For a PDF version of the below commentary please click here Weekly Letter 9-22-2014

Commentary at a glance:

-Financial markets moved higher last week on some of the highest weekly volume of the year.

-Fed Chair Janet Yellen has spoken, but did she say anything new?

-Scotland has voted and the “No” vote has prevailed.

-Commodities all moved significantly lower last week.

-Economic news releases in aggregate came in slightly better than market expectations.

 

Market Wrap-Up: With several of the recent unknowns in the global financial markets becoming knowns last week, the major indexes in the US produced positive returns for the week. Perhaps the event that had the greatest potential to cause financial fallout last week was the Scottish independence vote, which turned out to be a resounding “No” and left the United Kingdom, at least for now, still united. Below are my standard charts with the key indexes represented by the green lines and the most recent trend lines on the three major indexes and the 52-week average level of the VIX represented by the red lines:

4 charts 9-22-14

From a purely technical standpoint the Dow (upper right pane above) moved well ahead of the other two indexes last week as it moved all of the way up to its most recent trend line. While it did not actually break through to the upside, it also did not bounce off the trend line to the downside. The next few days will be very important for the Dow as we see if the index can make it through the trend line to the upside or if it will ultimately bounce off the line to the downside. The speed with which it has moved higher and the strong volume would tend to indicate that the index should be able to break through the trend line without much trouble during the early part of this week’s trading. Both the S&P 500 (upper left pane above) and the NASDAQ (lower left pane above) are technically at about the same points in relation to their trend lines, with both seeming to be more comfortable just moving sideways than actually moving higher and retesting the trend. As time goes on, if the trend line continues to ascend at the same slope it has been going all along it becomes harder and harder for the index to actually catch up and cross over the trend line. If the S&P and NASDAQ do not start catching up pretty quickly these trend lines run the risk of getting too far out to reach and becoming technically much less important than smaller trends likely starting to emerge. The VIX (lower right pane above) made a valiant effort to break back above the 52-week average level signified by the red horizontal line, breaking above on Monday last week. However, after managing to move above the average level it quickly knocked back down below the line and now looks set to continue to move lower for the time being. Volume last week was some of the highest we have seen so far this year so the upward movements that look like they are in place from last week have a bit more meaning than the near zero volume movements we have been seeing for the past several months. Let’s wait and see if the trends can continue and the markets push higher heading into the end of 2014.

 

National News: National news during the first half of last week was abuzz with speculation about what the Federal Reserve Chair Janet Yellen would say about her plan to raise interest rates on Wednesday. Wednesday’s interest rate decision came and was unchanged over the previous meeting, as expected, but then the fun of reading the statement very closely and listening to her hour long press conference began. The main question on everyone’s mind was if she would clarify what is meant by the statement that interest rates will remain low for a “considerable period of time” after the end of quantitative easing. In true Fed fashion she gave no indication of anything more precise than she had already given as to the timing of when interest rates may start to increase. There were, however, some changes in the statement that the market took note of. The first was a change in the average expected Federal Feds rate at the end of 2015. The initial guidance going into the meeting from previous meetings was that the Fed funds rate would be 1.125 percent by year-end. This rate has been raised to 1.375 percent. This indicates that the Fed funds rate is now expected to go up much faster than first thought once it does start moving next year. The statement also made some remarks about the System Open Market Account, the account the Fed owns trillions of dollar of securities in. The statement said that once rates start to increase and reach “normal” levels, the Fed will look to stop reinvesting interest and principal payments on the debts. In a sense, this is the time when the Fed’s balance sheet will actually begin to stop growing. As for the holdings on the balance sheet in the System Open Market Account, the statement said the Fed has no intention of selling any assets and that it could keep the holdings on its books for the foreseeable future. This statement alleviated the fear that the Fed may be forced to sell assets at an inopportune time in the future, taking losses on its investments. As always at the end of the statement, Fed Chair Yellen added the language that the current thinking is based on current data points and if those data points should change in the future, the Fed can quickly change its policies and direction to adjust for the changing market. After reading through the statement it looks like Fed Chair Yellen did not turn any more hawkish than she was going into the meeting and she did a very good job of saying almost nothing that the market did not already know, playing right down the middle of the fairway.

 

 

International News: International news last week focused on one main topic and a few sub topics with the main topic being the vote that took place on Thursday in Scotland to see if the country would formally start the process of ending its 307 year relationship with the United Kingdom. The vote had been expected to be very close, but in looking at the final numbers the “No” vote (55.3%) easily beat the “yes” vote (44.7%) in a vote that saw more than 85 percent on the turn out numbers. There will be no great financial shift away from Scotland and there will be no fighting over who will get control of the oil field off the Scottish coast. But this whole vote and event does seem to add weight to the fact the countries and regions that feel they are not being treated fairly by another “overseeing” country had better be prepared for change in the future as we will likely see more and more of this type of vote in the future.  While this vote may not have gone the way some people would have liked, it does open the door to future votes if things like taxes are increased or spending within a given country declines. Catalonia has long been trying to gain its independence from Spain and with a procedural vote in the region gaining approval on Friday by a count of 106 for and 28 against; it looks like Catalonia may hold a referendum vote on independence in the near future. The big difference between Catalonia and Scotland, however, is that the Spanish government has said it does not care about the outcome of any vote; it will continue to hold Catalonia as a part of Spain no matter what. This could turn into a big issue within Spain as Catalonia is the area of Spain that has the most money and resources and therefore the greatest chance of being able to go at it alone. With the small economic impact of Spain on the global scale, it is unlikely that a vote would cause the same alarm as the Scottish vote. A potentially more impactful event also took place last week in Europe as the ECB sold its first round of targeted long term loans. These are loans to financial institutions that are very cheap (0.15%) and geared toward spurring lending. The banks that took the most loans were in Italy and Spain, which made up 45 percent of the total amount of loans made. Overall, the offering sold much less than was anticipated by the markets going into the sale. This is both good and bad. It is good because banks did not buy all that they could. It is bad because if the banks in Europe could not find anything to do with money with only a 0.15 % interest rate, it is unlikely they are providing much lending to their local economies since the cash they have on their books must be enough to cover their qualified demand.

 

The other big news of the week last week was provided by China as it produced several key economic data points that indicate that its economy is not going as fast as China would like and may be slowing down even more. Last week the Central Bank of China put about 500 billion Yuan into the economy (about $81 billion US dollars) through cash given to the major banks. The Central Bank of China injected the money under the guise that there may be a cash crunch going into a week-long holiday that takes place during the first week of October. Investors did not believe the “potential cash holiday crunch.” Rather, investors think the money is being put into the system because of the slow data points that have recently been coming out. The most recent PMI data out of China shows that manufacturing is slowing down and actually contracting. The latest GDP estimates have been steadily coming down and showing that China is now expected to grow at 7 percent, well below the 7.5 percent Premier Li Keqiang wanted to see, having said earlier this year that the economy of China would grow at 7.5 percent. The long term ramifications of China slowing down could have ripple effects across many different economies with the most impacted being the countries supplying China with the raw materials China consumes in such large quantities. Potentially, the most directly impacted country is Australia, which relies very heavily on its exports of raw materials to China. We saw this direct correlation this week as the poor economic data coming out of China led to a decline in the Australian stock market of 1.72 percent. In the coming months we will have to wait and see if China continues to slow down and also to see the actions the government takes to try to stabilize the sliding economy; all with the potential to significantly impact the global economy.

Market Statistics: Last week saw all three of the major US indexes move higher on some of the highest volume we have seen so far this year as traders seemed to be moving back into the market and pushing it higher:

 

Index Change Volume
Dow 1.72% Above Average
S&P 500 1.25% Above Average
NASDAQ 0.27% Above Average

 

With the volume last week being so much stronger than it has been over the past few weeks some investors may think that the bull market is once again going to start running. The upward movement combined with the increase in volume finally gave the markets some direction after they had been chopping around for so many weeks. While it takes more than one week of data to point to a new bull market, last week was a good start.

 

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
Pharmaceuticals 2.60% Software -1.11%
Biotechnology 2.10% Networking Technology -0.48%
Broker Dealers 1.93% Real Estate -0.41%
Healthcare 1.91% Medical Devices -0.32%
Basic Materials 1.84% Natural resources -0.21%

Last week was interesting to see the split within technology as Pharmaceuticals and Biotechnology took the top spots of all the sectors while the more traditional software and networking companies had a very difficult week, despite the large increase seen on Friday of Alibaba, which finally pulled off its much anticipated IPO.

