspect of the sectors last week was semiconductors, which bucked the trend and was one of the top 5 performing sectors of the week, despite the NASDAQ seeing the lowest performance of the three major indexes.

The broad US fixed income market was very uneventful last week; the moves were primarily driven by foreign central bank monetary actions, of which the US was a beneficiary:

Fixed Income Change
Long (20+ years) 0.51%
Middle (7-10 years) 0.11%
Short (less than 1 year) 0.00%
TIPS -0.12%

Last week the value of the US dollar increased by 0.90 percent against a basket of international currencies, with much of this move occurring on Friday after the rate cut in China and speech by ECB President Draghi. The strongest of the currencies last week was the Canadian dollar as it gained 0.49 percent against the US dollar, thanks in large part to the moves in both natural resources and energy. The Japanese Yen continued to be the weakest currency in the world as it fell by 1.30 percent against the value of the US dollar. The Yen has now fallen for each of the last 5 weeks, in total declining by 9.31 percent. During the week last week the Yen hit a record low level of 119¥ to $1. Now might be a good time to get serious about a vacation to Japan, if you were considering one, as the Yen continues to struggle against the US dollar and the upcoming elections in Japan are unlikely to help the Yen much going forward.

Commodities were mixed last week as the metals moved noticeably higher, while oil finally turned in a positive week:

Metals Change Commodities Change
Gold 0.80% Oil 0.76%
Silver 1.02% Livestock -0.64%
Copper 2.84% Grains -1.62%
Agriculture -0.70%

The overall Goldman Sachs Commodity Index turned in a gain of 0.63 percent last week, while the Dow Jones UBS Commodity Index advanced by 1.08 percent. For the week oil moved higher by 0.76 percent with West Texas Intermediary (WTI) spot oil prices settling at $76.50 at the end of the week. The soft commodities such as grains and livestock all moved lower last week, in what is hopefully a sign for some relief to come to the grocery stores near you in the future. Gold, Silver and Copper all moved higher last week with the more industrially used Copper enjoying the surprise drop in interest rates in China on the thought that it could drive demand for the semiprecious metal.

In a surprising turn of events, Brazil really turned around last week with the Sao Paulo based Se BOVESPA turning in the best performance by far. For the week the SE BOVESPA jumped 8.33 percent on speculation that President Dilma Rousseff will appoint a very pro-markets finance minster, Joaquim Levy. If she does appoint him it would signal a major potential change from the very protectionist government she has been running the past few years. The worst performance of the week last week was found in Hong Kong with the Hang Seng declining by 2.70 percent as unrest in the country looks like it could once against start to increase.

Last week was a bit of a choppy week for the VIX with the index starting out on Monday moving higher, then moving flat for two days only to decline by more than the index increased on Monday over the course of Thursday and Friday. In total, the VIX gave up 3.08 percent for the week and remains below the 52-week average level for the VIX. At the current level of 12.90 the VIX is implying a move of about 3.72 percent over the course of the next 30 days. As always, the direction of the move is unknown.

 

For the trading week ending on 11/21/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 1.28 % 6.42 %
Aggressive Benchmark 1.07 % 3.74 %
Growth Model 1.06 % 7.01 %
Growth Benchmark 0.83 % 3.00 %
Moderate Model 0.79 % 6.97 %
Moderate Benchmark 0.59 % 2.23 %
Income Model 0.68 % 6.52 %
Income Benchmark 0.30 % 1.25 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

We made no changes to our models over the course of the previous week. We did not take any further steps into our three partial positions, those being Semiconductors, Small and Mid Cap stocks. One of our new investments, Profunds Rising Dollar (RDPIX), broke out to the upside on Friday last week, thanks to all of the central bank intervention that was seen. This trend looks like it will continue in the future as it looks less and less likely that many of the major regions of the world will be able to do anything other than loosen fiscal policies to promote growth.

 

Economic News:  Last week was a pretty uneventful week for economic news releases, but there was one that blew expectations out of the water and it is highlighted in green below:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 11/17/2014 Empire Manufacturing November 2014 10.2 12
Neutral 11/18/2014 PPI October 2014 0.20% -0.20%
Neutral 11/18/2014 Core PPI October 2014 0.40% 0.10%
Slightly Negative 11/19/2014 Housing Starts October 2014 1009K 1025K
Slightly Positive 11/19/2014 Building Permits October 2014 1080K 1040K
Neutral 11/19/2014 FOMC Minutes October Meeting -
Neutral 11/20/2014 Initial Claims Previous Week 291K 285K
Neutral 11/20/2014 Continuing Claims Previous Week 2330K 2375K
Neutral 11/20/2014 CPI October 2014 0.00% -0.10%
Neutral 11/20/2014 Core CPI October 2014 0.20% 0.10%
Neutral 11/20/2014 Existing Home Sales October 2014 5.26M 5.17M
Positive 11/20/2014 Philadelphia Fed November 2014 40.8 18

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week’s economic news releases started on Monday with the release of the latest Empire Manufacturing data that showed growth in the greater New York region, but slower growth than was first expected. On Tuesday the Producer Price Index (PPI) was released and showed that prices increased slightly at the producer level during October despite the large decline in the price of fuel. The increase was not enough to cause inflation alarms to go off, but it will be watched closely over the coming months for a trend. On Wednesday two housing figures were released to a ho-hum reception as housing starts missed expectations by a little, while building permits beat expectations by a little. The big release of the day was the FOMC meeting minutes from the previous meeting, but the minutes held almost no new information and ended up being somewhat of a letdown to the markets. The week’s economic releases wrapped up on Thursday when the big surprise of the week was released, that being the Philadelphia Fed’s manufacturing index number that just crushed expectations. Expectations for the manufacturing number out of Philly going into Thursday were for a reading of 18, which is in line with what was seen out of New York earlier during the week, but the actual release came in at 40.8. The reading of 40.8 is the second highest reading we have seen since prior to the decline of 2008, second only to a reading of 43.4 back in March of 2011. At first I thought this release was a misprint when I saw it so I dug into the release and the numbers did shake out that they had a stellar month during November, with the biggest contributions to the figure being new orders and order shipments. Can this type of growth continue in Philly? Probably not at the current pace, but the order book does look pretty strong going forward so we could continue to see growth at some rate in the region going forward. The other two releases that made a few headlines on Thursday last week included the Consumer Price Index (CPI) and Core CPI, which showed that prices at the consumer level were flat during the month of October, thanks to falling fuel prices perfectly offsetting rising prices on food.

 

This week is a typical week for economic news releases as far as the number of releases, but they are crammed into just two days with the holiday this week in the US. The releases highlighted below have the potential to move the overall markets:

 

Date Release Release Range Market Expectation
11/25/2014 GDP – Second Estimate Q3 2014 3.2%
11/25/2014 Case-Shiller 20-city Index September 2014 4.6%
11/25/2014 Consumer Confidence November 2014 96
11/26/2014 Initial Claims Previous Week 288K
11/26/2014 Continuing Claims Previous Week 2348K
11/26/2014 Durable Orders October 2014 -0.6%
11/26/2014 Durable Goods -ex transportation October 2014 0.5%
11/26/2014 Personal Income October 2014 0.4%
11/26/2014 Personal Spending October 2014 0.3%
11/26/2014 Chicago PMI November 2014 63
11/26/2014 University of Michigan Consumer Sentiment Index November 2014 90
11/26/2014 New Home Sales October 2014 470K
11/26/2014 Pending Home Sales October 2014 0.5%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

On Tuesday one of the big releases of the week is set to be released, that being the third estimate of third quarter 2014 GDP, which is expected to be moved slightly lower from the second estimate of 3.5 percent down to 3.2 percent. It is always tricky to judge how the markets will react when the GDP figure is released because if the number is worse than expected it may indicate that the Fed will keep low rates longer. The flip side is also true, meaning that if the number is better than expected it may trigger fears that the Fed will raise rates sooner than anticipated. Also released on Tuesday is consumer confidence for the month of November as well as the latest home price data, which as always is very stale. Consumer confidence could in theory move the markets, but it would take a print drastically away from expectations to do so. Wednesday is the last day of the week for economic news releases and there are a very large number of them. Mostly on Wednesday some will beat expectations while others will fall short, but the deviations will not be large enough for the few people working on Wednesday to even notice. The main releases to watch will be the durable goods orders, the Chicago area PMI and the University of Michigan’s Consumer Sentiment Index. Durable goods are expected to show a slight decline when transportation is included and a slight gain when it is removed. If this release misses expectations by a wide margin it has the most potential to move the markets. The Chicago area PMI will also be closely followed after the blow out number seen last week on the Philadelphia business and manufacturing index. Hopefully we can see a little of the Philly luck spread over into the Chicago area. Wrapping up the week on Wednesday will be the University of Michigan’s Consumer Sentiment Index, which will likely move in the same direction and by about the same magnitude as the overall consumer confidence figures released on Tuesday.

 

Fun fact of the week as you are eating turkey:

 

According to The Guinness Book of Records, the greatest dressed weight recorded for a turkey is 39.09 kg (86 lbs) at the annual “heaviest turkey” competition held in London, England on December 12, 1989.

 

Source: Guinness Book of Records

For a cleaner PDF version of the below commentary please click here Weekly Letter 11-17-2014

Commentary at a glance:

-The markets took a little breather last week.

-Keystone XL pipeline bill passed through the House; now it is on to the Senate.

-Europe is growing—just barely!

-Japan back in recession? No one saw that coming.

-Economic news releases in aggregate came in slightly above market expectations.

 

Market Wrap-Up: Onward and upward would be two very good words to describe the financial market movements in the US over the course of the past week as all three indexes moved higher. Technically all three indexes remain very bullish, but the general lack of volume seen during the movement is giving some investors pause. The charts below are of the three major US indexes, in green with their respective most recent technical support levels in red, and the VIX, with the average level of the VIX over the past one year draw with a red line:

4 charts 11-17-14

As you can see above, last week was a little bit of a breather for the S&P 500 (upper left pane above) as the index took a break from the rapid rise it has been experiencing since the middle of October, moving in an almost sideways manner. The Dow (upper right pane above) is almost an identical chart as the S&P 500 as it too took a little break last week after moving up so quickly. The NASDAQ (lower left pane above), however, continued to push higher last week at a much faster pace than the other two indexes. This type of movement, where the NASDAQ leads the way higher, is indicative of a market where risk is being taken by a large number of investors who are pushing the most risky equity assets higher. Historically, the NASDAQ is the most risky of the three indexes and thus has the highest beta.

 

Beta in this sense is a financial term that measures how much one investment moves when a second investment moves. For instance, if an investment has a beta of 1 compared to the S&P 500, if the S&P 500 increases by 10 percent you would expected the investment to also move by 10 percent. If an investment has a beta of 2 and the S&P 500 moves the same 10 percent, this other investment would move by 20 percent. The reverse also happens if the market is moving lower.

 

The historical average of beta for the NASDAQ versus the S&P 500 is about 1.12, meaning that during movements the NASDAQ participates in about 12 percent more of a move than the S&P 500. Within the NASDAQ, a sector such as semiconductors or biotechnologies can run a beta as high as 2. So with many investors expecting to see the market continue to move higher as we get into the holiday shopping season, it was not surprising to see the outperformance of the NASDAQ over the other major indexes.

 

National News: National news last week seemed to hold a lot of saber rattling in Washington DC between the two political parties. With both the House and Senate reconvening and the mid-term elections now behind us, it was back to business as usual with both sides not really leaning very far to meet the other on any topic. One of the major points of contention did see some movement last week as the House of Representatives passed the Keystone XL pipeline bill for the ninth time. The latest derivative of the bill is pretty straight forward and holds very little pork. Up next for the bill is the vote in the US Senate. Each of the other eight times the Keystone XL bill has been passed from the House to the Senate it has been killed either by a “No” vote or by the leadership in the Senate not allowing the legislation to come up for a vote. This time it will be different, as Senate Majority Leader Harry Reid has announced that the Senate will vote on the bill this week. The reason for the vote is a bit convoluted. There is still a run-off election to be held in Louisiana later this year between Republican Bill Cassidy and Democrat Mary Landrieu. One of the main talking points between the two during the run-up to the election was the fact that Landrieu had voted against the Keystone pipeline in previous votes in the Senate and this is seen as potentially costing her her Senate seat. With a new vote now before the run-off election the democrats are thinking she can vote yes on the bill and take away the main topic of the debate in the upcoming runoff election. This seems like petty politics as the Republicans already have control of the Senate going into 2015 no matter the outcome of the runoff in Louisiana, but politicians never seem to have a shortage of petty issues they are pushing around. If the bill does make it thought the Senate with a “Yes” vote, President Obama has to make a choice between vetoing the bill, which he has threatened to do with previous versions of the bill,or he can pass the legislation and have it be the end of the story for the Keystone XL. Oil is not the only hot topic right now in Washington as “immigration reform” has once again become a buzz phrase.

 

Immigration reform is something that has eluded the US political system for several years, largely because of the delectate nature of the issue and the usual antics of politicians. The stance right now is that President Obama is willing to take a step forward on the issue through the use of an executive action and bypass Congress on the issue. Republicans are crying foul, saying this action would “poison the well” of the two sides working together over the next two years, but it really looks like the President is set to go at it alone on this one. Why the big fuss over immigration reform? It has to do with votes and voters in elections. Historically, the Democrats have fared better with newly immigrant voters, and the Republicans see this reform as a way for Democrats to secure a large number of new voters for their party. Democrats, however, point out that no one is forcing new immigrants to the US to vote for Democrats and that the Republicans, if they had better politics to help such people, could also pick up votes. That is about where the two sides stop talking on the issue. With those two political footballs being tossed around in DC, the financial markets have taken to a more interesting and pertinent topic, that being the end of third quarter 2014 earnings season.

 

The third quarter earnings season is quickly drawing to a close as we have now seen close to 93 percent of the companies in the S&P 500 report their results. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

3D Systems -13% Energizer 17% Nordstrom 3%
ADT 12% Flowers Foods 5% Pinnacle Foods 0%
Caesars Entertainment -87% Fossil Group 8% Rayonier 35%
Cisco Systems 0% Intrawest Resorts 10% SeaWorld Entertainment -11%
D.R. Horton -8% J C Penney 7% Sotheby’s 19%
Dean Foods 77% Kohl’s -8% Transocean 25%
Dillard’s -5% Macy’s 24% Wal-Mart 3%

 

Last week’s earnings held little of interest, but we did see a wide deviation in performance among the retailers who announced with some turning in strong numbers while others looked weak. The biggest retailer of them all, Wal-Mart, saw sales increase on a quarterly basis for the first time during the last past 7 quarters. As far as retailers who had a rough quarter, Kohl’s and Dillard’s both saw sales missing expectations as foot traffic slowed in their stores. As we get closer to the holiday season the deals and gimmicks are sure to pick up as all of the retailers race to get the largest portion of the consumer pie that they can.

 

According to Factset Research, we have now seen 462 (93 percent) of the S&P 500 companies release their results. Of the 462 that have released, 77 percent have met or beaten earnings estimates, while 23 percent have fallen short of expectations. This 77 percent of companies beating on earnings would be the highest percentage since the third quarter of 2010 if the figure holds through the end of the reporting season. When looking at revenue, last week became a little worse for the quarter as there are now 59 percent of the companies that have reported beating estimates on a revenue basis, while 41 percent are falling short. With such a large percentage of companies having released their results, it is becoming more and more difficult mathematically for the numbers mentioned above to change and more likely that the 77 and 59 percent figures will be the final numbers for the quarter.