Fixed-income investments were mostly higher last week on increasing volume:

Fixed Income Change
Long (20+ years) 1.08%
Middle (7-10 years) 0.21%
Short (less than 1 year) 0.02%
TIPS -0.55%

Currency trading was high last week as traders around the world tried to prepare for either outcome of the Scottish vote, which took place this Thursday. Most of the volume was seen on the British Pound and the Euro as these two currencies were the most exposed to the outcome of the vote. After the “No” vote had been solidified we saw a small rally in the British pound that made up some of the losses that had been incurred over the previous two weeks. Overall, the US dollar gained 0.54 percent against a basket of international currencies. Aside from the strength of the US dollar the next strongest currency last week was the Canadian dollar, which gained 1.36 percent against the US dollar. The worst performing currency of the week was the Japanese Yen as it slid 1.44 percent against the value of the US dollar.

Commodities were down across the board last week as investors seemed to continue the selling that started two weeks ago. This week the hardest hit of the commodities seemed to be Silver, which declined by almost 4 percent:

Metals Change Commodities Change
Gold -1.09% Oil -0.67%
Silver -3.91% Livestock -0.54%
Copper -1.05% Grains -3.51%
Agriculture -1.33%

The overall Goldman Sachs Commodity Index turned in a loss of 0.43 percent last week, while the Dow Jones UBS Commodity Index declined by 1.28 percent. The biggest drops in the commodity indexes last week were driven by the continued plummeting value of grains and losses seen in Silver. After the broad based commodity indexes hit five year lows two weeks ago, they continued to forge ahead and make new lows last week and seem to be in no hurry to stop moving lower.

Last week was a mixed week for the global indexes as the Asian markets largely moved lower while the rest of the global indexes advanced. The best performance globally last week was found in Sweden with the Stockholm 30 Index gaining 2.37 percent. Australia was the country that saw the lowest performance of the week with the Sydney based All Ordinaries Index declining by 1.72 percent. The majority of the decline in the index was due to uncertainty about Chinese demand for raw materials moving forward after the slowdown in manufacturing was seen in Chinese data.

After advancing three weeks in a row going into last week, the VIX turned around abruptly and moved lower, giving up 9.02 percent last week as the fear over the future movements of the markets seemed to move lower. One of the driving factors to the decline in the VIX was the “No” outcome from the Scottish vote as this took one major financial uncertainty off the table. After looking like we were going to be moving back to the average level we have seen over the past year, it now looks like we are just as likely to move back down and test the lows we have seen over the past year as the direction of the VIX in the coming week is very unclear. At the current level of 12.11 the VIX is implying a move of about 3.50 percent over the course of the next 30 days on the S&P 500. As always, the direction of the move is unknown.

For the trading week ending on 9/19/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.80 % 2.34 %
Aggressive Benchmark 0.43 % 4.35 %
Growth Model 0.54 % 2.75 %
Growth Benchmark 0.33 % 3.45 %
Moderate Model 0.39 % 3.32 %
Moderate Benchmark 0.24 % 2.53 %
Income Model 0.35 % 3.46 %
Income Benchmark 0.12 % 1.36 %

*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 two changes to our models with both filling out partial positions. Our first change was to fill our position in NASDAQ using either Direxion Funds (DXQLX) or Rydex funds (RYOCX), depending on risk level of the models. Our second change was to fill out our position in Healthcare using either Profunds Healthcare (HCPIX) or Rydex funds (RYHIX), again depending on the risk level of the model. At this point we are very nearly fully invested across the board. In being fully invested we are diversified well across asset classes and sectors of the markets. The thought right now is that our individual equity and ETF holdings will provide an investment base in the various models and that the more tactical holdings such as NASDAQ and healthcare will provide higher potential upside participation. Going forward we have a good mix of investments while still maintaining the ability to quickly react to a market that is correcting to the downside.

 

Economic News:  Last week was a slow week for economic news releases, but a busy week for the Federal Reserve. Below is a table of the releases with the one that missed significantly highlighted in red while the ones that significantly beat expectations are highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Positive 9/15/2014 Empire Manufacturing September 2014 27.5 16
Neutral 9/16/2014 PPI August 2014 0.00% 0.00%
Neutral 9/16/2014 Core PPI August 2014 0.10% 0.10%
Negative 9/17/2014 CPI August 2014 -0.20% 0.00%
Neutral 9/17/2014 Core CPI August 2014 0.00% 0.20%
Slightly Positive 9/18/2014 Initial Claims Previous Week 280K 305K
Positive 9/18/2014 Continuing Claims Previous Week 2429K 2945K
Slightly Negative 9/18/2014 Housing Starts August 2014 956K 1045K
Neutral 9/18/2014 Building Permits August 2014 998K 1054K
Neutral 9/18/2014 Philadelphia Fed September 2014 22.5 23.5

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

 

Last week started out strong with a very upbeat number on Monday from the Empire Manufacturing Index for the month of September. The market had been expecting an increase from the August level of 14.7 up to 16, but the number easily beat those expectations, coming in at 27.5. While this is a very strong manufacturing number for the greater New York region, it does seem like the very large increase could be due to some pent up demand hitting manufacturing all at once. On Tuesday the Producer Price Index (PPI) was released and came in showing zero, as expected, while the core PPI number showed a one tenth of a percent increase. On Wednesday the Consumer Price Index (CPI) was released and showed that prices overall at the consumer level declined by 0.2 percent and that core prices were flat during August. This decline in prices at the consumer level is very concerning as it is indicative of a potentially deflationary environment. Deflation is something all central bankers fear as it is very difficult to stop and can have very large impacts on the overall health of the economy. So this data point is concerning, but it takes much more than just a single ancillary data point to cause a stir. The markets and the Federal Reserve will closely watch in the coming months to make sure August was just a one-off event and not the start of a trend. On Thursday the standard weekly unemployment related figures were released with both initial and continuing claims coming in better than expected. Continuing jobless claims were more than 500,000 lower than expected, which is a very positive development. Putting a little bit of a dampener on the positive news of the day on Thursday was the release of two housing numbers that were both below expectations. Both housing starts and building permits remained below the 1 million level, while expectations had been for both figures to be higher than 1 million units. Last week wrapped up on Thursday with the release of the Philadelphia Fed’s Manufacturing index for the month of September and, unlike the New York number earlier in the week, this release slightly missed expectations, coming in at 22.5 versus expectations of 23.5. The difference between both manufacturing numbers is somewhat intriguing since they are in the same geographic region of the US, but there does not appear to be a clear reason for the divergence. In the end, both numbers are very strong as any reading above zero indicates that manufacturing is picking up and both regions are clearly doing well.

 

This week is a slow week for economic news releases, but there are two releases that have the potential to move the markets. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
9/22/2014 Existing Home Sales August 2014 5.2M
9/24/2014 New Home Sales August 2014 435K
9/25/2014 Initial Claims Previous Week 300K
9/25/2014 Continuing Claims Previous Week 2470K
9/25/2014 Durable Orders August 2014 -16.3%
9/25/2014 Durable Goods -ex transportation August 2014 0.7%
9/26/2014 GDP – Third Estimate Q2 2014 4.6%
9/26/2014 University of Michigan    Consumer Sentiment Index September 2014 84.60

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

 

This week starts off on Monday with the release of the Existing home sales figures for the month of August, which if anything like the housing data last week may be a little disappointing. On Wednesday the second economic news release of the week is set to be released with the new home sales figure for the month of August and this too may disappoint if it follows the trend we have seen developing. On Thursday the standard weekly unemployment related figures are set to be released with expectations that both figures will have increased slightly over the levels seen last week. The more important numbers released on Thursday are going to be the Durable goods orders for the month of August, which are expected to show a large decline overall.  Much of the expected decline (-16.3 percent) will be due to a sharp decline in the airplane orders as July is typically the largest ordering month for new planes and this year was no exception. The durable goods orders numbers when transportation is removed from the equation should look much better and come in with a much better number showing a slight 0.7 percent increase in overall orders. On Friday there are two releases that have the potential to move the markets, those being the third estimate of second quarter GDP in the US and the University of Michigan’s Consumer Sentiment Index for the month of September. Second quarter GDP is expected to be increased from 4.2 percent up to 4.6 percent, but this seems like lofty expectations. I would not be surprised at all to see this GDP revision go the other way and actually print lower than the second estimate of 4.2 percent. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of September (final estimate) and it is expected to show no change over the previous estimate. Typically, this release comes in very close to expectations so it would take something dramatic to get the market to react much to this release.

 

Fun fact of the week: Keeping with Scotland, we have a second fun fact of the week that is Scottish:

 

The shortest scheduled flight in the world is one-and-a-half miles long from Westray to Papa Westray in the Orkney Islands of Scotland. The journey takes 1 minute 14 seconds to complete.

Source: http://www.telegraph.co.uk/

For a PDF version of the below commentary please click here Weekly Letter 9-15-2014

Commentary at a glance:

-Financial markets moved lower for the first week in the past six on increased volume.

-President Obama laid out his plan for dealing with Islamic State.

-Is Scotland ready to break away from the UK?

-Commodities all moved significantly lower last week.

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

 

Market Wrap-Up: Jitters coming out about Europe, Ukraine, slowing Asian economies and uncertainty around the upcoming Federal Reserve interest rates increases all contributed to the market moving lower last week. The decline of the market was done on the highest volume we have seen over the past four weeks, but the volume was still low compared to average. Below are my standard charts with the key indexes represented by the green lines and the most recent trend lines on the three major indexes and the 52-week average level of the VIX represented by the red lines:

4 charts 9-15-14

From a technical standpoint, all three of the major US indexes have broken down a little over the course of the past week. The NASDAQ (lower left pane above) remains the strongest of the three major indexes, but looks like it could try to move lower in the coming days as it most recently failed to break out to a new top for the fourth time in the past three weeks. The Dow (upper right pane above) and the S&P 500 (upper left pane above) both show significant signs of breaking down. After both indexes failed to materially move above their respective most recent trend lines they now look like they are content to move lower over the very short term. From a technical standpoint it looks like there is some weakness in the markets, but these markets have recently been very prone to jumping on negative news and turning it into positive for the markets and vice versa. As the time for the Federal Reserve to potentially raise interest rates draws near the market seems to become more and more jumpy. We will likely see this chopping market over the course of the next few months and into next year as money managers and individual investors alike try to decide the upcoming actions of the Fed. Last week was particularly choppy with Europe making it back into the headlines as there is the chance for an “unforeseen” financial event this week as Scotland votes to potentially leave its union with the UK. This vote in Scotland is likely what was driving the temporary spike in the VIX, which jumped more than 10 percent last week on fears of the financial markets moving down in the coming weeks.

 

National News: National news last week focused on the US and what the US is doing in several key geopolitical hot spots around the world. Currently, the biggest issue at hand is the Islamic State (IS) and what the international community will do to stop the spread of the group, which even Al Qaeda has said is too extreme to be associated with. After a meeting of NATO two weeks ago, US President Obama went on TV last Wednesday evening to announce his current plan on dealing with and eliminating IS. While the details are still unclear, the US is currently building a coalition of countries that are willing to help pitch in and take care of IS. The US will likely spearhead the air strikes, using both drones and manned jets, while many of the Arab countries seem to be willing to step up ground forces in the region. While it will likely be a long and drawn out fight and a fight that will have no clear end, it is a fight the international community feels is worth taking on. Here in the US, we are starting to move full scale into the midterm elections and they are dominating much of the media.

 

Midterm elections are typically contentious, but this year seems to be even more so as it looks like the Republicans will easily maintain control of the House of Representatives. The Senate is up for grabs, with both sides claiming they will have control of it after the elections. Right now, taking an unbiased look at the seats which are up for election, it is just too close for me to call. Some seats will clearly swing toward the Republicans, while Democrats have a good chance of taking other seats currently held by Republicans. I was at a meeting last week at which Greg Valliere spoke (he is a well known Washington/political analyst) and he thought the Republicans would take control of the Senate, but only by one or two seats. Even if the Republicans do gain control of the Senate there is still likely to be gridlock in DC as President Obama is unlikely to go along with any of the Republican initiatives and the Republicans will for sure lack the ability to override a Presidential veto. With Congress at such a low approval rating (14 percent) according to Real Clear Politics, which took an average of 7 different polls including polls from both sides of the aisle, I don’t think Americans really care which side is in control, but feel both sides are not doing what the American people would like to see them do.

 

Aside from IS and elections, the focus of the national news has been on the Federal Reserve and when it will raise interest rates. Interest rates have been very low for an extended period of time and are about to be raised. Fed chair Janet Yellen has the unpleasant jobs of being the Fed Chairperson during the start of the rising interest rates. Right now most economists expect interest rates to increase during the first half of 2015, but the move will be very dependent on data, data that has recently been signaling that the economy and employment situation in the US may not be as strong as some would like you to believe. We should get some clarity later this week after the Fed releases its most recent interest rate decision on Wednesday as Chair Yellen has a press conference following the release. She does not have a press conference after the October meeting, so if she is going to change her stance on the language about raising interest rates this week would be the opportune time to do so since she can explain her reasoning immediately afterward. She is also scheduled to speak publically on Thursday as well, which gives her some time between the speeches to clarify anything she feels the market is incorrectly reading into the statement. This could really be a market moving pair of speeches as the last time major fed policy changes were announced the market immediately followed the announcement with the “taper tantrum.”

 

International News: International news last week paused somewhat in its wall to wall coverage about what is happening in Ukraine, shifting focus to a small country of only about 5 million people—Scotland. Scotland, a country known for Scotch, the Loch Ness Monster, golf and Bagpipes; may soon be known as the country that peacefully left its union with the United Kingdom and started off a round of global financial uncertainty. On Thursday the 18th the people of Scotland will vote for independence from the United Kingdom and it looks like the vote will be too close to call either way until all of the ballots are counted. A vote of “No” for independence will likely lead to no changes in the status quo and life will go on as it has for the past several hundred years with the UK benefiting from things like oil coming from the northern oil fields up around Scotland. A vote of “Yes” leads to a very uncertain future for Scotland, the UK and the British Pound. A “Yes” vote would most directly cause a rift between the UK and Scotland as to who owns the offshore oil fields around Scotland. The UK has said that even if they vote “Yes” the oil fields will continue to be owned by the UK and that this point is not negotiable. Scotland has said that if it becomes independent the oil fields are rightfully theirs and it will take control of them. More important than the oil fields is what happens to Scottish debt, which up until now has been issued and backed by the full credit of the UK. Much of the debt does not have any clauses about what should happen if Scotland or any other country for that matter decides to leave the UK. Technically, the UK would be on the hook for the debts of the past and Scotland would owe nothing. From a more logistical standpoint, the question of the currency for Scotland comes top of mind as Scotland is currently on the British Pound. The UK has announced that an independent Scotland could not use the pound and Scotland is far below the qualifying economic standards to try to apply to become a member of the Euro, so it is stuck with starting its own currency. Who will want the currency of a relatively poor northern European country of only about 5 million people? Pretty much, only people who are vacationing there and few others. From a financial standpoint, the “foreign” banks in Scotland would likely vacate the premises, which could cause a run on the banks prior to them leaving as Scotland residents are too unsure about what will happen with a currency for the country. This in turn could stress the whole of the UK and lead to a bit of a financial pinch. The most likely outcome, however, is that Scotland will use the vote, either “yes” or “no,” to gain more autonomy from the UK without actually breaking away. One way to help appease some of the Scotts would be to allow them into UK politics and give them a voice in what is happening within their region.

 

In another region of the world, Ukraine continues to struggle with Russia over the eastern portion of the country. Last week the international community launched yet another round of sanctions, this time targeted at the Russia Energy sector. Russian energy has long been the cash cow for Russia and the lifeline of funds the country needs desperately. It was also an area that sanctions had not specifically targeted in the past as it could lead to an energy war between Europe, which has none, and Russia, which is the largest supplier of energy to Europe. All of this was happening while under a ceasefire between the two sides in the fight; a ceasefire that has held up, but only barely as both sides have been accused of firing on the other. While there may be some impact on the global oil market by the sanctions and the ongoing fighting over eastern Ukraine, it seem like the majority of the markets are largely over the conflict and not paying much attention to the situation on the ground. This is exactly what Russian President Putin would like as it buys him more time to get into the European winter, a time when his natural gas is needed more than ever and he has an upper hand on the negotiations.