 

The cliff in the number of companies reporting earnings this week continues to be apparent as there are only 264 companies scheduled to report earnings after more than 1,000 last week. Below is a table of the better known companies releasing earnings with the potentially most impactful releases highlighted in green:

Agilent Technologies Jack In The Box Salesforce.com
Best Buy Jacobs Engineering Sears
Buckle Kirkland’s Splunk
Dick’s Sporting Goods La-Z-Boy Staples
Dollar Tree Lowe’s Companies Stein Mart
Foot Locker Medtronic Target
Gap Michaels TJX Companies
Home Depot PetSmart Tyson Foods
J M Smucker Ross Stores Williams-Sonoma

 

Much like last week, retailers will once again be in the spotlight this week as there are a number of key big box stores releasing their earnings results for the third quarter of 2014. The two companies that will be watched the closest this week are Home Depot and Lowe’s as they are the two undisputed leaders in home improvement sales in the US. The market could get a pretty good gauge on the US housing market from these releases as people typically do not put much money into their homes if they think their home value will be eroded over time. However, the flip side is also true in that people do put money into their homes when they think their house will appreciate over the near term. Home Depot will also be interesting this quarter as it will likely discuss the data breach that was made known over the quarter and what, if any, impact it is seeing on its business from the leak. As with most quarterly results, the forward looking guidance will be very important this week, but it may be even more important than normal, as many of the companies reporting are gearing up for holiday sales—sales that can easily make up a large percentage of their overall annual revenues.

 

International News: News on the international front last week was pretty interesting; we received news that was expected and some that was less than expected. The first of the expected news was that Russia continues to move into Ukraine, as it has for some time, only this time Russia seems to be much less afraid of showing the international community that it is doing so, removing markings on tanks and other military hardware that was easily photographed crossing the border. Hope emanating from talks between Russia and the rest of the world at the APEC summit, held early last week, faded as Russia announced it would begin flying military exercises in the Gulf of Mexico shortly after the end of the meetings. What Russia could possibly be exercising for is anyone’s guess and the likelihood of Russia actually sending war planes on an exercise mission to the Gulf of Mexico seems low at this point. However, there does seem to be little limit as to what Russia President Putin is willing to do to stick a stick in the eye of the rest of the world. Just last week Sweden released photographs of what it claims is the seafloor after being disrupted by a Russian submarine. The images are clear that something was there on the seafloor moving along the bottom, but there is no direct evidence that it was a Russian sub; and of course Russia is denying even being in the area with a sub. As we move more and more into winter we will likely see Russia escalate the situation in Ukraine as it feels it has a seasonal advantage over negotiations during winter. Russia, however, is becoming more and more desperate as the price of oil continues to decline, now moving under $76 per barrel. While sanctions hurt Russia a little, oil prices this low will really have a profound impact on the Russian economy if prices remain low for a long time as the cost per barrel of oil coming out of Russia to the international market is something over $100. This means that unless oil is over $100 per barrel, it is not economically feasible for Russia to be drilling oil. A life blood for the Kremlin and Russia overall, without being flush with cash from oil President Putin is in a weakening state.

 

Russia and Ukraine did not comprise the only news out of Europe last week as Eurostat released its latest projections of the third quarter GDP figures for the Eurozone overall as well as many of the member states. The chart below, created using Eurostat data, shows the Eurozone as well as 15 of the 18 Eurozone member countries:

Euro GDP Chnage 11-17-14

As you can see above, the Eurozone grew at an overall rate of 0.2 percent (green column above) during the third quarter. However, much of this growth is coming from areas not very statistically significant to the overall health of the Eurozone. Greece, for example, grew at 0.7 percent and Slovakia grew at 0.6 percent, while the true work horses of the Eurozone – Germany, Italy and France – grew at 0.1, -0.1 and 0.3 percent, respectively. Italy was particularity worrisome as it has now seen three consecutive quarters of falling GDP, meaning that the third largest economy in Europe is in a recession. All of this negative news about the situation in Europe is sure to be noticed by President of the European Central Bank (ECB) Mario Draghi, who is now more likely than ever to step in with some form on quantitative easing and buy debts of the individual countries. Italy, however, was not the only country last week to see a technical recession as Japan also made a surprise announcement.

 

Japan has been a struggling economy now for more than the past two decades, and the troubles seem to be continuing. Over the weekend Japan released its third quarter GDP change figure and it showed that Japan saw its GDP figure contract by an annualized rate of 1.6 percent. This follows on the heels of a 7.3 percent contraction during the second quarter and thus moves the country into a technical recession. The horrible second quarter number was due to the “one time” ramifications of the new tax and the fact that people bought less with the new tax than under the old system. This decline in the second quarter was actually expected. The third quarter, however, saw expectations of a growth of 2.1 percent, making the negative print all of the more surprising. This negative print puts the future of Abenomics into the question. In fact, the Prime Minister has even alluded to the possibility that a vote may be taken later this year or early next year to see if the country should go through with the next round of tax hikes, which is slated for the middle of 2015 and is part of the last phase of Abenomics. Whatever the outcome of the vote, if there is one, it seems that Japan is really unsteady right now and that the efforts by many Japanese economists seem to be bearing very little fruit as the country continues to struggle to move forward.

 

Market Statistics: All three of the major US indexes made it four weeks in a row last week for gains in the rally that followed the selloff back in early October. Volume on average was a little below the 52-week average level of volume. Volume during this recent upward movement has been much lower than it was to the downside, something that is a little puzzling and concerning at the same time:

 

Index Change Volume
NASDAQ 1.21% Below Average
S&P 500 0.39% Average
Dow 0.35% Below Average

 

As mentioned above in the first section of this report, from a technical standpoint the three major indexes all look strong, but they have failed in large part to retest the previous technical levels. This failure to test previous technical levels puts the markets at risk to large swings as investors have few technical levels to watch for support prior to giving back a significant part of the gains seen over the past few weeks.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Telecommunications 2.70% Utilities -2.83%
Home Construction 2.32% Oil & Gas Exploration -2.81%
Technology 2.11% Energy -1.89%
Consumer Discretionary 1.95% Natural resources -1.41%
Consumer Service 1.88% Biotechnology -0.68%

The most interesting of the ten sectors listed above was the placement of Biotechnology. Typically, when the NASDAQ turns in the best performance of the week Biotechnology is one of the major benefactors of such a move, as the NASDAQ is very laden with biotechnology companies. Last week, however, NASDAQ saw strong performance while biotechnology pulled back a little. Most likely this was caused by some investors pulling profits out of the sector in favor of broader based technology risk.

The broad US fixed income market was very uneventful last week with losses being seen in every category except for very short term bonds:

Fixed Income Change
Long (20+ years) -0.22%
Middle (7-10 years) -0.07%
Short (less than 1 year) 0.01%
TIPS -0.37%

Last week the value of the US dollar decreased by 0.09 percent against a basket of international currencies. The strongest of the currencies last week was the Australian dollar as it gained 1.40 percent against the US dollar, thanks in large part to the Asian Economic summit and the prospects of more raw materials being needed from Australia in the future. The Japanese Yen continued to be the weakest currency in the world as it fell by 1.42 percent against the value of the US dollar. During the week last week the Yen hit a record low level of 116.75¥ to $1. If you were thinking about going to Japan for vacation any time soon, now might be a good time to really get serious about it as the Yen has weakened against the US dollar by almost 16 percent over the course of just the last 3 months.

Commodities were mixed last week as the metals moved noticeably higher, while oil continued to slide as it has done for the past few months.

Metals Change Commodities Change
Gold 1.33% Oil -5.54%
Silver 3.51% Livestock 2.80%
Copper 0.19% Grains 3.49%
Agriculture 1.89%

The overall Goldman Sachs Commodity Index turned in a loss of 2.26 percent last week, while the Dow Jones UBS Commodity Index declined by 0.49 percent. As has been the case for many weeks, oil was the biggest driver in the deviation of performance between the two indexes. For the week, oil declined by 5.54 percent with West Texas Intermediary (WTI) spot oil prices falling below $76 and looking like there is room to move lower. At some point oil will move low enough that it will be a good investment at very depressed prices, but trying to determine when that will be is very difficult. Grains jumped higher last week by almost 3.5 percent, a trend that has been very prevalent over the past few months. All of the upward price movement in grains will be seen in the grocery store pretty soon as many items such as flour and meats all have a lot of grain price sensitivity. Gold, Silver and Copper all moved higher last week, but didn’t really have any specific news or articles that gave a strong reason for the move.

Despite the falling Yen, Japan’s main stock index saw a good week of performance, led in part by the exporting companies seeing the relative price of their goods decline for foreign buyers as the value of the Yen falls against nearly all world currencies. The best performance globally last week was the Japanese Nikkei Index, which advanced by 3.62 percent. Russia made it out of the dog house last week as the worst performing index globally was found in Mexico with the Mexican IPC Index falling by 2.79 percent over the course of the week.

The VIX last week saw a pretty tame trading week, during which there were very few wild days of trading with large intraday movements. In total the VIX gained 1.45 percent for the week, but it remains well below the 52-week average level we have seen on the VIX. At the current level of 13.31 the VIX is implying a move of about 3.84 percent over the course of the next 30 days and, as always, the direction of the move is unknown.

 

For the trading week ending on 11/14/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.25 % 5.06 %
Aggressive Benchmark 0.51 % 2.63 %
Growth Model -0.31 % 5.87 %
Growth Benchmark 0.41 % 2.15 %
Moderate Model -0.36 % 6.12 %
Moderate Benchmark 0.29 % 1.63 %
Income Model -0.42 % 5.78 %
Income Benchmark 0.14 % 0.94 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

Over the course of the previous week we made several changes to our models that adjusted the amount and type of risk we are currently taking on our models. Our first set of changes was to initiate small positions in three different sectors of the markets through the use of tradable mutual funds. The three sectors of the markets were semiconductors, Mid Cap Growth and Small Cap Growth. All three areas of the market are areas we had been watching for a few weeks and with the consolidation movements we saw over the past two weeks it looked like a good opportunity to buy a little to open the positions. If we see the areas of the markets decline over the coming days, we will likely be buying on the dips to fill out our positions. Another adjustment we made last week was to buy a full position in the Rydex Rising US dollar Fund (RDPIX) in our lower risk investment models. The US dollar has been on an upward trend now for several months and, much like the other sectors, took a bit of a pause over the course of the past 2 weeks, moving in a sideways manor. We took this sideways movement as an opportunity to buy into the fund. The thesis behind the continuing strength of the US dollar is less about the US dollar and more about what other major currencies around the world are having done to them. In Europe the ECB is going to undertake a new round of quantitative easing, thus putting downward pressure on the Euro. In Japan you have the same situation with the Yen seemingly in a free fall against all of the world currencies, including the US dollar. In Switzerland, keeping the Euro peg could arbitrarily hurt the value of its currency. Finally, in Latin America, with the elections now behind us in Brazil it looks like the government is going to continue to be okay with the fall of the Real as it makes its exports more attractive to the international community. With all of the above mentioned items in mind it looks like the US dollar could continue to see strength in the near and midterm.

 

Economic News:  Last week was an uneventful week for economic news releases. None of the releases significantly beat or missed market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 11/13/2014 Initial Claims Previous Week 290K 280K
Neutral 11/13/2014 Continuing Claims Previous Week 2392K 2353K
Slightly Positive 11/13/2014 JOLTS – Job Openings September 2014 4.735M 4.850M
Neutral 11/14/2014 Retail Sales October 2014 0.30% 0.30%
Neutral 11/14/2014 Retail Sales ex-auto October 2014 0.30% 0.20%
Slightly Positive 11/14/2014 University of Michigan Consumer Sentiment Index November 2014 89.4 87.5

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

With Tuesday being a Federal Holiday the economic new releases started very late on Thursday with the standard weekly unemployment related figures for the previous week. Both initial and continuing jobless claims came in higher than was expected, but not by enough to cause alarm in the markets. Later during the day the JOLTS jobs number was released and indicated that there were about 100,000 fewer open positions at US companies than economists had been predicting, a positive sign for the health of the labor market as employers are filling positions with qualified personnel. On Friday the big release of the week, Retail sales for the month of October, was released and came in exactly at expectations, showing growth of three tenths of a percent. It is much better than the decline of three tenths of a percent we saw during September, but still low compared to some of the stronger growth time periods for the US economy that we have seen in the past. Wrapping up the week on Friday was the release of the University of Michigan Consumer Sentiment Index for the month of November (second estimate), which showed a slight improvement from the first estimate, but not enough of a surprise to get the market excited.

 

This week is a typical week for economic news releases with several releases that realistically have the potential to move the overall markets highlighted in green below:

 

Date Release Release Range Market Expectation
11/17/2014 Empire Manufacturing November 2014 12
11/18/2014 PPI October 2014 -0.20%
11/18/2014 Core PPI October 2014 0.10%
11/19/2014 Housing Starts October 2014 1025K
11/19/2014 Building Permits October 2014 1040K
11/19/2014 FOMC Minutes October Meeting -
11/20/2014 Initial Claims Previous Week 285K
11/20/2014 Continuing Claims Previous Week 2375K
11/20/2014 CPI October 2014 -0.10%
11/20/2014 Core CPI October 2014 0.10%
11/20/2014 Existing Home Sales October 2014 5.17M
11/20/2014 Philadelphia Fed November 2014 18

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts off on Monday with the release of the Empire Manufacturing number, which is expected to show a reading of 12, up from a reading of 6.2 in October. Any number above zero means expansion, so the larger the positive number the better, as manufacturing in the greater New York area is important to the overall health of the US economy. On Tuesday the Producer Price Index (PPI) is set to be released and it is expected that overall prices at the producer level will be shown to have fallen by two tenths of a percent, thanks in large part to the falling prices of fuel and energy. With the volatile factors in the PPI removed, the core PPI is expected to show a meager increase of one tenth of a percent. On Wednesday the start of the October housing related figures is set to come out with the housing starts and building permit numbers, both of which are expected to be just over 1 million units. Of more interest to the markets on Wednesday will be the release of the FOMC meeting minutes from the October Fed meeting. Many money managers and economists like to go through the meeting minutes to see if they can glean any more information about the meeting that was released in the press release, but there is rarely any new information that is material to the markets in the release. On Thursday the standard weekly unemployment related figures are both set to be released with expectations that both figures will have come down a little when compared to two weeks ago. Later during the day on Thursday the Consumer Price Index (CPI) for the month of October is set to be released with expectations that overall prices declined, thanks to the decline in fuel and energy, while prices excluding volatile assets are expected to have increased one tenth of a percent. Also released on Thursday is the existing home sales figure for the month of October, which in conjunction with the earlier housing related figures should give us a pretty good idea about the strength of the US housing market. Wrapping up the week on Thursday is the release of the Philadelphia Fed Manufacturing Index. Expectations are for a slowdown in manufacturing expansion as a reading of 18 is expected, compared to a reading of 20.7 from October, but even at 18 it would indicate that manufacturing in Philly is very vibrant.

 

Fun fact of the week:

 

If all the natural gas pipelines in the U.S. were connected to each other they would stretch to and from the moon almost three times.

Source: Interstate Natural Gas Association of America

For a cleaner PDF version of the below commentary please click here Weekly Letter 11-10-2014

Commentary at a glance:

-US markets moved upward as investors cheered the election results.

-US mid-term elections are finished and it was a good night for Republicans.

-Russia is once again meddling in Ukraine.

-Asia starts their annual APEC summit this week.

-Economic news releases in aggregate came in slightly above market expectations.

 

Market Wrap-Up: Last week saw all three of the US markets continue to move higher as earnings season rolled on and some of the jitters about the midterm elections worked themselves out. Volume last week was just about average compared to what we have seen over the past year. I kept the charts below the same this week with the  previous high level of the past three months delineated by the red lines on all three of the indexes, while the red line on the VIX chart represents the average level of the VIX over the past one year:

4 charts 11-10-14

As you can clearly see above, all three of the major indexes had little problem with jumping back over the previous high levels as two of the three indexes closed at multiple all time highs. From a technical standpoint, the Dow (upper right pane) is the strongest of the three indexes with the S&P 500 (upper left pane above) coming in a close second. The NASDAQ continues to be the straggler of the three major indexes as it still has not made it over its early 2000 level and currently fails to have the same pop in its step as the other indexes. Technically at this point the markets are probably a bit overdone to the upside as the move we have seen off the bottom back in mid-October has been very sharp, without much reason for being so. The US economy overall is growing, but growing at a slow pace and certainly not at a pace that historically has driven double digit returns on the equity markets in the past. On the bond side of the investment markets, the picture has not really changed as interest rates are roughly where they were to start the year, despite everyone thinking they would be higher than they are. The Fed is still anticipated to start increasing rates next year with the timing of said increases somewhat left open to interpretation by the language used by the Fed. One thing is clear and remains clear and that is that the Fed will have to raise interest rates to get to a more normal level so it can deal with unforeseen crises that will come in the future. With the indexes moving higher last week it was not surprising to see the VIX (lower right pane above) continue on its path lower, moving through the 1-year average level we have seen and looking to be headed for the lowest level of the year.

 

National News: National news last week focused on two main topics: the first being the mid-term elections and the second being the start of the end to third quarter earnings season. Mid-term elections are finally done and gone and we can all return to our favorite type of media without having to hear or see political ads for at least a few months (until the Presidential election debates starts next year). Tuesday was great if you are a Republican and not so great if you are a Democrat, but one thing is for sure, there will be some changes coming to the political landscape in Washington DC. While there are still two states that have yet to be officially called, the Republicans did take control of the US Senate, even without the two undetermined seats. While turnout was high in some areas, it was low overall. According to the United States Elections Project run out of the University of Florida, voter turnout was only 36.4 percent nationwide, which is the lowest point since the 1942 mid-term election, as depicted by the chart below:

voter turn out 11-10-14

With Republicans taking control of the Senate and maintaining control of the House of Representatives things could become a little dicey in DC over the coming two years. First, we have this in-between lame duck session of Congress in which the Democrats do not have enough votes to push much through the Senate and the Republicans can block almost anything in the House. President Obama has threatened to use executive orders to make changes to immigration and several other pieces of legislation that have been in the works for a long time. He is taking this approach because once the new Senate is seated President Obama has far fewer options for things to pass through the Senate and actually make it to his desk. One item that will likely be pushed through early next year will be the Keystone XL pipeline as the Senate and the House will both vote in favor of passing the bill. The President, who has threatened to veto the bill, will then be left in a tough spot as it is highly likely that enough Democrats will cross the aisle to override a Presidential veto should it come down to that. Obamacare is one topic that made many headlines during the midterm elections and while the Republicans could make yet another attempt at large changes it is more likely that they will attack small pieces of the legislation and not try to repeal the whole thing. In looking at the bigger picture painted by the election results, and taking into consideration the individual state results for things like state Senate and Governor Races, Tuesday was really a referendum vote on the Democrat policies that have been put in place over the past two years. Many of the races that were “too close to call” going into Election Day turned out to have the Republicans win by double digit margins. Will this tidal wave of change continue into the Presidential election of 2016? Mostly likely it will not as Americans will watch Washington DC a bit closer than normal over the next two years and try to see which party, if either, actually has any good ideas about trying to make the US better rather than just continuing to fight between the two parties. While all of the election results were being digested, third quarter earnings season continued to draw toward a close.

 

Third quarter earnings season started to draw to an end last week, with the number of companies having reported earnings now near 90 percent of the S&P 500. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

Alexander & Baldwin 163% El Pollo Loco 0% Qualcomm -5%
AOL -5% Famous Dave’s of America -7% Scripps Networks 11%
Aqua America 0% Hain Celestial Group 3% SolarCity 31%
Archer Daniels Midland 7% Humana -8% South Jersey Industries 0%
Babcock & Wilcox 20% International Paper 8% Sprint -280%
Black Diamond 1200% J & J Snack Foods 2% Sprouts Farmers Market 13%
Bloomin’ Brands 25% Jack Henry & Associates 2% St. Joe -100%
Boulder Brands 0% Kate Spade & Co -100% Sysco 4%
Burger King Worldwide 0% King Digital Entertainment 20% Tesla Motors 100%
CenturyLink 2% LeapFrog Enterprises -200% Texas Roadhouse -7%
Chiquita Brands -33% Level Communications 19% Time 14%
Church & Dwight 4% Liberty Media -62% Time Warner 30%
Consolidated Edison 3% Molson Coors Brewing -3% Transocean Pushed
Cooper Tire & Rubber 7% News Corp 200% Valero Energy 27%
CVS Health 1% Noodles & Co 0% Walt Disney 1%
DaVita HealthCare -1% Office Depot 11% Wendys -11%
DIRECTV 6% Papa John’s International 5% Whole Foods Market 9%
DISH Network -24% Prudential Financial -9% Zillow 27%

 

Perhaps one of the most anticipated earnings results of the week last week was Tesla, which saw earnings beat expectations, but guided fourth quarter numbers so low that traders lowered the value of the company’s stock price. Local Colorado companies seemed to have a rough go last week with Liberty Media missing earnings, as did Molson Coors and DaVita Healthcare. Whole Foods Market turned in an okay quarter, but does see increased competition in the future potentially hurting their margins.

 

According to Factset Research, we have now seen 446 (89 percent) of the S&P 500 companies release their results. Of the 446 that have released, 77 percent of them have met or beaten earnings estimates while 23 percent have fallen short of expectations. This 77 percent of companies beating on earnings would be the highest percentage since the third quarter of 2010 if the figure holds through the end of the reporting season. When looking at revenue, last week improved results for the quarter as there are now 60 percent of the companies that have reported beating estimates on a revenue basis while 40 percent are falling short. With such a large percentage of companies having released their results, it is becoming more and more difficult mathematically for the numbers mentioned above to change and it is becoming more and more likely that the 77 and 60 percent figures will be the final numbers for the quarter.

 

This week we really see the effect of the drop off in the number of companies reporting earnings, going from more than 1,400 the previous couple of weeks down to less than 1,000 this week and, of those 1,000, very few are names an average person would recognize. Below is a table of the better known companies releasing earnings with the potentially most impactful releases highlighted in green:

 

3D Systems Energizer Nordstrom
ADT Flowers Foods Pinnacle Foods
Caesars Entertainment Fossil Group Rayonier
Cisco Systems Intrawest Resorts SeaWorld Entertainment
D.R. Horton J C Penney Sotheby’s
Dean Foods Kohl’s Transocean
Dillard’s Macy’s Wal-Mart

 

Big retailer results will be the focus of the earnings results released this week as Wal-Mart, Macy’s, Kohl’s, Dillard’s and Sotheby’s all report their results. With the mixed consumer related data that we have seen as well as the mixed results from other major retailers, it seems we could see the higher end stores beat expectations this week while the lower end store may fall a little short. As is typically the case, the forward guidance is what will drive the stock movement, if there is any, with the holiday season being right around the corner. An interesting company releasing results this week is 3D systems, which is a leader in 3D printers. The growth in the industry has been very fast, but it seems the companies that have a strong hold on the industry have steadily been losing market share to smaller and startup companies; we will have to see if the trend has hurt 3D systems.

 

International News: International news last week focused on a few main topics, with the first being the deteriorating situation in Russia once again. A truce has officially been in place between Ukraine and Russia since September 5th, but since then there have been small skirmishes between the two sides. It appears that Russia has now waited long enough and is stepping up its military activities within Ukraine as columns of tanks and other heavy weaponry were seen crossing the border over the past few days. With more Russia involvement, the government in Kiev sent more military personnel down to the region and while they are not fully engaged in fighting it looks like the conflict will be headed that way quickly. So why the lull in activity for almost a month? The lull occurred because Ukraine and the west believed Russia when they signed the truce, but in reality it was merely a stalling tactic by President Putin to bring Europe and many regions closer to winter. With winter now setting into the region Russia’s negotiating position is strengthened as it has the ability to turn off vital gas to the region if things do not go its way. There have been several articles about the supply of natural gas and how eastern Europe and Ukraine have enough stock piles to make it through the winter without needing any more shipments, but there is a lot of doubt about how much gas reserves they actually have and if they could make it through winter without Russian gas. With the calendar now on his perceived side, it looks like President Putin is going to make yet another push for control of the eastern part of Ukraine. Will the world actually step up and come to Ukraine’s rescue?

 

Another focus of the international news late last week was the start of the Asia Pacific Economic Cooperation (APEC) Summit that US President Obama and many other heads of state are attending. One of the focal points of the meeting this time around is for China to try to convince the world that they are on the right track and that despite the slowdown in economic growth that we have seen over the past few years, China remains one of the best growth stories and places for investment in the future. President Xi Jinping tried to set the tone on Sunday with his opening remarks in which he said that there are a number of risks to economic growth in China, but that it is “not so scary” as the rest of the world is making it seem. Adding fuel to the fire between China, Russia and the rest of the world was an announcement that Russia will work with China to see if they can create a plan for Russia to supply more gas to the region than the $400 billion worth agreed to in a pact back in May. Looking for other buyers while Europe is struggling to deal with Russia is sure to draw some criticism as China typically does not go along with international sanctions, playing a bit by its own rules and what is in the best interest of China. Moving back toward Europe, there was an interesting vote in Spain over the weekend that could have far reaching ramifications.

 

Catalonia, the wealthiest region of Spain, held a vote over the weekend that asked voters to decide if the region should become its own state and if so whether it should be an independent state. The turnout for the vote was only about 40 percent, but those who did turn out voted overwhelmingly in favor of Catalonia breaking away from Spain. Why does one small region’s vote matter? It matters because with the passage it outlines that a peaceful vote can be attained in Europe against the state governments. The Government in Spain has said the vote was illegal and it would not abide by the results, nor would the international community, but the vote to leave did occur, so now what happens? First off, Catalonia will have to decide if it really wants to push the envelope further than this symbolic vote. If it does, the first most logical step would be for the region to stop paying anything toward the Spanish government in Madrid. This in turn would lead to Madrid cutting off monetary flows to the region, but this may not be as bad as it sounds since the region has long paid out more money than it has gotten back. Next, Catalonia would have to set up its own currency or attempt to join the Euro, which is not a for sure thing to a new member state. Catalonia would then have to try to join the EU overall so that it could continue trading with its long standing trading partners, trading that had occurred under Spanish agreements. Then there is the bigger headache of retirement pensions and other benefits that would be cut by Spain, needing to be picked up by the new government. In the end it is unlikely the region will truly break away from Spain, but it may get a little more political clout out of the vote, since there seems to be enough votes to push to leave, if need be.

 

Market Statistics: All three of the major US indexes made it three weeks in a row last week for gains, with the NASDAQ just barely managing to pull off the feat. Volume overall for the first week of November was average with the Dow below average, while the S&P was above average and the NASDAQ was almost exactly at the average level:

 

Index Change Volume
Dow 1.05% Below Average
S&P 500 0.69% Above Average
NASDAQ 0.04% Average

 

Both the Dow and the S&P 500 made three new all time highs last week, closing out the week at such a level. The NASDAQ, on the other hand, still remains more than 8 percent below the previous all time high seen in March of 2000 during the technology bubble that later exploded, sending the NASDAQ down some 77 percent before the decline was fully over.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Transportation 2.31% Healthcare Providers -2.77%
Home Construction 1.99% Biotechnology -2.18%
Software 1.85% Telecommunications -1.51%
Utilities 1.72% Pharmaceuticals -1.23%
Financial Services 1.67% Financials -0.91%

There was nothing really surprising here as there was almost balance last week between the number of sectors that increased and the number that decreased in value over the course of the week.

The broad US fixed income market was very uneventful last week with small gains being seen in most markets:

Fixed Income Change
Long (20+ years) 0.42%
Middle (7-10 years) 0.14%
Short (less than 1 year) -0.01%
TIPS 0.48%

Last week the value of the US dollar advanced by 0.78 percent against a basket of international currencies. The strongest of the currencies last week was the Swiss Franc as it gained 0.01 percent against the US dollar. With all of the actions taken by the Bank of Japan over the past few weeks it was not surprising to see that the Japanese Yen continued to move lower last week, falling by 2 percent against the US dollar over the course of the week, briefly hitting 114 yen to $1 US dollar during trading last week.

Commodities were mixed last week as the metals moved noticeably lower:

Metals Change Commodities Change
Gold 0.28% Oil -2.54%
Silver -2.58% Livestock 0.60%
Copper -0.46% Grains -2.45%
Agriculture -1.05%

The overall Goldman Sachs Commodity Index turned in a loss of 1.44 percent last week, while the Dow Jones UBS Commodity Index advanced by 0.04 percent. As has been the case for many weeks oil was the biggest driver in the deviation of performance between the two indexes. For the week, oil declined by 2.54 percent, hitting the lowest level seen since the middle of 2010 and it does not look like the recent decline is over yet. Grains failed to make it six weeks in a row of gains last week, experiencing a decline of almost 2.5 percent. Metals traded mixed last week with silver being hit the most for no apparent reason.

Last week saw the developed markets around the globe move higher while the developing markets seemed to struggle. The best performance globally last week was found in Japan with the Tokyo based Nikkei Index advancing by 2.84 percent. With tensions once again building between Russia and the west it was not surprising to see that Russia turned in the worst performance of the week with the MSCI Russia Capped Index declining by 5.33 percent.

Last week the VIX continued to struggle as it has for the past few weeks, declining by 6.49 percent as it continues to move toward the lowest level we have seen this year. We are now more than 6 percent under the average level of the past year and with the current trend it looks as if the VIX will be content to continue to move lower. Since the intraday high of 31.06 on October 15th the VIX has now fallen by almost 60 percent. At the current level of 13.12 the VIX is implying a move of about 3.78 percent over the course of the next 30 days and, as always, the direction of the move is unknown.

For the trading week ending on 11/7/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.75 % 5.31 %
Aggressive Benchmark -0.32 % 2.12 %
Growth Model 0.73 % 6.20 %
Growth Benchmark -0.25 % 1.74 %
Moderate Model 0.61 % 6.49 %
Moderate Benchmark -0.17 % 1.34 %
Income Model 0.54 % 6.23 %
Income Benchmark -0.08 % 0.80 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

We made only one trade during the course of the previous week and that was to close our position in the Wasatch Frontier Markets Small Cap Fund (WAFMX). After performing very well over the past 10 months that we owned the fund, we started to see a divergence in performance of WAFMX when compared to other areas of potential investment. While the fund did not move meaningfully lower during the recent decline, in almost all other areas of the markets it has been underperforming by a wider margin on the upside than it recently protected on the down. The proceeds from the sale of the fund are currently being held in cash as we evaluate the best investment opportunity for the funds going forward. Areas of the market that are currently looking the most attractive on a relative strength basis include mid cap value stocks and the more high flying technology sectors such as biotechnology and pharmaceuticals. However, both sectors, when looked at from a fundamental standpoint, look like they could be a little over bought and highly valued at the current time.

 

Economic News:  Last week was all about employment in the US economic news releases and the picture was good, but a little weaker than many were hoping to see. Below is a table of the releases with the releases that significantly missed expectations highlighted in red (there were none), while the one that significantly beat expectations is highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Positive 11/3/2014 ISM Index October 2014 59.0 56.2
Neutral 11/5/2014 ADP Employment Change October 2014 230K 220K
Neutral 11/5/2014 ISM Services October 2014 57.1 58.0
Neutral 11/6/2014 Challenger Job Cuts October 2014 11.9% N/A
Neutral 11/6/2014 Initial Claims Previous Week 278K 285K
Neutral 11/6/2014 Continuing Claims Previous Week 2348K 2380K
Slightly Negative 11/7/2014 Nonfarm Payrolls October 2014 214K 235K
Slightly Negative 11/7/2014 Nonfarm Private Payrolls October 2014 209K 228K
Slightly Positive 11/7/2014 Unemployment Rate October 2014 5.8% 5.9%
Neutral 11/7/2014 Consumer Credit September 2014 $15.9 B $16.0 B

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started out positively on Monday with the ISM Index showing a gain in manufacturing overall in the US during the month of October. The gain was larger than anticipated and pushed the markets higher for a little while. On Wednesday the first of the employment related figures for the week were released with the ADP Employment change figure for the month of October showing 10,000 more jobs than predicted being formed during the month. Later during the day on Wednesday the Services side of the ISM was released and came in close to expectation, but a little lower than the overall ISM, which was released earlier during the week. On Thursday the standard weekly unemployment related figures were released with both beating expectations. On Friday the releases everyone was waiting for were released. Overall unemployment in the US was shown to have declined by one tenth of a percent from 5.9 down to 5.8 percent, which is good, but the payroll figures failed to keep up. Both nonfarm public and private payroll figures came in below expectations and indicate that the decline in the overall unemployment rate was not due to people finding jobs, but rather people stopping looking for work. Wrapping up the week last week was the September reading of consumer credit, which came in at $15.9 billion, very close to the expected $16 billion and indicated that the US consumer was in fact able to access money through credit despite the tighter lending standards that many financial institutions are employing.