Market Statistics: Last week saw all three of the major US indexes move lower for the first time in the past six weeks, and the downward movement was done on higher volume than we have seen over the past four weeks, but still remained below the one year average weekly volume level:

 

Index Change Volume
NASDAQ -0.33% Below Average
Dow -0.87% Below Average
S&P 500 -1.10% Below Average

 

With volume picking up to the down side it is cause for some pause given the high levels the markets have been at over the past few weeks, but it does not mean the markets are in for a decline in the near future.

 

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
Technology 2.13% Residential Real Estate -6.19%
Broker Dealers 2.12% Real Estate -5.55%
Regional Banks 1.39% Energy -3.81%
Financial Services 0.65% Oil & Gas Exploration -3.80%
Aerospace & Defense 0.59% Natural resources -3.29%

Much of the declines seen last week in the natural resources sector of the market can be attributed to continued slow economic growth that has been coming out of China over the past few weeks. While there were no specific reports last week that carried any more weight than others over the past few months, it seems investors are really starting to take notice of the weakness in China and therefore pricing much lower demand going forward of the materials China consumes in large quantities.

Fixed-income investments were mostly down last week on high volume:

Fixed Income Change
Long (20+ years) -2.03%
Middle (7-10 years) -1.09%
Short (less than 1 year) 0.00%
TIPS -1.26%

Currency trading was high last week as traders around the world are trying to get set for either outcome of the Scottish vote taking place this Thursday. Most of the volume was seen on the British Pound and the Euro as these two currencies are the most exposed to the outcome of the vote. Overall, the US dollar gained 0.58 percent against a basket of international currencies. Aside from the strength of the US dollar the next strongest currency last week was the Swiss Franc, which gained 0.24 percent against the US dollar. The worst performing currency of the week was the Australian dollar as it slid 3.61 percent against the value of the US dollar.

Commodities were down across the board last week as investors seemed to be selling almost anything indiscriminately. Gold was particularly hard hit last week despite it being a “safe haven” asset that normally would perform well in uncertain times such as we find ourselves in now:

Metals Change Commodities Change
Gold -3.01% Oil -1.24%
Silver -2.88% Livestock -1.89%
Copper -2.67% Grains -5.27%
Agriculture -3.52%

The overall Goldman Sachs Commodity Index turned in a loss of 2.87 percent last week, while the Dow Jones UBS Commodity Index declined by 2.34 percent. The biggest drop in the commodity indexes last week was driven by the plummeting value of grains and losses seen in oil. With the decline seen last year many of the broad based commodity indexes are hitting five year low points with much of the decline being blamed on a slowdown in the Chinese economy, which is the largest consumer of raw materials in the world.

Last week was a mixed week for the global indexes as the Asian markets largely advanced, while the rest of the global indexes declined. The best performance globally last week was found in Japan with the Tokyo based Nikkei Index gaining 1.54 percent. Brazil was the country that saw the lowest performance of the week, after being the best just two short weeks ago, with the Sao Paulo based Se BOVESPA Index declining by 6.19 percent. The majority of the decline in the index was due to uncertainty in the upcoming Presidential election in Brazil, which looks much more uncertain now than it did even two weeks ago.

The VIX made it three weeks in a row of gains, advancing by a little more than 10 percent last week. After having been significantly below the 52-week average level of the VIX for the past three weeks the VIX is slowly closing the gap and moving ever closer to the average level of the VIX seen during the past year. Maybe the VIX is finally waking up and just moving higher in small increments rather than spiking up, just to fall back down to earth, as it has done several times over the course of 2014. At the current level of 13.31 the VIX is implying a move of about 3.85 percent over the course of the next 30 days on the S&P 500. As always, the direction of the move is unknown.

For the trading week ending on 9/12/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.89 % 1.51 %
Aggressive Benchmark -1.30 % 3.90 %
Growth Model -0.89 % 2.17 %
Growth Benchmark -1.00 % 3.11 %
Moderate Model -0.91 % 3.11 %
Moderate Benchmark -0.72 % 2.28 %
Income Model -1.10 % 3.08 %
Income Benchmark -0.36 % 1.24 %

*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 as the market gave no clear signal as to the future movements. We still have a bit of cash in many of our models and will continue to wait and see if there are any opportunities we see to purchase something that is undervalued.

 

Economic News:  Last week was a slow week for economic news releases. Below is a table of the releases with the ones that missed significantly highlighted in red (there were none) while the ones that significantly beat expectations are highlighted in green (there were none):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 9/8/2014 Consumer Credit July 2014 $26.0B $17.8B
Slightly Negative 9/11/2014 Initial Claims Previous Week 315K 300K
Neutral 9/11/2014 Continuing Claims Previous Week 2487K 2495K
Neutral 9/12/2014 Retail Sales August 2014 0.60% 0.60%
Neutral 9/12/2014 Retail Sales ex-auto August 2014 0.30% 0.30%
Neutral 9/12/2014 University of Michigan Consumer Sentiment Index September 2014 84.6 83.5

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

 

Last week started out on Monday with the release of a slightly better than expected figure on consumer credit, which was shown to have expanded by $26 billion during the month of July. Credit expansion is needed in the current economic environment as it gives way to more spending at various levels of the economy and thus keeps the economy growing. On Thursday the standard weekly unemployment claims figures were released with the initial jobless claims coming in slightly higher than expected and continuing claims slightly lower, leading the two figures to have an offsetting effect on the overall market impact. On Friday retail sales for the month of August were shown to have grown by 0.6 percent when including auto sales and 0.3 percent when excluding auto sales. While these numbers are not really strong they are decent and do not suggest that there is an eminent slow down coming in consumer spending. Wrapping up the week on Friday last week was the release of the University of Michigan’s Consumer Sentiment Index for the month of September, which increased slightly over the last estimate from the end of August. The increase, however, was not enough to overcome the negative sentiment the market seemed to be hanging on to on Friday as the indexes moved into the first weekly loss in the past six weeks.

 

This week is a slow week for economic news releases, but there are two releases that have the potential to move the markets. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
9/15/2014 Empire Manufacturing September 2014 16
9/16/2014 PPI August 2014 0.00%
9/16/2014 Core PPI August 2014 0.10%
9/17/2014 CPI August 2014 0.00%
9/17/2014 Core CPI August 2014 0.20%
9/18/2014 Initial Claims Previous Week 305K
9/18/2014 Continuing Claims Previous Week 2945K
9/18/2014 Housing Starts August 2014 1045K
9/18/2014 Building Permits August 2014 1054K
9/18/2014 Philadelphia Fed September 2014 23.5

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

 

This week starts off Monday with the release of the Empire Manufacturing index for the month of September. If it goes as the other recent manufacturing numbers have gone, it should easily beat expectations and provide a bit of a boost to the overall markets. On Tuesday the Producer Price Index (PPI) for the month of August is set to be released with expectations of zero change in prices at the producer level; core PPI is expected to show a slight increase of 0.1 percent during the same month. Both of these figures are very low and do not signal any inflation at all in the economy at the producer level. The Federal Reserve probably would like to see a bit more inflation than zero as a zero inflationary rate environment is dangerously close to deflation, which is something that scares all economists. The numbers at the consumer level were not much better as the Consumer Price Index (CPI) showed a zero for August, while Core CPI came in at 0.2 percent. Again, numbers this low are a bit concerning for Federal Reserve officials as they are very close or right at the inflection point between inflation and deflation. On Thursday the standard weekly unemployment related figures for the previous week are set to be released with expectations that initial claims will have gone down slightly and continuing claims will have gone up slightly over the course of the previous week. Potentially of more interest on Thursday will be the latest round of housing related figures that include both housing starts and building permits, both for the month of August and both expecting to show more than 1 million units. If both of these figures come to fruition it would be a positive development for the overall economy as it would signal that the US housing market is continuing to strengthen. The flip side of that argument is that if these two figures miss, it may lead to more critics of the US housing market calling out even louder that housing is about to go down. This week wraps up on Thursday with the Philadelphia Fed releasing its latest manufacturing index data point for the month of September. Expectations are for a slightly lower reading than the August 28 level, but anything above zero signals manufacturing expansion, so a reading in the low 20’s would be seen as positive. In addition to the scheduled economic news releases, this week also holds an interest rate decision by the Federal Reserve and two sets of speeches by Fed Chair Janet Yellen. These two speeches will be very closely watched by all market participants as everyone waits to see if she will mention anything about raising interest rates.