 

This week is a very slow week for economic news releases with only one release that realistically has the potential to move the overall markets, which is highlighted in green below:

 

Date Release Release Range Market Expectation
11/13/2014 Initial Claims Previous Week 280K
11/13/2014 Continuing Claims Previous Week 2353K
11/13/2014 JOLTS – Job Openings September 2014 4 M
11/14/2014 Retail Sales October 2014 0.30%
11/14/2014 Retail Sales ex-auto October 2014 0.20%
11/14/2014 University of Michigan Consumer Sentiment Index November 2014 87.5

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts out on Thursday with the release of the initial and continuing jobless claims for the previous week, with both figures expected to be slightly higher than they were two weeks ago. Also released on Thursday is the JOLTS jobs report, which is expected to show a reading of about 4 million jobs. Since this is old data, in that the government already released its unemployment figures for the month of October, it would take a very wide deviation from expectations to get the markets to react to this release. On Friday the release of the week is set to be released, that being the retail sales figure for the month of October, which is expected to show a slight increase of 0.3 percent during the month overall and 0.2 percent when excluding auto sales. With the sales figure potentially being so close to zero we could see a bit of a negative market reaction if this reading goes sub zero. I think there is more risk of a poor reading on this release than a positive surprise after all of the other October consumer related information that has come out recently. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of November (first estimate), which is expected to show a slight increase over the final number from October, but nothing big enough to get excited about. In addition to the scheduled economic news releases this week also has five Federal Reserve officials giving speeches on a wide variety of topics. The market will for sure be watching each of these speeches closely for any sign as to when the Fed may start to increase interest rates.

 

Fun fact of the week:

Catalonia once stood alone. History revisited:

 

The first reference to Catalonia and the Catalans appears in the Liber maiolichinus de gestis Pisanorum illustribus, a Pisan chronicle (written between 1117 and 1125) of the conquest of Minorca by a joint force of Italians, Catalans, and Occitans.

 

Source: Sussle.org

For a PDF version of the below commentary please click here Weekly Letter 11-3-2014

Commentary at a glance:

-US markets continued to march higher last week heading into the midterm US elections.

-Japan launches surprise quantitative easing—here we go again!

-Election time is upon us here in the US and it is going to be a nail biter.

-The Fed has finally drawn their latest round of quantitative easing to an end.

-Economic news releases in aggregate came in at market expectations.

 

Market Wrap-Up: Last week saw all three of the US markets continue to move higher, thanks in large part to earnings announcements and the surprise stimulus from the Bank of Japan. Overall the volume last week was nothing all that exciting as it was just about average compared to what we have seen over the past year. I have redrawn the charts below this week to show the previous high level of the past three months, depicted by the red lines, on all three of the indexes; while keeping the red line for the VIX on the lower right chart representing the average level of the VIX over the past one year:

4 charts 11-3-14

With the rally that started a little more than two weeks ago, the three major US indexes have now made back all of the lost ground and exceeded the previous highs made just before the decline occurred. At this point, from a technical standpoint, it is a bit of a toss up to decide which of the indexes is the strongest. The Dow (upper right pane above) may have a little bit of an edge as it has the strongest velocity moving higher and is also the furthest above the previous high level. The S&P 500 (upper left pane) and the NSADAQ (lower left pane above) are almost exactly tied from a technical standpoint. At this point it looks like the three major US indexes have probably moved up too much too fast. The markets cannot move in just straight lines one way or the other without taking steps back here and there. A little bit of a pull back is highly likely. However, the pull back that is likely to follow in the near future is not likely to be very strong, especially when you look at the VIX as an indicator of the volatility expected in the near future. The VIX last week moved right back down to the 52-week average level (signified by the red horizontal line) and does not look to be in any hurry to reverse course any time soon.

 

National News: National news last week focused on two main topics with the first being the midterm election being held tomorrow across the US and the second being the statement from the Federal Reserve, which was put out after the monthly meeting held on Wednesday last week. The midterm election in the US is being held tomorrow, November 4th, in many states across the country and the outcome of the election could have an impact on what happens in Washington DC over the next two years. Below is a map, provided by Real Clear Politics and JP Morgan Asset Management, of the US with the US Senate races and their predicted outcomes:

election map 11-3-14

As you can see, the results will be very close, but the majority of polls are indicating that the Republicans are likely to take control of the US Senate while maintaining the control of the House of Representatives. In many cases, however, the margin of error in the polls is as large and the margin of victory predicted, which means it is too close to call. One thing seems pretty clear and that is that we will have continued grid lock in Washington DC as both sides of the aisle dig in their heels on a variety of topics. Since the Republicans do not have the numbers to override a Presidential veto, we will likely see very little meaningful legislation over the next two years. In total, there are about 11 seats up for grabs this time around and we may very well not know the outcome of the election until early next year after potential runoff elections in states such as Georgia, which if very close will be forced into a runoff. Other than the elections, the Federal Reserve was in the spot light this last week after concluding its monthly meeting.

 

The Federal Reserve met over Tuesday and Wednesday last week, at the end of the meeting releasing a statement that kept interest rates unchanged. In addition to the interest rate decision, the press release also officially ended the government’s bond buying program known as quantitative easing (QE) as the tapering program was allowed to run its course through the end of October. The Fed left its “considerable time” estimate on the amount of time interest rates will remain low after the end of QE. While there were several changes in the Fed language, most Fed watchers saw the statement last week as slightly more hawkish than it has been in the past as it noted improvement in the US labor market, despite the financial troubles starting to appear in other parts of the world. In addition to all of the above mentioned information coming out about the US over the course of the past week, it was also the heart of third quarter earnings season.

 

Third quarter earnings season continued last week with the number of companies having reported earnings now having passed 70 percent. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see, there were more positive than negative results. Negative earnings surprises are highlighted in red, while positive surprises in excess of 10 percent are highlighted in green:

 

Aetna 13% Coach 18% Iron Mountain -10% Sherwin-Williams 7%
Aflac 6% ConocoPhillips 10% Kellogg 1% Sirius XM Radio 0%
Allstate 2% Crocs 114% Kraft Foods Group 4% Southern 2%
Altria Group 1% Cummins 2% LinkedIn 100% Spirit Airlines 5%
AmerisourceBergen 5% Denny’s 11% Manitowoc -20% Starbucks 0%
Amgen 12% Electronic Arts 44% Marriott International 5% Starwood Hotels 2%
Arrow Electronics 7% Equity Residential 1% MasterCard 14% Sturm Ruger -70%
Arthur J. Gallagher 0% Exxon Mobil 11% Merck & Co 2% SunPower 9%
Atmel 0% Facebook 0% Metlife 16% Time Warner Cable -2%
AutoNation 5% Freeport-McMoRan 3% MGM Resorts -133% T-Mobile -500%
Avis Budget Group 7% Gilead Sciences 9% New York Times 400% Twitter 0%
Ball 5% GNC 1% Noble Corporation 6% Visa 3%
Big 5 Sporting Goods 26% Goodyear Tire & Rubber 23% Noble Energy -22% Waste Management 6%
BorgWarner 0% GoPro 500% Owens & Minor -9% WellPoint 4%
Buffalo Wild Wings 8% Groupon 75% Panera Bread -3% Western Union 13%
Cardinal Health 3% Hanesbrands 1% Parker Hannifin 14% Weyerhaeuser 10%
CBRE Group 11% HealthSouth 10% Pfizer 2% Whirlpool -3%
Chevron 16% Hershey -3% Phillips 66 20% Wisconsin Energy 12%
Cliffs Natural Resources 320% Hess 16% Public Storage 0% Wynn Resorts 7%
Clorox 2% Hyatt Hotels -23% Ralph Lauren 10% Xcel Energy -4%

 

Energy was a focus last week in the companies that released earnings and for the most part the earnings were pretty good with the big players seeing earnings beat by about 10 percent, despite the decline in the price of oil that started at the end of the third quarter. The other focus of earnings last week was the US consumer and here the picture was a little less positive, with companies such as T-Mobile, Sturm Ruger, Hyatt and Hershey all having a tough quarter. Visa and MasterCard both turned in nice results for the quarter as they saw increased usage of credit cards during the quarter.

 

According to Factset Research we have now seen 362 (72 percent) of the S&P 500 companies release their results. Of the 362 that have released, 78 percent of them have met or beaten earnings estimates, while 22 percent have fallen short of expectations. This 78 percent figures is 3 percentage points higher than it was last week and remains well above the 1- and 5-year average level of the percentage of companies that beat expectations on an earnings per share basis. When looking at revenue last week, the figures became slightly worse for third quarter earnings as now only 59 percent of companies are beating estimated revenues with 41 percent falling short. This 59 percent represents a 1 percentage point decline over the 60 percent figure we saw two weeks ago. What this continues to tell us is that companies are beating estimates not because of sales, but because of other actions such as lowering costs or other management wizardry and the magic of corporate accounting. Being near the three quarter mark for earnings, we are starting to get to that point where it would be difficult mathematically for the numbers of companies beating expectations to drastically change from the figures above.

 

This week is the second busiest week for earnings releases for the third quarter of 2014 as there are more than 1,400 companies releasing their results. Many of these companies are lesser known companies, but there are still some household names. Below is a table of the better known companies releasing earnings with the potentially most impactful releases highlighted in green:

 

Alexander & Baldwin El Pollo Loco Qualcomm
AOL Famous Dave’s of America Scripps Networks
Aqua America Hain Celestial Group SolarCity
Archer Daniels Midland Humana South Jersey Industries
Babcock & Wilcox International Paper Sprint
Black Diamond J & J Snack Foods Sprouts Farmers Market
Bloomin’ Brands Jack Henry & Associates St. Joe
Boulder Brands Kate Spade & Sysco
Burger King Worldwide King Digital Entertainment Tesla Motors
CenturyLink LeapFrog Enterprises Texas Roadhouse
Chiquita Brands Level Communications Time
Church & Dwight Liberty Media Time Warner
Consolidated Edison Molson Coors Brewing Transocean
Cooper Tire & Rubber News Corp Valero Energy
CVS Health Noodles & Co Walt Disney
DaVita HealthCare Office Depot Wendys
DIRECTV Papa John’s International Whole Foods Market
DISH Network Prudential Financial Zillow

 

The focus of this week’s earnings results will be mainly on consumer product related companies. Tesla will be very closely watched to see if it is making any money with the limited number of vehicles it can produce in a quarter and the strong demand for its current vehicle as well as new models like the all wheel drive Tesla Model S. Whole Foods will also be an interesting release to watch as it is actively starting a new campaign against the stigma of being the “Whole Paycheck” grocery store. After this week there is a sharp drop off in the number of companies reporting earnings as we draw closer and closer to the end of the third quarter earnings season.

 

International News: International News last week was fairly uneventful until Friday when the Bank of Japan (BOJ) announced a surprise round of stimulus for the Japanese economy. The latest round of stimulus is going to increase the BOJ’s bond buying program to about 80 trillion yen per year, which is an increase of between 10 and 20 trillion yen more than originally planned. The money will be used to buy ETFs, J REITs and Japanese government bonds. This expansion of the quantitative easing is a sort of admittance of the problems Japan is still having, despite all of the money the country has thrown at its struggling economy—an economy that has been struggling for more than 20 years. This move comes on the back of weak economic announcements recently released about Japan, including one that showed that GDP in Japan is likely to have contracted by 7.1 percent during the second quarter of 2014. This attempt to pick up the economy comes as the economy continues to struggle with the consumption tax, which was implemented as part of Abenomics back in April of 2014, before yet another increase in taxes is set to take place in late 2015. At this point, the central bankers in Japan and much of the Japanese government are really trying to throw everything they can think of at the problem of a softening and weakly growing economy. For more than the past two decades, nothing they have tired has worked out particularly well, so why not give this new expansion of cheap money a run?

 

Market Statistics: Last week saw all three of the major US indexes move higher by more than 2.5 percent on average volume as they made it two strong weeks in a row following the steep drop we saw during the start of October:

 

Index Change Volume
Dow 3.48% Average
NASDAQ 3.28% Average
S&P 500 2.72% Above Average

 

Much of the outperformance of the Dow this last week can be attributed to earnings results from a few key members of the Dow. Visa in particular saw a jump of more than 13 percent during the week after it announced positive earnings results. Johnson and Johnson also helped push the Dow higher as it turned in a gain of 4.51 percent. In fact, the only company that is a Dow 30 component stock that turned in loss during the week was Wal-Mart, which saw a decline of 0.14 percent for the week.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Semiconductors 5.44% Home Construction -0.12%
Regional Banks 4.86% Basic Materials 0.49%
Financial Services 4.63% Natural resources 0.76%
Telecommunications 4.14% Energy 1.60%
Software 3.96% Real Estate 1.79%

The only real surprise last week in the sector movement was the fact that the Home Construction sector managed to be the sole sector of the market to turn in a decline in performance. This was largely due to the sector perhaps getting a little ahead of itself over the past few weeks as the optimism about the US housing market seems to be fading slightly in some key areas of the country.

With continued gains in the broad equity markets last week it was not surprising to see that fixed income had a second tough week as investors continued to move from the safety of bonds into the high flying equity markets:

Fixed Income Change
Long (20+ years) -0.39%
Middle (7-10 years) -0.53%
Short (less than 1 year) -0.01%
TIPS -0.19%

While there was some reaction to the Federal Reserve announcement, the fixed income market last week was largely uneventful. The majority of the fixed income market was down less than one half of a percent as there was some adjustment in some institutional portfolios to the new language of the Fed statement. Last week the value of the US dollar advanced by 1.36 percent against a basket of international currencies. The strongest of the currencies last week was the Australian dollar, for the second week in a row, as it gained 0.14 percent against the US dollar. Not surprising, the Japanese Yen had the hardest time this week with the majority of the weakness being on Friday after the announcement of the new BOJ actions. In total, the Japanese Yen fell by 3.67 percent against the US dollar over the course of the week, briefly hitting 111 yen to $1 US dollar on Friday.

Commodities were mixed last week as the metals moved noticeably lower, while oil finally had a relatively calm week.

Metals Change Commodities Change
Gold -4.81% Oil 0.01%
Silver -6.06% Livestock -1.40%
Copper -4.10% Grains 5.51%
Agriculture -0.19%

The overall Goldman Sachs Commodity Index turned in a gain of 0.43 percent last week, while the Dow Jones UBS Commodity Index advanced by 1.35 percent. After falling for several months, oil finally had a steady week last week, hardly moving at all, which was a great relief to many investors in the oil markets. Grains saw a nice pop as a lot of the harvest is starting to come in throughout the US prior to the onset of winter. Metals were interesting to watch last week as both the precious and non-precious metals were hit hard as investors seemed to be indiscriminately selling in favor of other assets classes.

All of the major global indexes advanced last week with Asia and Latin America leading the way higher. The best performance globally last week was found in Brazil, after being the worst performer two weeks ago, with the Sao Paulo based Se BOVESPA Index advancing by 5.17 percent. Canada saw the worst performance of the week as the Toronto base TSX Index gained only 0.48 percent.

With the all of the indexes moving higher it was not surprising to see the VIX continue to free fall back to earth from its previous spike. Last week the VIX declined by 12.91 percent. We have now seen the VIX decline by almost 50 percent over the course of only the past two weeks. After the decline seen last week, the VIX is now almost exactly on top of the 1-year average level of the VIX. At the current level of 14.03, the VIX is implying a move of about 4.05 percent over the course of the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 10/31/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 2.66 % 4.25 %
Aggressive Benchmark 2.25 % 2.45 %
Growth Model 2.20 % 5.43 %
Growth Benchmark 1.74 % 1.99 %
Moderate Model 1.63 % 5.84 %
Moderate Benchmark 1.24 % 1.51 %
Income Model 1.28 % 5.65 %
Income Benchmark 0.63 % 0.89 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

We made no changes in any of our models over the course of the previous week. The investments we own by and large performed very well last week despite the continued increase in the markets. One bright spot I wanted to point out in our investment last week was AmerisourceBergen (ABC) as the company released its latest quarter earnings results, beating analyst expectations by nearly 5 percent. The more impressive thing in the release was that it provided guidance for full year 2015 that was 10 to 13 percent above the expectations the company had released just three months ago. One of the main drivers of the outperformance of ABC has been the agreement signed with Walgreens during the middle of 2013 and this partnership really seems to be bearing fruit. On the announcement day of the above news last week, the stock jumped up by 6.4 percent.