For  a PDF version of the below commentary please click here Weekly Letter 9-8-2014

Commentary at a glance:

-Financial markets continued their rally coming out of the Holiday weekend.

-Mario Draghi has spoken and actually moved forward with a little action.

-Cease fire between Russia and Ukraine. Say it isn’t so!

-Two changes to our models over the course of the previous week.

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

 

Market Wrap-Up: With last week being a partial week for trading due to the Labor Day holiday it was not surprising to see that the markets were fairly boring. Volume was low, as expected, but it was almost as high as the full week of trading that took place two weeks ago. Below are my standard charts with the key indexes represented by the green lines and the most recent trend lines on the three major indexes and the 52-week average level of the VIX represented by the red lines:

4 charts

From a technical standpoint, last week was a pretty uneventful week as the three major indexes attempted and in large part failed to move meaningfully above their most recent, respective trend lines. This uneventful week occurred while the VIX also saw muted trading, as would be expected. Much of the muted trading can be attributed to the Labor Day holiday, as mentioned above, and a general lack of developments globally in any of the geopolitical situations that have caused problems in the financial markets around the world in recent weeks. Even actions finally being taken by Mario Draghi, President of the European Central bank (ECB), failed to excite the markets. At this point it is hard to say which of the major indexes is the strongest as the NASDAQ (lower left pane above) tried but ultimately failed to stay above its most recent trend line last week. With the index technically breaking down, having moved back below the trend line, it can’t be the strongest index. The S&P 500 (upper left pane above) is a good candidate for the strongest index as it is closest to its most recent trend, but has failed to move over the trend line in three attempts during the last two weeks. The Dow (upper right pane above) is the final candidate to choose from and may be the strongest technically as it remains below the most recent trend line, but has only attempted to break it one time and failed. While the indexes were fighting with their trend lines the VIX remained solidly below its 52-week average and seemed content staying in a very narrow trading range. This was somewhat surprising given the cease fire reached late during the week between the Ukrainian government, the Russians and the pro-Russian rebels. Perhaps there is just a lot of international skepticism surrounding the deal.

 

International News: International news made the majority of the headlines last week as there was a NATO summit, a speech and actions taken by Mario Draghi at the ECB and a potential peace deal for the situation in Ukraine. The largest market moving event last week was the announcement by the ECB that it was taking action to help stabilize the sliding economic situation in Europe. President Draghi on Thursday announced that he was cutting interest rates from the already low 0.15% down to 0.05% in an effort to get people and business to borrow money. Further adding to the drive to push money into the economy was his second move of the day, which was to lower the deposit rate from -0.15% down to -0.20%. The chart below from the Wall Street Journal illustrates where interest rates currently are and where they have come from over the past 4 years.

ECb rates

While a negative interest rate may seem surprising, it makes sense as an effort to make banks lend money. Banks are required to keep a certain amount of money in reserves for their everyday business activities, but recently the banks have not been lending money out. Instead, they have been borrowing from the ECB at the very low interest rate of 0.15% and then investing the borrowed money into various fixed income debt instruments that were paying anywhere from 1 to 4 percent. In a sense, they were making the spread as a profit and taking on very little risk. The problem is that buying debt instruments with their cash helps the banks, but fails to actually help the people and the overall economy. With the deposit rate now being negative, the banks are being punitively punished by the ECB if they have more cash or short term investments on their books than is required. Taking deposit rates negative is a bit unusual, but has been done in the past and typically proves very effective. In addition to moving interest rates President Mario Draghi also announced a relatively small asset purchasing program under which the ECB will purchase several types of asset backed securities, but the details of the plan will be more fully released in October. For now we know that the plan will likely be between 700 billion Euros and 1 trillion Euros in size as President Draghi said the ECB would like expand its balance sheet from the current 2 trillion Euros up to between 2.7 and 3 trillion Euros. All of this movement had several noticeable impacts on the global financial markets. First, the Euro dove against most international currencies, hitting a one year low against the US dollar for example. Next, other central banks that are not part of the Euro currency were forced to take action, such as Denmark lowering interest rates. While it will be a long time before we see if the actions of last Thursday are enough to stem the economic issues growing in Europe, at least it is a first step in the correct direction.  Staying in Europe last week were many global leaders as they came together in Wales for a large NATO meeting at the end of the week.

 

The NATO summit last week focused on Russia and the ongoing situation in Ukraine, but much of the news was taken by Russia as it announced that it would enter into a cease fire with Ukraine and get the rebels under control. This was largely seen as a ploy to get the NATO members to delay new sanctions on Russia. Russia, on the other hand, is just trying to buy time as it knows it will have an upper hand in all negotiations once winter hits as it controls a vast amount of much needed natural gas for heating. So called “freezeout” negotiations are something Russia has done in the past and would love to do again as it is very effective. While NATO was holding its meeting, Russian President Putin was attempting to further strengthen ties between Russia as its neighbors, meeting in Mongolia to form strong ties with the country, much like he has done with China in recent weeks. The other brief topic on the NATO meeting was Islamic State (IS) and all parties agreed that actions need to be taken to stop the group’s progress. Aside from Europe, Japan has made the news last week as it announced some key economic figures.

 

Japan is currently in the middle of a very lengthy financial experiment in which it is trying to reverse the effects of a stalled economy that has been struggling for the past 20 years. So called “Abenomics” are in full effect, during which the Bank of Japan (BOJ) is taking nearly all actions possible in an attempt to jump start Japan’s economy. The latest action under the plan was the “third arrow” of Abenomics, which was to increase the tax rate on purchased goods. While this is necessary so that the government can receive more revenue, the impact of the move hit the economy pretty hard. GDP last week was shown to have slid by 1.8 percent during the second quarter of 2014. This comes on the heels of strong GDP growth during the first quarter as many extra purchases were made ahead of the tax rate hike that took place during the second quarter of 2014. We will have to wait and see if the Japanese economy has the strength to pull out of the decline in GDP or if the BOJ will have to go back to the drawing board to try to fix the economy once again.

 

National News: National news last week was very quiet as the holiday week meant there were no politicians in Washington DC to mess things up and make announcements. Wall Street was also largely quiet as traders and big money managers were starting to make their way back from summer holidays. The largest announcements that made headlines last week came from President Obama as he announced that the US will pursue IS in Iraq and Syria with a goal of “degrading and destroying” them. He has also gotten the support from the Arab league as they too are in support of eradicating IS from as much of the region as possible.

 

Market Statistics: Last week saw all three of the major US indexes move higher, but the volume was some of the weakest weekly volume we have seen in the past two years, even when taking into account that it was a 4 day trading week:

 

Index Change Volume
Dow 0.23% Low
S&P 500 0.22% Low
NASDAQ 0.06% Low

 

As mentioned above the markets had a pretty lack luster week. We will have to see if the markets pick up volume over the next few weeks. Until then the low volume, narrow trading range will likely continue.

 

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% Oil&Gas Exploration -2.17%
Infrastructure 1.31% Biotechnology -2.15%
Software 1.23% Natural resources -1.89%
Semiconductors 1.02% Energy -1.60%
Financials 1.00% Home Construction -1.41%

Fixed-income investments were all down last week:

Fixed Income Change
Long (20+ years) -2.79%
Middle (7-10 years) -0.99%
Short (less than 1 year) -0.01%
TIPS -1.00%

Currency trading was heavy last week as traders reacted to the announcement from the ECB. The Euro slid against the dollar last week and ended the week at the lowest point against the dollar we have seen in the past year, ending the week at $1.29 to the dollar. Overall, the US dollar gained 1.26 percent against a basket of international currencies. Weakness was widespread in the European currencies with everything from the British Pound to the Swiss Franc falling by more than 1.5 percent against the dollar.

Commodities were almost all down last week after concerns about the future growth in Europe and Japan seemed to have a very large impact on a wide array of commodities. Last week Livestock continued a two week rebound after having declined by more than 14 percent in less than a month; with the two week advance we have seen, livestock has now nearly made up the entire large decline.

Metals Change Commodities Change
Gold -1.45% Oil -2.51%
Silver -1.55% Livestock 6.53%
Copper -2.85% Grains -2.74%
Agriculture -0.11%

The overall Goldman Sachs Commodity Index turned in a loss of 1.65 percent for performance last week, while the Dow Jones UBS Commodity Index gave up by 1.49 percent. The biggest driver of the overall performance of the commodities last week was the weakening in Europe.

The best performance of the week was found in China with the Shanghai based Se Composite Index gaining 4.99 percent. The worst performance globally last week was found in Brazil with the Sao Paulo based Se BOVESPA Index falling 0.99 percent.

The VIX made it two weeks in a row of gains last week after advancing 0.92 percent during a week that saw very little overall volatility. The VIX remains well below the average level we have seen over the past 52 weeks and seems to be indicating that the current geo-political situations that are causing issues will be resolved without much financial market impact. At the current level of 12.09 the VIX is implying a move of about 3.5 percent over the course of the next 30 days on the S&P 500. As always, the direction of the move is unknown.

For the shortened trading week ending on 9/5/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.52 % 2.41 %
Aggressive Benchmark 0.17 % 5.26 %
Growth Model 0.38 % 3.06 %
Growth Benchmark 0.14 % 4.15 %
Moderate Model 0.30 % 3.87 %
Moderate Benchmark 0.10 % 3.02 %
Income Model 0.21 % 4.24 %
Income Benchmark 0.05 % 1.60 %

*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 two changes in our models over the course of the previous week and that was to put some of the cash we have been holding to work in our least aggressive models. We added a new position in the Principal Global Diversified Income Fund (PGDIX). The fund is a go anywhere global mutual fund that currently has a yield of about 4.2 percent and contains a wide variety of diversified assets. The goal of the fund is to produce a reasonable current income while maintaining very low volatility. We also added a little to our Wasatch Frontier Markets (WAFMX) as this position has been performing very well recently and has done so in a very uncorrelated manor. At this point we are nearly fully invested across all of our models, but we maintain a tilt toward safe assets as the market still seems like it is a bit overvalued and could be in for a moderate correction before the end of the year.

 

Economic News:  With the trading week being cut short by one day it made for a fast week of pretty little important information being released. Below is a table of the releases with the ones that missed significantly highlighted in red, while the ones that significantly beat expectations are highlighted in green (there were none):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 9/2/2014 ISM Index August 2014 59.0 57.0
Neutral 9/4/2014 ADP Employment Change August 2014 204K 220K
Neutral 9/4/2014 Initial Claims Previous Week 302K 300K
Slightly Positive 9/4/2014 Continuing Claims Previous Week 2464K 2525K
Slightly Positive 9/4/2014 ISM Services August 2014 59.6 57.9
Negative 9/5/2014 Nonfarm Payrolls August 2014 142K 220K
Negative 9/5/2014 Nonfarm Private Payrolls August 2014 134K 200K
Neutral 9/5/2014 Unemployment Rate August 2014 6.10% 6.10%

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

 

This week the focus of the economic news release was employment and the news was mixed at best. The week started off on Tuesday with the release of the ISM index for the month of August. While the report came in a little above expectations it was not strong enough to get very excited about. On Thursday the first of the employment figures for the week were released with the ADP employment change figure coming in slightly below expectations, leading some analysts to caution on the optimism that was taking hold about the upcoming payroll figures being released the following day. The standard weekly unemployment figures painted an equally unconvincing picture and led to even more speculation about the employment situation in the US. Later during the day on Thursday the Services side of the ISM was released and, much like the overall ISM released earlier during the week, didn’t seem to have the push behind it for the market to really take notice. On Friday the big release of the week came out with the headline unemployment rate being shown at 6.1 percent in August, down from 6.2 during July. While this may seem positive, the payroll numbers were so bad that the overall announcement was negative about the overall health of the economy. Nonfarm public payrolls came in at a paltry 142,000, while economists had been expecting 220,000, and nonfarm private payrolls came in at 134,000, while expectations had been for 200,000. Both of these figures cast some real doubt on the overall headline number, but that did not adversely affect the markets. The markets took the poor payroll figures and turned it into good news that the unemployment market may be weaker than first thought, which in turn could kick out the time when Janet Yellen starts to raise interest rates.

 

This week is a very slow week for economic news releases, but there are two releases that have the potential to move the markets. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
9/8/2014 Consumer Credit July 2014 $17.8B
9/11/2014 Initial Claims Previous Week 300K
9/11/2014 Continuing Claims Previous Week 2495K
9/12/2014 Retail Sales August 2014 0.60%
9/12/2014 Retail Sales ex-auto August 2014 0.30%
9/12/2014 University of Michigan Consumer Sentiment Index September 2014 83.5

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

 

This week kicks off on Monday with the release of the consumer credit report for the month of July, which is expected to show that credit expanded by almost $18 billion during the month. This is in line with the $17.3 billion we saw in June. $18 billion during a month is a good sign for the US economy. However, the nagging problem in consumer credit is that the people and companies receiving much of the credit are the people and businesses that do not need credit as lending standards are very tight.  On Thursday the standard weekly unemployment figures are set to be released with expectations of both figures being slightly lower than they were last week. On Friday the two big releases of the week are set to be released, those being retail sales and the consumer sentiment index. Retail Sales for the month of August will be released with expectations that both, including and excluding autos retail sales, will have gone up during the month. With the July figures being flat it will be very interesting to see how much of a change we could see in just one month’s time, a month that saw fairly weak consumer spending. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of September (first estimate), which is expected to show a slightly higher reading than the final figure for August. With no scheduled Fed speeches being made this week it looks like the financial markets may be relegated to the Alibaba IPO news and wondering when and how high of a price the IPO will hit.

 

Fun fact of the week:

During the Chinese equivalent of Black Friday, Alibaba processed more than $5.75 billion in sales. That’s 3X more sales in just one day than America saw on Black Friday — on just one company’s websites.

Source: Business Insider

For a PDF version of the below commentary please click here Weekly Letter 9-2-2014

Commentary at a glance:

-Financial markets continued their rally going into the Holiday weekend.

-Volume was painfully low; will it last after Labor Day?

-Russia “unofficially” invaded Ukraine and the world watched.

-Germany has hit the skids; will the rest of Europe follow?

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

 

Market Wrap-Up: Poor economic data out of Europe and increasing tension in Ukraine provided for the main headlines last week, but they did not deter the three major US indexes from advancing. This advance was done on very low volume, however. Low volume is expected for the week prior to the Labor Day holiday, but the extent of the low trading volume was still a little surprising. Below are my standard charts with the key indexes represented by the green lines and the most recent trend lines on the three major indexes and the 52-week average level of the VIX represented by the red lines:

 

As you can see in the above charts, all three of the major US indexes continued to march higher last week, as did the VIX, which is somewhat of an uncommon occurrence. Typically, the VIX moves in the opposite direction of the overall financial markets, but that was not the case last week. You may notice that I redrew the red lines above, this week going with the most recent trading trend rather than the most recent trading channels; the slope of the red lines is roughly equal to the average return over each time frame. Trend lines are technical indicators that some traders believe have significance, in that they treat them like support or resistance levels that change on a daily basis. Right now the NASDAQ (lower left pane above) is the strongest of the three major indexes, having recently bounced off of its trend line to the upside. The S&P 500 (upper left pane above) remains the second strongest index as it is fighting with its most recent trend line and seems to be having a little trouble breaking out above it. The Dow (upper right pane above) is the weakest of the three major indexes as it bounced off its most recent trend line to the downside and looks poised to move lower over the coming days. One caveat to the above-mentioned movements that occurred last week is that they were all done with some of the lowest weekly volume that we have seen in the past two years. While summer is typically a slow time of year for trading volume, last week’s volume was unusual, even for summer. There is some thought that the real direction of the market will be decided in the next two weeks as the large traders return from summer vacation and begin to invest again. This is something that should be very easy to spot. If we see volume pick back up to the historical average, we will know the large traders are back to work and the market may be telling us a truer trend. If the volume stays low we all will likely continue to question the validity of the current market levels.