 

Economic News:  Last week was an eventful week on the economic news releases front; in aggregate the releases came in slightly below market expectations. Below is a table of the releases with the releases that significantly missed expectations highlighted in red, while the ones that significantly beat expectations are highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 10/27/2014 Pending Home Sales September 2014 0.30% 0.50%
Negative 10/28/2014 Durable Orders September 2014 -1.30% 0.60%
Negative 10/28/2014 Durable Goods -ex transportation September 2014 -0.20% 0.50%
Neutral 10/28/2014 Case-Shiller 20-city Index August 2014 5.60% 5.50%
Positive 10/28/2014 Consumer Confidence October 2014 94.5 87.2
Neutral 10/29/2014 FOMC Rate Decision October 2014 0.25% 0.25%
Neutral 10/30/2014 Initial Claims Previous Week 287K 284K
Neutral 10/30/2014 Continuing Claims Previous Week 2384K 2375K
Slightly Positive 10/30/2014 GDP-Adv. Q3 2014 3.50% 3.00%
Neutral 10/31/2014 Personal Income September 2014 0.20% 0.30%
Negative 10/31/2014 Personal Spending September 2014 -0.20% 0.10%
Neutral 10/31/2014 PCE Prices – Core September 2014 0.10% 0.10%
Positive 10/31/2014 Chicago PMI October 2014 66.2 60
Neutral 10/31/2014 University of Michigan Consumer Sentiment Index October 2014 86.9 86.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started out on Monday with an uneventful release of pending home sales for the month of September, which was a little surprising given the strength we saw in the housing numbers two weeks ago. On Tuesday the durable goods orders for the month of September were released and both readings were negative. Overall orders fell by 1.3 percent versus an expected increase of 0.6 percent, while orders excluding transportation declined by 0.2 percent when it was expected that they would increase by 0.5 percent. Durable goods orders are seen as a good indicator of the overall health of the economy in the US because these goods are typically high dollar goods and not something people and companies purchase when the economy is either not good or the consumer thinks it may not be good in the near future. One aspect of this indicator is that it can change wildly with government spending and spending by businesses on aircraft since planes are so expensive, but this did not seem to be the case for this release as the slowdown was across the board. Helping to offset some of the negative news of the day on Tuesday was the release of the October reading of consumer confidence, as measured by the US government. According to the data, confidence rose from a reading of 89 in September to 94.5 in October, with the 94.5 reading being the highest level we have seen in the past 7 years. This is very positive. If only the government could figure out how to make these very confident people actually spend money and help the economy we could really get this US economy moving forward quickly. On Wednesday the Fed released its latest interest rate decision as well as a statement about ending QE. Initially the markets did not seem to like this release, but they settled down toward the end of the day causing the release to become pretty uneventful. On Thursday the standard unemployment related figures were released with both coming in very close to market expectations. Also released on Thursday was the advanced estimate for third quarter GDP, which the government showed increased by 3.5 percent during the quarter, slightly better than the 3.0 percent that was expected. The advanced GDP estimate, however, is notorious for being revised, so not a whole lot of weight was given to this release. On Friday, more mixed data was released with personal income and spending coming out first. Personal income was shown to have increased slightly during September, but spending was shown to have decreased slightly. With these two releases, plus the durable goods orders earlier in the week, I think it is safe to say that the US consumer is pretty confused about the health of the overall US economy. Later during the day on Friday the Chicago area PMI was released and showed that manufacturing in the greater Chicago area increased by more than was expected during the month of October, which is a positive sign for the US economy, but a sign that would have to be validated by other regions also seeing an uptick in manufacturing prior to it being fully believed by the markets. Wrapping up the week on Friday last week was the release of the University of Michigan’s Consumer Sentiment Index for the month of October, which came in almost exactly in line with expectations and was largely ignored by the markets.

 

This week is a typical week for economic news releases, but we do have a few extra month-end related releases. The focus of the week will be on employment in the US. The releases that have the highest potential to move the markets are highlighted in green:

 

Date Release Release Range Market Expectation
11/3/2014 ISM Index October 2014 56.2
11/5/2014 ADP Employment Change October 2014 220K
11/5/2014 ISM Services October 2014 58.0
11/6/2014 Challenger Job Cuts October 2014 N/A
11/6/2014 Initial Claims Previous Week 285K
11/6/2014 Continuing Claims Previous Week 2380K
11/7/2014 Nonfarm Payrolls October 2014 235K
11/7/2014 Nonfarm Private Payrolls October 2014 228K
11/7/2014 Unemployment Rate October 2014 5.9%
11/7/2014 Consumer Credit September 2014 $16.0 B

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts out on Monday with the release of the ISM Index for the month of October, which is expected to show almost no change compared to the level seen in September. On Wednesday the first of the employment related figures of the week is set to be released with the ADP Employment change figure for the month of October. The change expected in the ADP figure is for about 220,000 new jobs to have been added during the month. Any major deviation from this figure will likely have economists changing their predictions for the other employment related figures to be released later during the week, but this type of deviation would be very rare. Also released on Wednesday is the services side of the ISM Index, which is expected to show that services during October stayed about the same as they were in September. On Thursday the standard weekly unemployment related figures are set to be released with very little change expected on either of the data points when compared to the previous week. On Friday, the releases everyone will be waiting all week to be released will finally be released. The official unemployment in the US for the month of October will be released with expectations that there will be no change from the 5.9 percent level seen during September. As always the market will likely pay much more attention to the nonfarm public and private payrolls for direction as to what is actually happening with the US job market. The participation rate in the labor force will also be closely watched as it is a key figure the Fed watches. If all of these releases go as expected it should be a pretty uneventful set of employment releases, but if not the market could react either positively or negatively very quickly. The week wraps up with the release of consumer credit for the month of September, which is expected to show an expansion of $16 billion.

 

Fun fact of the week:

Voters speak in Brazil:

 

In 1959, the elected winner in the city council election in Sao Paulo was Cacareco, a five-year old female rhinoceros at the local zool. Cacareco won by a landslide, with 100,000 votes (15% of the total votes), representing one of the highest totals for a local candidate in Brazil’s history to date.

 

Source: New York Times

For a PDF version of the below commentary please click here Weekly Letter 10-27-2014

Commentary at a glance:

-Staying in roller coaster mode, last week saw some of the best performance of the past year.

-Stress test results are in and do not look all bad.

-Earnings season continues to move forward with the results being less than stellar.

-Brazil has re-elected Dilma Rousseff as President; the stock market fell.

-Economic news releases in aggregate came in at market expectations.

 

Market Wrap-Up: What a difference one week can make from the stand point of a technical analysis. Gone is the negative assessment of all three of the major indexes and the VIX, which seems to have nearly forgotten why it spiked to the highest level we have seen in the past two years. Below are my standard charts with the various indexes drawn in green lines, while their most recent trading channels have been drawn in red. The VIX is the odd man out as its chart shows the VIX in green and the one-year average level of the VIX in red:

4 charts 10-27-14

As you can clearly see above, all three of the major indexes turned in a heroic move last week, in one case even breaking out of the recent trend channel analysis. The NASDAQ (lower left pane above) is clearly the strongest of the three major indexes at this point. This is for a few different reasons. First, the NASDAQ broke into its most recent trading channel early last week. The index then proceeded to break right through the trading channel to the upside, only to fall back down to the upper bound of the channel and bounce off of it to the upside. Along the way the index also managed to easily move through various other resistance levels, such as the low point seen back in August and the low point reached prior to the decline in early October. At this point the next major level of resistance will be the high level hit multiple times during September. The S&P 500 (upper left pane above) and the Dow (upper right pane above) are both in roughly similar boats, as they technically broke into and through their most recent trading channels, but with a slight hiccup in the middle of the move. Both of these indexes need to come back down to test the upper bound of the trading channel and bounce higher for them to get to the same technical conviction level as the NASDAQ. One area of caution surrounding the move is the volume with which the move was made. Volume went from being very high two weeks ago, to just average, and this could mean that while the move was nice last week it may not last; more on this topic below in the Market Statistics section. While the indexes were moving sharply higher the VIX was headed in the opposite direction, falling by more than 24 percent during the course of the week, nearly fully erasing the spike that had occurred over the previous few weeks.

 

National News: National news last week seemed to be all about the rally in the global financial markets. While there were very few concrete reasons for such a rally to have taken place, the pundits in the media were glad to talk about something other than declining markets. One of the most talked about drivers for the market performance last week was earnings season and the fact that 75 percent of the companies that have reported earnings have beaten estimates. While this may sound good at first glance, you may remember that expectations for the third quarter earnings season are very low. They had seemingly been revised down every week since the end of the second quarter. So while more companies are beating earnings than was expected, they are doing so mainly because of the extremely low bar set for expectations.

 

Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

3M 1% Ford Motor 26% PulteGroup 3%
Amazon.com -30% General Dynamics 7% Raytheon 2%
American Airlines Group 2% General Motors 2% Reynolds American 4%
Apple 9% Genuine Parts 1% Simon Property -6%
AT&T -2% Halliburton 8% Six Flags Entertainment -28%
Boeing 9% Harley-Davidson 15% Texas Instruments 7%
Bristol-Myers Squibb 10% IBM -14% Tractor Supply 8%
Cabela’s -6% Janus Capital Group 0% Travelers Companies 19%
Caterpillar 29% Kimberly-Clark 5% U.S. Bancorp 0%
Chipotle Mexican Grill 8% Lexmark International 13% Under Armour 3%
Chubb 11% Lockheed Martin 1% Union Pacific 1%
Coca-Cola 2% McDonald’s 11% United Technologies 1%
Colgate-Palmolive 1% Microsoft 10% Verizon Communications -3%
Cree -46% Northrop Grumman 7% VF -1%
Dow Chemical 7% Occidental Petroleum -5% Waste Connections 4%
Dr Pepper Snapple 11% O’Reilly Automotive 6% Werner Enterprises 0%
Dunkin’ Brands 4% Overstock.com 17% Wyndham Worldwide 2%
Eli Lilly and 0% Owens Corning 26% Xerox 4%
Ethan Allen Interiors 26% Procter & Gamble -1% Yahoo! 105%

 

As you can see above, there continues to be more green than red, which is a good sign for the quarter.  However, one of the red earnings numbers was particularly concerning, that being Amazon. Amazon has long been a darling company that is either loved or hated by investors, but few can argue that Amazon is not innovative. When Amazon missed estimates by 30 percent this quarter, however, some investors started to cry foul as CEO Jeff Bezos seems willing to spend all of the money Amazon makes on obscure technologies and ideas that seem to not pan out. One of the latest items was the major loss the company took on the Amazon Fire Smart phone, which failed to sell. The company still has millions of the phones and cannot currently get rid of them. In stark contrast to Amazon is Overstock.com, which turned in a very nice quarter, beating expectations by 17 percent as the company focused on what makes it good, which is selling items online, not working up some massive new technology. According to Factset Research we have now seen 208 of the S&P 500 companies release their results. Of the 208 that have released 75 percent have met or beaten earnings estimates while 25 percent have fallen short of expectations. This 75 percent figure is above both the one-year and five-year average of companies beating expectations. When looking at revenue the picture is a worse as only 60 percent of companies have reported better than expected sales, while 40 percent have missed estimates. What this tells us is that companies are beating estimates not because of sales, but because of other actions such as lowering costs or through other management wizardry and the magic of corporate accounting. We are still a long way from the end of the third quarter earnings season, but so far the overall outlook is mixed.

 

This week is the single busiest week for earnings releases for the third quarter of 2014 as there are more than 1,500 companies releasing their results. Below is a table of the better known companies releasing earnings with the potentially most impactful releases highlighted in green:

 

Aetna Coach Iron Mountain Sherwin-Williams
Aflac ConocoPhillips Kellogg Sirius XM Radio
Allstate Crocs Kraft Foods Group Southern
Altria Group Cummins LinkedIn Spirit Airlines
AmerisourceBergen Denny’s Manitowoc Starbucks
Amgen Electronic Arts Marriott International Starwood Hotels
Arrow Electronics Equity Residential MasterCard Sturm Ruger
Arthur J. Gallagher Exxon Mobil Merck & Co SunPower
Atmel Facebook Metlife Time Warner Cable
AutoNation Freeport-McMoRan MGM Resorts T-Mobile
Avis Budget Group Gilead Sciences New York Times Twitter
Ball GNC Noble Corporation Visa
Big 5 Sporting Goods Goodyear Tire & Rubber Noble Energy Waste Management
BorgWarner GoPro Owens & Minor WellPoint
Buffalo Wild Wings Groupon Panera Bread Western Union
Cardinal Health Hanesbrands Parker Hannifin Weyerhaeuser
CBRE Group HealthSouth Pfizer Whirlpool
Chevron Hershey Phillips 66 Wisconsin Energy
Cliffs Natural Resources Hess Public Storage Wynn Resorts
Clorox Hyatt Hotels Ralph Lauren Xcel Energy

 

Energy will be the focal point of earnings this week as nearly all of the major integrated oil and gas companies from around the world release their earnings for the third quarter. Of particular interest during these releases will be the impact, if any, of the operations of companies operating in west Africa, as we have already heard from companies like Exxon that have warned financials could be impacted by the Ebola outbreak. Two other companies that will be closely watched are MasterCard and Visa as both of these companies combined process and majority of credit card payments made in the US and typically have a good feel for consumer spending. Add in the smattering of consumer product companies such as Starbucks, Ralph Lauren, T-Mobile and Coach and it should make for an interesting week of results.

 

International News: International news last week focused mainly on a few old stories that are starting to make headlines yet again. The main focus of financial news last week was the release of the European Central Bank (ECB) banking stress tests, which were released on Sunday. In total there were 24 banks that “failed” the stress test, but of the 24, ten fixed the problem between being notified by the ECB and the release of the report, so there are only about 14 banks that still need some work. Of those 14 it is not surprising to see that four of them are in Italy, two are in Greece and the balance are in very small European countries such as Cyprus and Slovenia. With the stress test completed, what does it mean for the remaining troubled banks? Very little. The banks have only to come up with and implement a plan to strengthen their balance sheets enough to pass the test. Most likely it means the individual countries in which the banks are located will bail them out by backing the companies. In some instances it means the banks may have to borrow funds from the ECB directly. Overall, the test shows that the banks in Europe have largely cleaned up their assets and business models since the decline in 2008, which is good since it does not look like Europe is currently on steady financial footing. Stress in the Euro zone has recently lead the ECB to start buying bonds in a form of quantitative easing very similar to the QE the US Federal reserve launched under Ben Bernanke several years ago, which is currently being tapered. It will take a while to see if the ECB can do enough to stabilize the European economy or if the European economies will continue to fall further and further back into a recession. One wild card that remains with the situation in Europe is the natural gas normally supplied by Russia. Russia is still fighting over part of Ukraine and backing the rebels, so as winter draws near we may see increasing tension between the two sides. Ukraine knows it is in trouble this winter if the dispute is not settled. In other international news last week, Dilma Rousseff won re-election as President in Brazil in a runoff election that was finalized over the weekend. This result means there will likely be little change in the form of a more friendly business environment in Brazil and is largely why the main financial market in Brazil, the SE BOVESPA, declined by more than 6 percent over the course of the past week.