 

National News: National news last week was largely uneventful as there were enough events on the global front that took the vast majority of the headlines. With that being said, national headlines should start to pick up in the next week or two as politicians return to Washington DC and we start to enter the midyear election cycle, a fun time for everyone! Last week was the last week of earnings season for the second quarter of 2014. Most of the retailer figures released last week came in better than expected, but there were not enough companies announcing earnings to move the overall needle for the quarter. 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:

 

Abercrombie & Fitch 90% Dollar General 0% GUESS? -7%
Best Buy 42% DSW 23% Sanderson Farms -15%
Big Lots 3% Express 0% Tiffany & Co 12%
Brown Shoe Company 21% Greif -51% Williams-Sonoma 0%

 

According to Factset Research, we have now seen 99 percent of the component companies of the S&P 500 release their second quarter 2014 earnings figures. Both the percentage of companies beating earnings per share and revenues per share remained the same last week, despite strong figures from some of the retailers. When looking at the companies that have released earnings, 74 percent have released earnings that met or exceeded analyst expectations, while 26 percent have missed expectations. The longer term historical average is for 72 percent of reports to beat expectations, so the second quarter of 2014 by this metric will officially close as a better than average quarter. Revenues of the companies that have released earnings increased to 66 percent having beaten estimates, while 34 percent have missed revenue expectations. This figure of 66 percent beating expectations will close better than the longer run average, which according to Factset is only 57 percent of companies beating on revenues. We are now into the start of September, which means the third quarter earnings season is just two months away. Overall, analysts and investors alike are looking for stronger numbers to come out of the third quarter than they did the second.

 

International News: International news last week was pretty busy with lots of interesting data points about various economies being released and a much more formal ground invasion of Ukraine by Russia at the end of the week. The largest concern over the past week has come out of Germany with the German government officially revising their second quarter GDP figure down to a -0.2 percent and also revising their first quarter GDP figure down to 0.7 percent. This means that there is a very real possibility that Germany may fall into a technical recession after they report their third quarter GDP number in a few months time. The reasons for the decline in GDP are numerous, but one of the key drivers is a lack in spending on retail sales that has gripped the economy. In looking at the most current data available, July retail sales for Germany turned in a decline of -1.4 percent, which is the worst monthly contraction in sales since the start of 2012. This lack of spending comes at a time when the manufacturing strength of Germany is very much being called into question should the price of natural gas flowing from Russia either increase substantially or the natural gas be turned off completely. With Germany showing such signs of weakness, it is nearly impossible to foresee the rest of Europe picking up the slack and keeping Europe as a whole from falling back into a recession, and this is before the potentially large impacts of Russia’s actions taken as retaliation against international sanctions against themselves. The big question now is “What can be done about Europe”?

European Central Bank (ECB) President Mario Draghi, is one of a few people in the world who potentially has the ability to make an impact on the overall health of the European economy, but can he actually do enough this time around? It seems as if some type of quantitative easing is in store for Europe, but what kind and how much remains very unclear. The time to act is quickly approaching if he is hoping to stave off falling into a recession and may in fact have already passed. President Draghi seems to know that the ECB cannot fix the problems on their own as he called for countries within Europe to look at how they can bolster their own economies last week in his speech at the Jackson Hole Economic summit. He called on countries to revisit their budgets and their austerity measures to see if there is any way to get more money flowing into the various troubled economies. This loose money policy, however, is exactly the type of policies that got Europe (and the US for that matter) into the financial mess that led to the great recession of 2008. So it will be a very delicate balancing act between adding too much money into the economy and not enough to keep everything moving forward. It seems President Draghi’s most likely option is to announce an open ended stimulus plan that builds bigger and bigger as time goes on, utilizing purchases of debts to help fund the banking system. This will ultimately expand the ECBs balance sheet, but seems to be the only viable option. Whether or not this type of action is legal for the ECB to undertake is a whole other question that will likely be sorted out in court.

While the economic situation in Europe is becoming more and more precarious it could not have happened at a better time for Russian President Putin, who seems hell bent on taking the part of Eastern Ukraine he wants. Late last week Russian military personnel crossed into Ukraine and quickly gave the pro-Russian rebels the strength they needed to take back much of the Ukrainian government advances of the past three weeks. In addition to taking back territory with the help of Russia, the rebels opened a new front to the south, which represents a key land connection between Russia and the already annexed Crimea, which Russia took less than a year ago. While the world was quick to condemn the actions of the Russians and Russia quickly called the images of troop movements on the ground in Ukraine “screen shots” from video games, there seems to be very little that can be done to stop Russia from taking what it wants. President Putin has an all time high Presidential approval rating and so far all of the sanctions the international community has put on Russia seem to not have had much of an impact. Plus President Putin knows it is almost the start of winter in Europe when the Europeans can largely not afford to not receive national gas from Russia. The sanctions in place may be at risk in exchange for natural gas for heating Europe. The latest development occurred on Sunday when President Putin called for Ukraine to consider statehood for eastern Ukraine, a move which would most likely end up with eastern Ukraine becoming its own state before being absorbed by Russia. I am sure the people who vote in the area would vote for Russia under heavy Russian pressure to do so.

Market Statistics: Last week saw all three of the major US indexes move higher, but the volume was some of the weakest weekly volume we have seen in the past two years:

 

Index Change Volume
NASDAQ 0.92% Very Low
S&P 500 0.75% Very Low
Dow 0.57% Very Low

 

It will be very interesting to watch next week to see if volume picks up a little from the very low levels we have been seeing for the past few weeks. In theory, it should pick up as traders and large money managers return to work after taking their summer holidays, but we will have to wait and see if the increase materializes.

 

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 3.80% International Real Estate -0.48%
Oil&Gas Exploration 2.84% Transportation -0.19%
Natural resources 2.07% Home Construction -0.08%
Energy 2.06% Industrials -0.08%
Utilities 1.96% Consumer Discretionary 0.08%

Fixed-income investments were mixed last week on summer volume:

Fixed Income Change
Long (20+ years) 1.50%
Middle (7-10 years) 0.48%
Short (less than 1 year) -0.01%
TIPS 0.29%

Currency trading was pretty light last week as traders were getting ready for the long holiday weekend in the US, but there was one interesting currency move last week and that involved the Euro. The Euro slid last week against the dollar, ending the week at the lowest point against the dollar we have seen all year, as represented in the chart from Bloomberg below:

The decline in the Euro was due to continued weakness in economic data coming out about Europe, while the ECB has largely remained silent as to how it will try to step in to support the European economy. Overall, the US dollar gained 0.36 percent against a basket of international currencies. Aside from the strength of the US dollar the next strongest currency last week was the Canadian dollar, which gained 0.58 percent against the US dollar. The worst performing currency of the week was the Swiss Franc as it slid 2.51 percent against the value of the US dollar.

Commodities were almost all up last week, turning around a multiple week slide they had been on going into last week. Last week Livestock saw a nice rebound after having declined by more than 14 percent in less than a month:

Metals Change Commodities Change
Gold 0.54% Oil 2.65%
Silver 0.11% Livestock 4.09%
Copper 0.73% Grains -1.27%
Agriculture 2.04%

The overall Goldman Sachs Commodity Index turned in a gain of 1.55 percent for performance last week, while the Dow Jones UBS Commodity Index advanced by 0.72 percent. The biggest driver of the overall performance of the commodities last week was the Russian actions in Ukraine; as this helped drive up the price of oil and many of the other commodities.

Last week was a mixed week for the global indexes as the Asian markets largely declined, while the western indexes largely advanced. The best performance globally last week was found in Brazil with the Sao Paulo based Se BOVESPA Index gaining 4.93 percent. Russia was the country that saw the lowest performance of the week with the Russian Capped Index declining by 4.44 percent, with much of the decline coming on the last two trading days as Russia advanced into Ukraine.

The VIX broke a three week slide last week, turning in a weekly gain of 4.45 percent during a week that was pretty uneventful for the VIX. The VIX is currently well below the average of the past year (13.84) for the VIX and remains low despite the geopolitical tensions that seem to be continuing to build around the world. So far during 2014 we have not seen too many calm days in a row on the VIX and with it now having been 7 days during which the VIX has moved very little, it seems we could be in for a bit of a move either up or down from the current level. At the current level of 11.98 the VIX is implying a move of about 3.5 percent over the course of the next 30 days on the S&P 500. As always the direction of the move is unknown.

For the trading week ending on 8/29/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.65 % 1.89 %
Aggressive Benchmark 0.63 % 5.09 %
Growth Model 0.56 % 2.68 %
Growth Benchmark 0.49 % 4.01 %
Moderate Model 0.44 % 3.57 %
Moderate Benchmark 0.35 % 2.92 %
Income Model 0.47 % 4.03 %
Income Benchmark 0.18 % 1.55 %

*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 changes to our models over the course of the previous week. The first change was to add exposure to our NASDAQ holdings through either Direxion funds NASDAQ (DXQLX) or Rydex NASDAQ fund (RYOCX), with the different funds being used in different risk based models. Our second change was to add a new position in Healthcare, using either Rydex (RYHIX) or Profunds (HCPIX). Both healthcare and NASDAQ remain the strongest areas of the investable markets and look poised to continue to outperform the overall market.