 

 

Market Statistics: Last week saw all three of the major US indexes move substantially higher on average volume as they turned in one of their best weeks in the past year:

 

Index Change Volume
NASDAQ 5.29% Average
S&P 500 4.12% Average
Dow 2.59% Average

 

While all three of the major indexes saw strong performance during the week, the performance was a little awkward as it was done on average volume. After seeing some of the highest volumes of the year two weeks ago when the markets were moving lower, seeing such weak relative volume on the upside last week gives some pause for concern. Clearly not all of the investors who were hurt two weeks ago in the decline jumped back into the markets last week for the bounce, so there must be a bit of money waiting on the sidelines. Will the money be engaged or will it be perfectly content to remain on the sidelines and watch as the market tries to make sense of all of the contradicting information that is suddenly making headlines around the world.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Biotechnology 8.82% Materials 1.60%
Healthcare 6.79% Consumer Staples 1.78%
Semiconductors 6.73% US Telecommunications 1.99%
Medical Devices 6.03% Global Telecommunications 2.33%
Pharmaceuticals 5.83% Residential Real Estate 2.46%

Last week the sectors that performed the best were almost an exact copy of the sectors of the markets that saw the worst performance two weeks ago. This is not uncommon when the markets are chopping wildly as investors buy and sell risk in their accounts. Last week it was Biotechnologies’ turn to shine as it moved back into the best performing sector of the markets for 2014, so far just barely edging out the strong performance we have seen in real estate. On the flip side it was not surprising to see that materials, consumer staples and telecommunications saw the weakest performance of the week last week as these are some of the main sectors investors view as safe havens. When the markets turn into rally mode, many investors pull from less risky assets and put the money into more risky assets as they “chase” the markets. This is largely what was driving the performance of the various sectors of the markets over the past week.

With such strong gains in the broad equity markets last week it was not surprising to see that fixed income by and large had a difficult week as investors moved from the safety of bonds into the high flying equity markets:

Fixed Income Change
Long (20+ years) -1.12%
Middle (7-10 years) -0.49%
Short (less than 1 year) 0.02%
TIPS -0.62%

There was no flash crash with yields declining to under 2 percent as they did two weeks ago, and there was no apparent reason for investors to stay in long US government bonds, which they sold in large numbers, pushing the prices down as they shifted their allocation toward stocks. The long end of the yield curve (20 + years) was hit the hardest last week while the short term bonds (less than one year) saw a very slight rally. TIPS continued to struggle as there is just no sign of inflation in any meaningful amount coming out of any of the government’s economic data points. Last week the value of the US dollar advanced by 0.53 percent against a basket of international currencies. The strongest of the currencies last week was the Australian dollar as it gained 0.50 percent against the US dollar. The Euro will be in the spotlight this week as the results of the ECB banking stress tests are digested by the markets and the economies of the Euro continue to struggle with large amounts of weakness.

Commodities were mixed last week as investors moved gold lower after a strong week two weeks ago, while the soft commodities moved higher and oil continued its path downward:

Metals Change Commodities Change
Gold -0.54% Oil -2.10%
Silver -0.48% Livestock 1.13%
Copper 1.13% Grains 1.64%
Agriculture -1.64%

The overall Goldman Sachs Commodity Index turned in a loss of 0.50 percent last week, while the Dow Jones UBS Commodity Index declined by 0.35 percent. Oil continued to slide, last week falling by 2.10 percent as supply continued to outpace demand by a wide margin and Saudi Arabia continues to make no major changes in its output of oil. Oil has now fallen 24 percent since the middle of June in what is turning into one of the longest and steepest declines we have seen in the price of oil since it fell off a cliff back in 2008. But the continuously falling oil prices still means prices at the pump are likely to move even lower with many areas of the country likely to see prices move below $3 per gallon. According to the AAA fuel gauge report, the nationwide average for a gallon of gasoline is currently $3.04, which is down six cents from last week and looks headed to move below $3. If you happen to live in the Southern part of the US you have already probably seen prices move below $3 as prices typically fall fastest near the large refineries before slowly spreading across the rest of the US.

Last week was a predominantly higher week for the global indexes with the majority of the major indexes advancing while there were only a handful of countries that turned in negative performance. The best performance globally last week was found in Japan with the Tokyo based Nikkei Index advancing by 5.22 percent. Brazil saw the worst performance of the week as the Sao Paulo based Se BOVESPA fell by 6.79 percent, thanks in large part to the Presidential election runoff that took place over the weekend and saw Dilma Rousseff retain control of the government.

With the major indexes all moving higher by such a large amount, it was not surprising to see that the VIX fell by more than 26 percent over the course of the previous week. During the decline last week we had something occur on the VIX that is very rare; the VIX fell by more than 10 percent three days in a row. Looking back in history to early 2006, we have not had another three-day period with declines in excess of 10 percent per day. We have only seen the VIX decline by more than 10 percent two days in a row 5 other times looking back over the same time period. With this in mind, the chart below visually shows just how fast the VIX (green line) has come back down, but it also shows that the VIX is in an uptrend, as signified by the light blue line:

VIX trend 10-27-14

The spike of the past three weeks is officially over at this point, but it is not without an impact. While the VIX may trend lower from here, it is still very high when compared to where it has come from, but it is currently at a healthy level, a level in which investors remember that risks are in the equity markets at all times. Hopefully, this reminder keeps them from becoming complacent about the risks of investing. At the current level of 16.11 the VIX is implying a move of about 4.65 percent over the course of the next 30 days and, as always, the direction of the move is unknown.

For the trading week ending on 10/24/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 3.20 % 1.79 %
Aggressive Benchmark 2.77 % 0.19 %
Growth Model 2.92 % 3.13 %
Growth Benchmark 2.16 % 0.25 %
Moderate Model 2.50 % 4.13 %
Moderate Benchmark 1.54 % 0.26 %
Income Model 2.31 % 4.31 %
Income Benchmark 0.77 % 0.26 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

We made no changes in any of our models over the course of the previous week. The investments we own by and large performed very well last week, despite such a large increase in the markets. The current allocation of holdings we own in the various models have been providing protection during the recent downward movements of the markets while, as shown last week, participating in a very good amount of the upside movements of the overall markets.

 

Economic News:  Last week was as neutral a week for economic news releases as we can get as all of the releases came in very close to market expectations with no surprise either positive or negative:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 10/21/2014 Existing Home Sales September 2014 5.17M 5.11M
Neutral 10/22/2014 CPI September 2014 0.10% 0.00%
Neutral 10/22/2014 Core CPI September 2014 0.10% 0.20%
Neutral 10/23/2014 Initial Claims Previous Week 283K 283K
Neutral 10/23/2014 Continuing Claims Previous Week 2351K 2390K
Neutral 10/23/2014 Leading Indicators September 2014 0.80% 0.60%
Neutral 10/24/2014 New Home Sales September 2014 467K 473K

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started on Tuesday with the release of the existing home sales figure for the month of September, which came in as expected and was largely overlooked by the markets. On Wednesday the Consumer Price Index (CPI) figure for the month of September was released and came in showing a one tenth of a percent increase, while the core CPI (CPI minus the volatile things like food and energy) figure showed the same small increase of one tenth of a percent. Both of these figures indicated that inflation is currently not an issue in the US economy. However, prices are rising at a pace that is slow enough to cause some concern at the Federal Reserve, as they would much rather have inflation than deflation, something some Europeans are likely to experience in the coming quarters. On Thursday the standard weekly unemployment related figures were released with both coming in very close to expectations and the markets not giving the releases a second thought. Later during the day on Thursday the Leading Indicators (LEI) figure for the month of September was released and came in very close to the estimated 0.6 percent with the reading being 0.8 percent. While this number is positive it was not surprising to the markets as the PEI is just a compilation of various other economic indicators pulled into just one figure. On Friday the New Home Sales figure for the month of September was released, with the figure coming in much like all of the other releases of the week, close to market expectations.

 

This week is a busy week for economic news releases as we have a bunch of month-end data being released at the end of the week, as well as some key economic growth figures earlier during the week. The releases that have the highest potential to move the markets are highlighted in green:

 

Date Release Release Range Market Expectation
10/27/2014 Pending Home Sales September 2014 0.50%
10/28/2014 Durable Orders September 2014 0.60%
10/28/2014 Durable Goods -ex transportation September 2014 0.50%
10/28/2014 Case-Shiller 20-city Index August 2014 5.50%
10/28/2014 Consumer Confidence October 2014 87.2
10/29/2014 FOMC Rate Decision October 2014 0.25%
10/30/2014 Initial Claims Previous Week 284K
10/30/2014 Continuing Claims Previous Week 2375K
10/30/2014 GDP-Adv. Q3 2014 3.00%
10/31/2014 Personal Income September 2014 0.30%
10/31/2014 Personal Spending September 2014 0.10%
10/31/2014 PCE Prices – Core September 2014 0.10%
10/31/2014 Chicago PMI October 2014 60
10/31/2014 University of Michigan Consumer Sentiment Index October 2014 86.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts off on Monday with the release of the pending home sales figure for the month of September, which is expected to show a half of a percent increase over the August levels. Since this release is pending sales it would take something drastic one way or the other to overshadow the housing figures for actual sales during September released last week. On Tuesday durable goods orders for the month of September will be released and expectations are pretty low with a gain of less than one percent on both overall orders and orders excluding transportation. We could see an upside surprise on this one. Later during the day on Tuesday the Case-Shiller 20 City Home Price Index for the month of August is set to be released, but as normal the data is so stale the market will likely not notice the release. Being released at the same time, consumer confidence, as measured by the government, will likely be noticed by the markets. Confidence is expected to have increased slightly with most of the increase being explained by the declining price in gasoline and energy. On Wednesday the latest interest rate decision will be released by the Fed and the release will be closely watched. October is the month during which the tapering program is expected to come to an end and the Fed will stop buying bonds with new money on the open market. However, there is some speculation that given the weakness we have seen recently in the economic data, the Fed may hold off on ending the tapering program. The market will also be closely watching for any new language about when the Fed may increase interest rates. If the Fed stays with the game plan it has been using for the last year, there will be a few changes to the language, but the changes will be vague and undecipherable. On Thursday the focus of the day will be on the advanced reading for third quarter GDP, as estimated by the US government. Expectations are for a GDP reading of 3 percent growth during the quarter, which is well below the second quarter figure of 4.6 percent. This release could really have an impact on the overall market if it either beats or misses expectations by a meaningful margin, as the figure is used in all sorts of calculations about many financial instruments. Friday starts with the release of personal income and spending as well as PCE prices, all for the month of September. All three figures are expected to show very little change between August and September and would have to deviate widely from expectations to get a market reaction. Later during the day on Friday the Chicago area PMI for the month of October is set to be released and the market will be closely watching to see if the region can stay on the manufacturing expansion path it has been on for the past few months. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment index for the month of October, which is expected to show no change over the level seen at the mid-way point through October released two weeks ago. The only Fed official speaking this week is the Chairwoman herself, Janet Yellen, on Thursday, so the market will surely be tuned into that as well.

 

Fun fact of the week:

 

The Greek currency, the Drachma, was started around 670 BC and came to an end in 2002 when Greece adopted the Euro as their national currency.

Source:fleur-de-coin.com

For a PDF version of the below commentary please click here Weekly Letter 10-20-2014

Commentary at a glance:

-Hold on to your hats, the markets are in rollercoaster mode.

-Greece has once again made negative international headlines.

-VIX hit the highest level since late 2011 on Wednesday.

-Earnings season continues to roll, but caution is building.

-Economic news releases in aggregate came in significantly below market expectations.

 

Market Wrap-Up: The markets last week kept with the spastic trading we have seen over the past few weeks as it was a very wild ride for most investors. Technically, everything still does not look very strong. I kept the most recent trading channels (red lines) below because these levels will be key levels of support should the markets turn around and start to move higher in the coming days or weeks. The VIX chart also remains unchanged, showing both the VIX level in green and the 52-week average level (we are now well above this level) of the VIX in red:

4 charts 10-20-14

There was real fear in the markets on Wednesday last week. After negative news out of Europe tanked the European markets, the US markets gapped down. This gap down was followed by some negative economic news releases that helped push the markets down even further. In total the Dow was down more than 450 points at one point, the 10-year US government Bond hit a yield of 1.86 percent and the German 10-year Bund hit a yield 0.75 percent. The decline seemed to be a culmination of a few weeks of poor news, coupled with fears over Ebola, a slowdown in US manufacturing, Europe looking worse and oil prices continuing to fall. Why everything came to a head on Wednesday is a bit unknown, but it did and the markets reacted badly. With all of the poor news out about the markets, it was not surprising to see a Federal Reserve official make a statement in which there was a hint of keeping quantitative easing and potentially kicking out the interest rate hike even further into 2015. The damage had largely already been done, however, as the VIX spiked higher and reminded everyone that volatility still exists in the market. The VIX hit the highest level we have seen on the VIX since late 2011, briefly making it above 31.

 

From a technical standpoint, all three of the major indexes look very weak. The strongest of the three major indexes, technically, is the Dow (lower right pane above), which made it almost all of the way back to its most recent trend line. The S&P 500 (upper left pane above) and the NASDAQ (lower left pane above) are just about tied for last in technical strength. Both indexes have a long way to go to make it back to even the lower end of their most recent trend line. At this point it would not be surprising to see the markets bounce higher as the decline we have seen over the past three weeks has been very excessive. Perhaps the bounce started on Friday, but the volume seemed far too low for the move to be substantiated into this week as it was options expiration day. Both the S&P 500 and the NASDAQ have a significant way to go to make it back to the most recent low observed before the decline of last week. With earnings season not being as strong as some investors had hoped we could be in for a trying rest of October; a month that is typically a hard month anyways and does not need any help being more difficult than average.

 

National News: National news last week focused on Ebola and the wild market movements that were seen in the US markets. It may have been that Ebola spread to two nurses and potentially one more on a cruise ship, or maybe it was the poor economic data that was announced last week, but whatever the reason, last week was not a pleasant week for investors. One item touched on only briefly last week as the markets were performing badly was the fact that these latest data points may change the way the Fed is thinking. Fed Chair Janet Yellen follows data and does not attempt to be ahead of the curve in any manner. With slowing retail sales and falling prices at the producer level, thanks in large part to the decline in energy costs, the Fed may be forced to wait on raising interest rates next year. After the latest data was released, a poll from Bank of America showed that economists had on average moved their expectations of when interest rates will increase out to the fourth quarter of 2015 rather than the second quarter of 2015 emerging from the previous poll. While this would be good in the sense that cheap money will be around longer than excepted, it is bad because it will be around due to weakness that is starting to be seen in the US economy. Earnings season and the reactions of Wall Street, as well as companies’ forward guidance, may have much more of an impact on the movements of the markets than normal in the near term given the uncertainty in the economy.

 

Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

Advanced Micro Devices -25% eBay 2% Netflix 5%
American Express 1% General Electric 3% Overstock.com Pushed
Baker Hughes -11% Goldman Sachs 42% Philip Morris 5%
Bank of America 89% Google -8% RLI 13%
Bank of New York Mellon 5% Honeywell 1% Safeway 33%
BlackRock 12% Intel 2% SanDisk 9%
Capital One Financial 1% J B Hunt 2% Schlumberger 2%
Charles Schwab 0% Johnson & Johnson 6% Stryker 1%
Citigroup 3% JPMorgan Chase -2% United Rentals 7%
CSX 9% Kinder Morgan -3% UnitedHealth Group 7%
Del Frisco’s 14% Las Vegas Sands 0% WD-40 17%
Delta Air Lines 2% Mattel -7% Wells Fargo 0%
Domino’s Pizza 3% Morgan Stanley 20% Wolverine World Wide 7%

 

As you can see above, there is more green than red, which is a good sign for the quarter, but one of the red earnings numbers was particularly concerning, that being Google. Google is the quintessential bellwether for the technology industry and had a pretty far miss on its earnings. The results, however, were somewhat overshadowed as they were released right in the middle of the crazy trading that took place during the middle of the week last week. With so many companies announcing earnings last week we are starting to get a much better picture about the way third quarter earnings season will likely go in the future. According to Factset Research, we have now seen 82 of the S&P 500 companies release their results. Of the 82 that have released, 68 percent of them have met or beaten earnings estimates while 32 percent have fallen short of expectations. When looking at revenue, the picture is a little worse as only 63 percent of companies have reported better than expected sales while 37 percent have missed estimates. If these numbers keep up through the end of earnings season, third quarter earnings would in aggregate be positive, but much less positive than they were during the second quarter. We still have a long way to go on earnings announcements with this week being very busy.

 

This week we start to get more into the heart of earnings season as there are nearly 800 companies reporting earnings, some of which could really push the market around depending on what they release. Below is a table of the better known companies releasing earnings with the potentially most impactful releases highlighted in green:

 

3M Ford Motor PulteGroup
Amazon.com General Dynamics Raytheon
American Airlines Group General Motors Reynolds American
Apple Genuine Parts Simon Property
AT&T Halliburton Six Flags Entertainment
Boeing Harley-Davidson Texas Instruments
Bristol-Myers Squibb IBM Tractor Supply
Cabela’s Janus Capital Group Travelers Companies
Caterpillar Kimberly-Clark U.S. Bancorp
Chipotle Mexican Grill Lexmark International Under Armour
Chubb Lockheed Martin Union Pacific
Coca-Cola McDonald’s United Technologies
Colgate-Palmolive Microsoft Verizon Communications
Cree Northrop Grumman VF
Dow Chemical Occidental Petroleum Waste Connections
Dr Pepper Snapple O’Reilly Automotive Werner Enterprises
Dunkin’ Brands Overstock.com Wyndham Worldwide
Eli Lilly Owens Corning Xerox
Ethan Allen Interiors Procter & Gamble Yahoo!

 

The focus of this week’s earnings announcements will be on the US consumer. Companies like Apple, Amazon, Microsoft, Procter and Gamble and Verizon are all heavily dependent on the individual consumer. From the figures released during the quarter it would not be surprising to see a few of the major companies this week struggle on their earnings. One thing everyone is listening for on the various conference calls is what, if any, impact the company is seeing with the situation in Europe. So far about half of the companies that have announced earnings have spoken about the situation in Europe and about half of those have done so by identifying it as being a risk to their business going forward. It should be interesting to see what, if anything, companies such as McDonald’s and Coca-Cola say about the impact of the situation in Europe on their business, both during the quarter and going forward. Looking forward to the fourth quarter, according to Factset, we have seen ten companies announce that they expect their fourth quarter numbers to be worse than expected while only 3 companies have said they see figures above expectations for the fourth quarter of 2014.

 

International News: Greece made headlines last week and is being blamed as one of the culprits that led to the large decline seen globally on Wednesday. Fitch rating agency can be thanked for starting the scare about Greece as it released a report that showed that the banks in Greece are still very weak and could be in for real trouble when the European Central Bank (ECB) announces the results of its banking stress tests later this month. On Wednesday, following the Fitch announcement, the Greek stock exchange immediately tanked off, falling in excess of 10 percent, before the circuit breakers kicked in and halted trading. After the trading stop, the index did recover some, but still ended the day down more than 6 percent. Greek bonds, on the other hand, were being dropped like hot potatoes as the yield on the bonds pushed up to near 9 percent, starting from about 6 percent back in early October. The one year chart to the right from Bloomberg shows how fast the yields on the Greek debt spiked higher and how it was the highest level we have seen on the yields so far this year.Greek debt yield spike 10-20-14 With yields spiking and the equity market crashing it is easy to see why investors were spooked. The rest of Europe followed suit and moved lower, albeit much less than Greece, and ended the day with losses ranging from 2 to 4 four percent. This, taken with the recent weakness in Europe out of Germany, is likely the culprit behind the decline we saw on Wednesday. So where do we go from here? It is unlikely that the weakness being seen out of Greece will lead to contagion and everything going down. The main evidence of this is the fact that while the Greek bonds were spiking higher on Wednesday the other troubled countries bonds, such as Spain and Italy, were not jumping higher. In fact, they were not moving much at all. The main dark cloud over Europe right now is the bank stress tests the ECB performs and then releases on a semiannual basis. These stress test results will be released next weekend and we could see a bit of a reaction in the markets if the results are not favorable. Offsetting this fear is the fact that the ECB seems to have made it very clear that they are very close to starting to purchase sovereign bonds in their latest round of quantitative easing. It is an action that has been spoken about for more than 2 years and never actually undertaken. If the ECB does start to buy bonds, it would be a big step in the correct direction from the ECB.

 

Market Statistics: Last week saw all three of the major US indexes move lower on some of the highest volume we have seen so far during 2014:

 

Index Change Volume
NASDAQ -0.42% Highest in 2014
Dow -0.99% Very High
S&P 500 -1.02% Highest in 2014

 

As mentioned above, the markets had a bit of a wild ride last week, seeing the Dow decline at one point during the trading day on Wednesday in excess of 450 points. With the late Friday rally, however, the week actually looks relatively tame when looking at weekly data points compared to some of the wild moves we have been seeing over the past few weeks.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Home Construction 5.01% Medical Devices -3.20%
Transportation 3.53% Healthcare -2.43%
Semiconductors 2.76% Regional Banks -2.29%
Technology 2.62% Financial Services -1.59%
Industrials 2.09% Oil & Gas Exploration -1.58%

Last week was a very interesting week as it was more a story of the sectors that declined the least and then snapped back the furthest on Friday. Healthcare was one notable sector of the market that seems to have been left behind as it was sold profusely early in the week, but did not see the same bounce back that many of the sectors of the market saw during the Friday rally. On the positive side, several of the sectors that had been struggling over the past few weeks really saw a pop at the end of the week. Most notable was the jump in Home Construction, which popped on stronger than expected economic news releases pertaining to home building in the US.

With the volatility seen last week in the global financial markets and continued uncertainty about the situation in Europe it was no surprise to see US fixed income continuing to perform well:

Fixed Income Change
Long (20+ years) 0.85%
Middle (7-10 years) 0.72%
Short (less than 1 year) -0.01%
TIPS 0.18%

Compared to the past few weeks the fixed income markets had a very tame week when looking on a weekly basis, but some of the intraweek moves were very impressive. During the intraday trading on Wednesday, when the market was moving lower by more than 450 points, the 10-year US government bond slid down to a yield of 1.86 percent as there was a massive amount of demand for US government bonds. It had been a little more than a year since we had seen a yield on the 10-year government bond push below 2 percent and it made for a very exciting day in the normally boring fixed income world. Yields did recover quickly, coming nearly back up to where they had been by the close of trading on Wednesday. Last week the value of the US dollar declined by 0.87 percent against a basket of international currencies. The strongest of the currencies last week was the Swiss Franc as it gained 1.19 percent against the dollar. Much of the move in the Franc was due to the thought that the ECB is going to start buying assets and will thus push down the value of the Euro. This in turn would benefit the Swiss Franc as the government in Switzerland has vowed to keep the value of the Franc intact.

Commodities were mixed last week as investors pushed gold higher on the thought that the ECB will start purchasing sovereign bonds and oil continued to slide:

Metals Change Commodities Change
Gold 1.19% Oil -3.58%
Silver -0.36% Livestock -1.89%
Copper -1.09% Grains 3.88%
Agriculture -1.13%

The overall Goldman Sachs Commodity Index turned in a loss of 2.25 percent last week, while the Dow Jones UBS Commodity Index declined by 0.26 percent. The major difference in performance of the two commodity indexes is how the indexes are weighted. With the Goldman index being production weighted, a decline in oil hurts that index more than the Dow Jones UBS Commodity Index. Oil continued to slide, last week falling by 3.58 percent as supply continued to outpace demand by a wide margin and Saudi Arabia signaled that they do not intend to slow production to increase global oil prices. With the slide continuing last week in oil, oil has now officially fallen by more than 22.5 percent since the top that was seen back in June and it looks like prices could continue to move even lower. According to the AAA fuel gauge report, the nationwide average for a gallon of gasoline is currently $3.100, down from $3.348 a month ago. At this pace, if oil keeps declining we could see prices at the pump move below the $2.80 level before the end of the year.

Last week was a mixed week for the global indexes with the majority of the major indexes declining for the week. The best performance globally last week was found in Australia with the Sydney based All Ordinaries Index advancing by 1.43 percent. Asia saw the worst performance of the week last week with Taiwan in particular having a tough week as the Taiwan Weighted Index declined by 5.06 percent during the week. Japan also continued to struggle with Abenomics as the Nikkei declined by 2.38 percent.

Last week the VIX ended up moving higher for the week by 3.53 percent, but the final number does not do the index justice for just how crazy of a week we saw in movement on the VIX. As you can see in the chart below, the spike seen last week was a continuation of the spike we saw start two weeks ago, only we saw a bit more chop to the movement:

VIX Spike 10-20-14

The spike we saw on Wednesday is easily the highest we have seen this year and, in fact, the intraday spike high of 31.06 is the highest level we have seen on the VIX since late November of 2011. While the VIX did fall substantially (almost 13 percent) on Friday, thanks to the overdue relief rally, we are still riding the back side of a spike at this point. At the current level of the VIX (21.99), the implied market movement over the course of the next 30 days is 6.34 percent. As always the direction of the move is unknown. For a little perspective, at the peak (31.06) the VIX was implying a move of nearly 9 percent over the course of the next 30 days.

For the trading week ending on 10/17/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.36 % -1.29 %
Aggressive Benchmark -0.78 % -2.51 %
Growth Model -0.26 % 0.26 %
Growth Benchmark -0.60 % -1.87 %
Moderate Model -0.25 % 1.63 %
Moderate Benchmark -0.43 % -1.26 %
Income Model -0.34 % 1.98 %
Income Benchmark -0.21 % -0.50 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

We made no changes in any of our models over the course of the previous, volatile week. The investments we own by and large performed very well last week with our “safety” holdings providing the expected safety and our equity holding providing less downside participation compared to the overall markets and still seeing a nice gain on Friday when the markets jumped higher. At this point some of the investments we have been watching for the past few weeks have become cheaper, but with volatility likely to continue in the coming weeks as the Europeans figure out what they can do, we will likely get a chance in the near future to buy the areas of the markets we really like even cheaper.

 

Economic News:  Last week was a negative week for economic news releases; this is in part what led to such a wild week on the indexes. Below is a table of the releases with releases that significantly missed expectations highlighted in red. There were no releases that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Negative 10/15/2014 Retail Sales September 2014 -0.30% -0.20%
Negative 10/15/2014 Retail Sales ex-auto September 2014 -0.20% 0.30%
Negative 10/15/2014 PPI September 2014 -0.10% 0.10%
Neutral 10/15/2014 Core PPI September 2014 0.00% 0.10%
Negative 10/15/2014 Empire Manufacturing October 2014 6.2 20.4
Slightly Positive 10/16/2014 Initial Claims Previous Week 264K 290K
Neutral 10/16/2014 Continuing Claims Previous Week 2389K 2388K
Slightly Positive 10/16/2014 Industrial Production September 2014 1.00% 0.40%
Neutral 10/16/2014 Philadelphia Fed October 2014 20.7 19.8
Neutral 10/17/2014 Housing Starts September 2014 1017K 1013K
Neutral 10/17/2014 Building Permits September 2014 1018K 1030K
Slightly Positive 10/17/2014 University of Michigan Consumer Sentiment Index October 2014 86.4 84

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started out late and downright poor, with nearly all of the economic news releases that were released on Wednesday coming in well below expectations. Up first were retail sales figures for the month of September, which missed expectations and showed a decline in both overall retail sales as well as a decline in retail sales when auto sales were removed from the equation. Add in the Producer Price Index (PPI) showing a negative one tenth of a percent and the Fed is really in a pickle as to what to do with their mandate of price stability. While consumers would enjoy seeing prices decline, it is very hard on an economy as consumers sit on large purchases rather than making them in hopes that prices will be lower in the future than they are currently. The Empire Manufacturing figure also came in well below expectations as the market was expecting a reading of 20.4 and it came in at 6.2. While any number above zero signifies an expansion in manufacturing, this number represented such a slowdown in expansion that it scared the markets. About the only release on Wednesday that was not overly negative was the release of the Core PPI, which showed no change in prices when things like energy are removed from the PPI. On Thursday the economic news releases came in better than they did on Wednesday. Industrial production was shown to have increased by 1 percent during September, and the Philadelphia Fed manufacturing index came in slightly above expectations, alleviating some of the concern over the poor New York number that came out the day before.  On Friday two housing figures were released with both figures seeing positive reaction in the housing sector despite both figures being very close to market expectations. Wrapping up the week on Friday was the release of the second estimate of Consumer Sentiment for the month of October, which showed a slight uptick, but it was not enough of a surprise for the markets to really take notice of as everyone was so focused on the relief rally taking place on Friday.

 

This week is a slightly slower than normal week for economic news releases and there is only one release that could materially impact the overall trading of the markets; it is highlighted in green:

 

Date Release Release Range Market Expectation
10/21/2014 Existing Home Sales September 2014 5.11M
10/22/2014 CPI September 2014 0.00%
10/22/2014 Core CPI September 2014 0.20%
10/23/2014 Initial Claims Previous Week 283K
10/23/2014 Continuing Claims Previous Week 2390K
10/23/2014 Leading Indicators September 2014 0.60%
10/24/2014 New Home Sales September 2014 473K

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts off on Tuesday with the release of existing  home sales for the month of September. If the figure goes the same way as the housing data late during the week last week, we could see a bit of a positive surprise on this release. On Wednesday the Consumer Price Index (CPI) is set to be released with expectations of a zero reading. We are painfully close to the price declining and one of the Federal Reserve’s biggest fears coming to fruition. The core CPI number, however, is expected to be slightly positive, which should help smooth out any fears. The main driving force behind the falling prices is the falling price of oil and, in turn, energy, which may feel nice at the pump, but has longer term ramifications than most people consider. On Thursday the standard weekly unemployment reports come out with both expecting to be slightly higher than they were last week, but not by enough to really make a noticeable impact on the markets. Wrapping up the week on Friday is the release of the New Home sales figure for the month of September, which is expected to be slightly lower than it was during August as we move more and more into fall and winter, both times when the housing markets in the US largely cools down. With such little happening on the economic news release front this week the focus will likely be on third quarter earnings season.

 

Fun fact of the week:

Because of a gravitational pull, each year the moon drifts 1.5 inches farther away from Earth.

 

Source: http://www.aerospaceweb.org/          

For a PDF version of the below commentary please click here Weekly Letter 10-13-2014

Commentary at a glance:

-Wild ride last week in the equity markets!

-Europe scared the markets weeks before Halloween.

-October is historically a tough month for financial markets and so far this year is no exception.

-Earnings season has officially started and so far it is mixed.

-Economic news releases in aggregate came in slightly below market expectations.

 

Market Wrap-Up: Last week the declines blew right thought the various trend lines on two of the three major indexes and did so with much higher volume than we have seen in the past few months. I kept the most recent trading channels (red lines) below because these levels will be key levels of support should the markets turn around and start to move higher in the coming days or weeks. I kept the VIX chart unchanged, showing both the VIX level in green and the 52-week average level (we are now well above this level) of the VIX in red:

4 charts 10-13-14

The Dow (upper right pane above) remains the strongest of the three major indexes after the declines seen last week. While the Dow may be the strongest of the three major indexes, it is not saying much as even the Dow technically broke down below its most recent trading channel last week. It is, however, much stronger than both of the other indexes as it has so far not fallen below its most recent low point seen back in early August. The S&P 500 (upper left pane above) is the second strongest index of the three majors and is nothing to get very excited about. The S&P 500 bounced off of the upper bound of its most recent trading channel mid-week last week and began to move lower without looking back. The index easily blew right thorough all of the technical support levels that are commonly followed and proceeded to go down very quickly. The NASDAQ (lower left pane above) traded much like the S&P 500, only with the moves being more magnified. The NASDAQ bounced down below its most recent trading channel mid-week and it, too, fell below virtually all technical indicators that investors follow. So where do the indexes go from here?

 

Most likely we will see the markets recover some of the loss sustained last week if for no other reason than bargain hunters coming into the marketplace and buying stocks 4 or 5 percent cheaper than they were last week. For the most part, the strength of individual companies did not change last week; rather the decline was a more macro driven “risk off” trade. As with all risk off trades, there are good companies that get punished more than they should just because of the sector of the market they find themselves in. However, much beyond a bounce of a small percentage of what was lost last week will be very difficult to materialize because the reasons for the decline last week are big problems that will take a long time to sort out, such as slowing in Europe and Asia and falling global demand for natural resources. It has been a long time since we have seen a correction of 10 percent or more, an event that should happen about once per year, and we may very well finally be starting down the path to the correction that so many people have been calling for that until now has failed to materialize. With the losses seen so far, the NASDAQ has declined by 7 percent since it peaked out, the S&P 500 is down 5.23 percent and the Dow is down 4.26 percent. If a 10 percent correction is in the cards, we still have a long and volatile way to go. Volatility last week spiked higher, as you may expect given the markets moving lower, ending the week just shy of the highest level we have seen so far during 2014.

 

National News: Other than talking about the noticeably higher level of volatility last week the focus of the national news was on third quarter earnings season kicking off. With the markets swinging around wildly, there were many great headlines last week trying to explain the wild movements as investors watched red numbers stack up in their accounts. In the end it could have been a multitude of items that pushed the markets lower, with the main drivers being slowing economic growth in Europe and Asia as well as continued uncertainty about when the US Federal Reserve will finally increase interest rates in 2015. In the US, it is once again earnings season and last week saw Alcoa and others officially get things under way. There is a lot riding on earnings season this time around as this third quarter earnings season is the first of the year that should not have been impacted either positively or negatively by the adverse weather we saw during the first part of 2014 throughout much of the US. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see, it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

Alcoa 48% Fastenal 0% PepsiCo 5%
Container Store 0% Helen of Troy 43% Ruby Tuesday 92%
Costco Wholesale 4% IDT 0% Safeway Pushed
Family Dollar Stores -5% Monsanto -13% Yum! Brands 1%

 

The main company above to pay attention to is Alcoa, as they are typically seen as the bellwether for the overall earnings season. Alcoa is seen as the bellwether because its being one of the largest aluminum companies in the world means that it supplies aluminum to many different industries and sectors of the US economy. Alcoa released a very strong quarter with much of the strength coming from the aerospace and defense industry, an industry that is poised to outperform this quarter. One concerning area of the releases last week was the release of Family Dollar, which is a deep discount retailer that struggled during the third quarter. This is the first retailer to release and typically one that does well in uncertain times as shoppers on tight budgets go there to stretch their dollars as far as they can. We will have to wait and see if this is a sign of trouble to come from the big retailers or if this was just a one-off event.  It is still very early in the quarter, but I thought I would at least show the start of the quarter. According to Factset Research, we have now seen 27 members of the S&P 500 release earnings for the third quarter. Of those companies, 70 percent have reported earnings per share above expectations and 70 percent have reported revenues above expectations. If these numbers were to hold true for the remainder of earning season if would be a great third quarter earnings season. But we still have a very long way to go before the final quarterly numbers are known.

 

This week we start to get more into the heart of earnings season as there are numerous well known companies reporting earnings, some of which could really push the market around depending on what they release. Below is a table of the better known companies releasing earnings with the potentially most impactful releases highlighted in green:

 

Advanced Micro Devices eBay Netflix
American Express General Electric Overstock.com
Baker Hughes Goldman Sachs Philip Morris
Bank of America Google RLI
Bank of New York Mellon Honeywell Safeway
BlackRock Intel SanDisk
Capital One Financial J B Hunt Schlumberger
Charles Schwab Johnson & Johnson Stryker
Citigroup JPMorgan Chase United Rentals
CSX Kinder Morgan UnitedHealth Group
Del Frisco’s Las Vegas Sands WD-40
Delta Air Lines Mattel Wells Fargo
Domino’s Pizza Morgan Stanley Wolverine World Wide

 

The focus of this week’s earnings results will be the financials as many of the major financial institutions in the US are going to report their earnings. JP Morgan Chase will be closely watched as it had a major security event during the quarter in which hackers infiltrated its systems and stole a lot of information. American Express is another company that will be very closely watched as it typically has a good feel for consumer spending even before the retailers do as it has a very large pool of credit cards it processes constantly. Google is a bellwether company for the technology sector and it will be interesting to see how successful it has become at monetizing searches and data over the quarter, as well as to hear updates on some of its more interesting ventures such as Google Glass. After this week we should have a much better feel for which direction this third quarter earnings season will go.

 

International News: International news and events were surely the main driving factors behind last week’s poor equity performance globally. Continued weakness out of Europe was one of the leading factors for the decline. Markit research put out its latest Eurozone data early last week, data pertaining to manufacturing in the Eurozone. As you can see from the following Markit chart, it was not a pretty picture:

10-13-14 Eurozone PMI

Retail PMI (manufacturing, blue line above) in Europe is clearly falling and doing so at a very alarming pace. At the same time, consumer spending (red line) has also recently ticked down. More importantly, the downturn in Europe is affecting the core of the Eurozone this time around and not just the periphery, as it did a few years ago. Germany itself saw a manufacturing number that was the lowest it has been in 53 months, while the Eurozone overall is at a 17 month low. Making matters worse is the fact that in many areas of Europe prices are actually falling as a sign of deflation coming into the economy. This deflation is occurring at the same time that the European Central Bank (ECB) is just starting to get underway with its asset purchase program. It really looks like Europe could be in for a lot of financial trouble in the coming months and it comes just at a time when Russia is still lurking in the shadows, getting ready to start toying with the flow of natural gas to Europe during the winter. Adding to the concern last week, not just about Europe but about the world, was a report from the IMF.

 

Last week the IMF released its latest global growth forecasts in which it lowered its overall global growth expectations for 2014 from 3.6 percent down to 3.3 percent. The IMF also cut its outlook for 2015 from 3.9 percent down to 3.8 percent. For Europe, the IMF cut its GDP forecasts down to 0.8 percent growth in 2014 and 1.3 percent growth in 2015. The report called out the US as having “temporary setbacks,” but that these setbacks would not turn into major issues and that growth would continue in the US, albeit at a slow pace. The IMF report also called on large developed countries to spur growth in smaller less developed countries. These comments were aimed squarely at Germany and the fact that Germany has stopped trying to save all of the smaller European countries in favor of trying to save itself. Europe and the US were not the only areas of the world called out in the report as the report took aim at China, Japan and Latin America as well for needing to do more to get their economies growing once again. One solution to the slowing globally, according to the report, was posed in an IMF paper that outlined how spending on infrastructure could boost the global economy, while at the same time potentially setting up years of prosperity for countries that really undertake such measures. While infrastructure spending may work out in the short term, economies are still heavily reliant on consumers’ spending money, and if the global consumer is reluctant to spend, it can become increasingly difficult to entice them to loosen their wallets.

Market Statistics: Last week saw all three of the major US indexes move much lower on above average volume, including volume that may be considered high and very high:

 

Index Change Volume
Dow -2.74% Above Average
S&P 500 -3.14% High
NASDAQ -4.45% Very High

 

Whatever the reason for the markets being spooked, they sure were frightened last week, as the three major US indexes saw a broad based sell off. The reasons for the decline, discussed above, really leave investors wondering what really caused the decline as there was no single specific item that anyone can point to that led directly to the decline.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Residential Real Estate 3.01% Semiconductors -9.92%
Real Estate 2.20% Technology -8.23%
Utilities 0.92% Oil & Gas Exploration -6.95%
 Preferred Stock -0.18% Transportation -6.94%
Medical Devices -0.36% Natural resources -5.72%

Semiconductors got hit really hard last week as many investors pulled their holdings from the asset class. It was somewhat unusual to see a nearly 10 percent decline in any given sector of the markets during just one week. Given the dramatic decline in the NASDAQ last week, however, it was not surprising to see that the top two declining sectors of the market were NASDAQ heavy sectors. On the flip side, with such a sell off last week it was not surprising to see that Real Estate and Utilities were the best performing sectors of the markets as they are historically very defensive sectors and areas of the markets that investors move into to “hide” from the overall madness in the markets.

With the volatility seen last week in the global financial markets and continued uncertainty about the situation in Europe, it was no surprise to see US fixed income perform very well:

Fixed Income Change
Long (20+ years) 2.00%
Middle (7-10 years) 1.33%
Short (less than 1 year) 0.02%
TIPS 1.23%

As there are continued worries about the future direction and strength of Europe, the US dollar and US government bonds seem like the only safe havens and last week was no exception as bonds saw increasing demand and yields fell across various maturities. The 10-year US government bond last week ended the week with a yield of 2.29 percent; this is the bond that you may remember many pundits on the news outlets calling for being well over 3 percent by the end of 2014, back when the year started. It seems US government bonds really are a safe haven asset, being the “best house in Detroit.”

Commodities were mixed last week as investors continued to push down the metals, while the soft commodities continued to push higher and oil continued to slide:

Metals Change Commodities Change
Gold 2.60% Oil -4.34%
Silver 3.23% Livestock 0.25%
Copper 1.30% Grains 2.44%
Agriculture 2.76%

The overall Goldman Sachs Commodity Index turned in a loss of 2.16 percent last week, while the Dow Jones UBS Commodity Index declined by 0.04 percent. The major difference in performance of the two commodity indexes is how the indexes are weighted. With the Goldman index being production weighted, a decline in oil hurts that index more than the Dow Jones UBS Commodity Index. Oil continued to slide, last week, falling by 4.34 percent as supply continued to outpace demand by a wide margin. With such a large decline last week, oil has now officially fallen by more than 20 percent since the top that was seen back in June and it looks like prices could continue to move even lower. Prices at the pump have fallen by about 20 cents over the past month and it is likely they will continue to fall in the coming months if oil prices remain where they are or if they move even lower.

Last week was a mixed week for the global indexes with some of the Asian markets and one Latin America market advancing while the rest of the global indexes declined. The best performance globally last week was found in Brazil as election results showed that Rousseff will likely remain in power after this year’s elections are over. The Sao Paulo based Se BOVESPA Index advanced by 1.42 percent. Sweden saw the worst performance of the week as the Stockholm based OMX index posted a decline of 4.91 percent. Much of the decline was due to the sliding energy prices being seen around the world.

Saying that the VIX both spiked and had a wild week last week would be a bit of an understatement. Last week the VIX started the week about 5 percent above the average level we have seen over the past year. It ended the week at 21.24, a jump of more than 45 percent. As you can see in the chart below, the spike seen last week was very fast and stopped almost exactly at the same point as the spike back in early February:

VIX Spike 10-13-14

With such a large spike on relatively little new information, it is highly likely that we will see the VIX tumble back down toward the one year average level of about 14. At the current level of the VIX (21.24), the implied market movement over the course of the next 30 days is 6.13 percent. As always, the direction of the move is unknown.

For the trading week ending on 10/10/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -1.95 % -0.93 %
Aggressive Benchmark -2.40 % -1.74 %
Growth Model -1.24 % 0.52 %
Growth Benchmark -1.87 % -1.27 %
Moderate Model -0.69 % 1.88 %
Moderate Benchmark -1.33 % -0.83 %
Income Model -0.45 % 2.33 %
Income Benchmark -0.66 % -0.30 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like our actual holdings, the hypothetical models are rebalanced daily to model targets.

 

We made a few adjustments to our models over the course of the previous trading week as we moved into position to take advantage of continued market volatility. Our first moves were our selling of a few different positions; the first being our exposure to NASDAQ. We sold both our Direxion Funds and Rydex NASDAQ positions. These two positions had been held to increase overall market exposure and were held as trading positions should the market turn around and become more volatile. In selling the two positions we significantly lowered the overall risk being taken in each of the models. With the proceeds from the sales we bought into a low volatility ETF called the Powershares S&P 500 Low Volatility Portfolio (SPLV).  We used this position rather than cash in case the markets do turn around and jump higher, as they have during previous small declines so far this year. SPLV should participate in a good percentage of any upside, while protecting very well on the down side as we have seen in recent trading. Since the end of September the S&P 500 is down 3.35 percent, while the SPLV is only down 0.71 percent. So in using SPLV, it allows a portion of our models to remain engaged with the markets while at the same time being very defensive. Another move we made last week was to sell our holding in Principal Global Diversified Income Fund (PGBAX). PGBAX was a fund we purchased a few months ago that focused on producing income on a monthly basis and has a lower volatility than the equity markets. While recently it has been exhibiting lower volatility than the market, it has still been moving lower and doing so on a trend that does not look like it will reverse course any time soon.

 

Our individual stock basket performance last week saw performance that was better than expected as investors seemed to be fleeing risky assets in favor of the stocks we already own. This type of scare trade will likely continue to play out in the future if volatility remains higher, as we think it probably will through at least the end of this year. In particular, last week our Utility holdings did very well with Wisconsin energy posting a weekly increase of nearly 4 percent, while Consolidated Edison was up 3.68 percent and South Jersey Industries advanced 2.27 percent.

 

Economic News:  Last week was one of the slowest, if not the slowest, weeks for economic news releases that we have seen all year. There were no economic news releases that either positively or negatively impacted the markets during the week last week:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 10/7/2014 Consumer Credit August 2014 $13.5B $20.0B
Neutral 10/8/2014 FOMC Minutes September Meeting
Neutral 10/9/2014 Initial Claims Previous Week 287K 295K
Neutral 10/9/2014 Continuing Claims Previous Week 2381K 2425K

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week the consumer credit figures for the month of August were released and came in slightly lower than expected as financial institutions seem to be tightening their lending standards. On Wednesday the Fed released its latest FOMC meeting minutes, but the minutes held virtually no new information and the speeches given by Fed Governors on the same day sent mixed messages as to when interest rates may begin to rise. On Thursday the standard weekly unemployment related figures were released and both came in better than expected, but not by enough to be seen in the markets as the markets were reacting to negative news coming out of Europe.

 

This week is essentially a holiday week with Columbus Day being observed on Monday and many of the economic news releases being condensed into the final few days of the week. The economic news releases that could potentially impact the market are highlighted in green:

 

Date Release Release Range Market Expectation
10/15/2014 Retail Sales September 2014 -0.20%
10/15/2014 Retail Sales ex-auto September 2014 0.30%
10/15/2014 PPI September 2014 0.10%
10/15/2014 Core PPI September 2014 0.10%
10/15/2014 Empire Manufacturing October 2014 20.4
10/16/2014 Initial Claims Previous Week 290K
10/16/2014 Continuing Claims Previous Week 2388K
10/16/2014 Industrial Production September 2014 0.40%
10/16/2014 Philadelphia Fed October 2014 19.8
10/17/2014 Housing Starts September 2014 1013K
10/17/2014 Building Permits September 2014 1030K
10/17/2014 University of Michigan Consumer Sentiment Index October 2014 84

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week starts off on Wednesday with the release of retail sales for the month of September, which is expected to show a small decline of 0.2 percent during the month. When auto sales are removed from the equation the markets are expecting a slight increase of 0.3 percent during September. These two figures could really move the markets if they come in significantly better or worse than expected. Also released on Wednesday is the latest Producer Price Index (PPI) figure as well as Empire Manufacturing for the month of October. Prices are likely to have remained nearly stable during the month, while the Empire Manufacturing index is likely to show that it is still expanding, but doing so at a slower pace than during September. On Thursday, in addition to the standard weekly employment data points, industrial production figures and the Philly Fed index are set to be released. Expectations are for industrial production to have turned positive during September, after slightly dipping negative during August, and that the Philly Fed, much like the Empire figure earlier during the week, will show growth, but at a slower pace than September. On Friday two housing numbers are set to be released, both housing starts and building permits, both for September, and both expected to be over the 1 million level; which seems like a pretty lofty goal. Wrapping up the week on Friday is the release of the University of Michigan’s’ Consumer Sentiment Index for the month of October (first estimate), which is expected to show very little change over the final estimate of September. Added into the mix of economic news releases this week are five speeches by Federal Reserve officials, including one on Friday by Chair Yellen that I am sure the market will be very closely watching.

 

Fun fact of the week:

Mailing an entire building has been illegal in the U.S. since 1916 when a man mailed a 40,000-ton brick bank across Utah to avoid high freight rates.

 

Source: National Postal Museum

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