 

Economic News:  Last week was an exciting week for economic news releases as there were several releases that did not come in as expected. Below is a table of the releases with the ones that missed significantly in highlighted in red while the ones that significantly beat expectations are highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 8/25/2014 New Home Sales July 2014 412K 427K
Positive 8/26/2014 Durable Orders July 2014 22.60% 7.00%
Negative 8/26/2014 Durable Goods -ex transportation July 2014 -0.80% 0.60%
Neutral 8/26/2014 Case-Shiller 20-city Index June 2014 8.10% 8.30%
Positive 8/26/2014 Consumer Confidence August 2014 92.4 88.3
Neutral 8/28/2014 Initial Claims Previous Week 298K 302K
Neutral 8/28/2014 Continuing Claims Previous Week 2527K 2520K
Neutral 8/28/2014 GDP – Second Estimate Q2 2014 4.20% 4.00%
Positive 8/28/2014 Pending Home Sales July 2014 3.30% 0.50%
Neutral 8/29/2014 Personal Income July 2014 0.20% 0.30%
Negative 8/29/2014 Personal Spending July 2014 -0.10% 0.10%
Neutral 8/29/2014 PCE Prices – Core July 2014 0.10% 0.10%
Positive 8/29/2014 Chicago PMI August 2014 64.3 54.8
Slightly Positive 8/29/2014 University of Michigan Consumer Sentiment Index August 2014 82.5 80

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

 

The week started off on Monday with the release of the new home sales figures for the month of July, which came in above 400,000, but below the expectations of 427,000. After such strong US housing figures last week this release felt like a bit of a letdown. On Tuesday durable goods orders for the month of July were released and provided the first upside surprise of the week in the economic news releases as orders were shown to have increased more than 22 percent during the month. As mentioned last week, durable goods orders can really bounce around and this month was no different since the market had been expecting only 7 percent. The big reason for the jump was air plane sales resulting from two major air shows being held during the month. When transportation is taken out of the calculation, durable goods orders actually fell by 0.8 percent, as opposed to expectations of increasing 0.6 percent. Also released on Tuesday was the Case-Shiller 20 City Home Price Index, which came in very close to market expectations and took a little bit of the US housing anxiety out of the markets following Monday’s sales figure. Wrapping up the day on Tuesday was the release of the Consumer Confidence Index for the month of August, which came in well above expectations at 92.4, while expectations had been for 88.3.  The big question answered later in the week was whether the confident consumer was spending money or not. On Thursday the standard weekly unemployment claims came in with both figures being slightly worse than expected, but not by a wide enough margin to cause alarm. Pending home sales were positive on Thursday as they indicated a 3.3 percent increase, as opposed to expectations of an only 0.5 percent increase. The big news of the day on Thursday was the second estimate of second quarter GDP for the US economy, which was revised upward from 4.0 up to 4.2 with the release. This figure still seems extremely high to me with drastic changes in inventory being the main driving force behind the change. On Friday we received the answer to the above question about confidence and spending when we saw that consumer spending actually decreased 0.1 percent during the month of July, despite the increase in confidence. While there is a one month lag between the spending figure and the confidence figure, which may explain the difference, it still looks like we are headed into the case where the consumer is very confident and very much holding on to their money, just in case. This situation is not positive for the overall health of the economy as the economy depends on people spending money. Also released on Friday was a positive number on the Chicago PMI, which came in at 64, while the market had been expecting only 54; this was in line with the other manufacturing figures we have been seeing over the past few weeks. Last week wrapped up on Friday with the release of the University of Michigan’s Consumer Sentiment Index for the month of August, showing a reading of 82.5, up slightly from the previous reading of 80. This, much like the consumer confidence figure, does not help the economy, but at least people seem to be thinking things are more positive; now if only we can get them to put their money where their mouth is, we would be well on our way.

 

This week is cut short by one day with the Labor Day holiday, but there are still several key economic news releases that could impact the overall movement of the markets; the focus of the week will be on employment. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
9/2/2014 ISM Index August 2014 57
9/4/2014 Challenger Job Cuts August 2014 NA
9/4/2014 ADP Employment Change August 2014 220K
9/4/2014 Initial Claims Previous Week 300K
9/4/2014 Continuing Claims Previous Week 2525K
9/4/2014 ISM Services August 2014 57.9
9/5/2014 Nonfarm Payrolls August 2014 220K
9/5/2014 Nonfarm Private Payrolls August 2014 200K
9/5/2014 Unemployment Rate August 2014 6.10%

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

 

This week starts off on Tuesday with the release of the ISM Index for the month of August, which should be pretty strong given the positive releases we have seen over the past few weeks about manufacturing in various regions of the US. On Thursday the start of the employment figures will be released with the Challenger Job cuts figure and the ADP employment change index, both for the month of August. Expectations for both figures are for slight improvements during the month, but nothing outstanding. The standard weekly unemployment figures will also be released on Thursday, but will likely be overshadowed by other releases unless one of them really beats expectations. Wrapping up the day on Thursday is the release of the Services side of the ISM Index, which is expected to have decreased slightly. On Friday the releases that everyone will have been waiting for will finally be released, those being the official unemployment rate as measured by the government and the nonfarm public and private payroll figures, all for the month of August. The overall unemployment rate is expected to have fallen by one tenth of a percent down to 6.1 percent, but more importantly, payrolls are both expected to be over 200,000. If any of these figures miss and we see either lower payroll figures or a higher unemployment rate, it seems the stock market will likely move higher. It would move higher because such moves would lessen the chance of an early interest rate hike in 2015 by the US Federal Reserve. I would not be surprised if this is the case with these releases on Friday.

 

Fun fact of the week:

Google’s founders were willing to sell to Excite for under $1 million in 1999—but Excite turned them down.

Source: Fortune.com

For a PDF version of the below commentary please click here Weekly Letter 8-25-2014

Commentary at a glance:

-Financial markets continued to rally on continued low volume.

-US Federal Reserve was front and center in the news last week.

-Russia got tired of waiting and sent their aid convoy into Ukraine.

-We made some noticeable changes in our models over the course of the previous week.

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

 

Market Wrap-Up: Continued relief from geopolitical tensions seemed to be the theme of last week’s trading as news about the developments in Iraq helped push the markets higher, despite a “ground invasion” into Russia, as the Ukrainian government called it. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 8-25-14

As you can see in the above charts, the NASDAQ (lower left pane above) continues to be the index that is technically the strongest as it has broken well above its most recent high and is meaningfully above its most recent trading range. The S&P 500 (upper left pane above) remains technically in second place, but last Friday developed a bit of a warning sign after it failed to meaningfully break above its most recent trading range. If the S&P 500 fails on Monday to move back above the upper bound of the trading range it could be a sign that a downward move on the index is coming in the near future. The Dow (upper right pane above) made a strong move last week and managed to jump all of the way into its most recent trading range after looking like it was going to be left behind by the upward trending range just two weeks ago. Despite the down tick on Friday the index remains well within the trading range and looks from a technical stand point like it could continue to push marginally higher. The next big milestone for the Dow will be breaking above the all time high, which it hit back in Mid July. For the S&P 500 the next milestone will be both a new all time high and trying to close above the 2,000 level for the first time ever. While there is little actual significance to the 2,000 level, it is a nice round number and therefore a significant level as some investors like to buy when indexes go over such psychological levels, thinking they will continue to push higher after such a breakout. While the atmosphere is almost getting euphoric on several of the major averages, the VIX moved lower last week and now sits in the lower end of the trading range it has been in for most of the year. With the VIX signaling complacency and the markets seemingly moving higher at will, now seems to be a time when we could be moving toward an unforeseen event that shocks the markets.

 

National News: National news last week was largely quiet except for the hubbub about the Kansas City Fed’s annual economics meeting held in Jackson Hole Wyoming and the highly anticipated speech Fed Chair Janet Yellen gave on Friday. In some years elaborate economic policies have been outlined at the Jackson Hole meeting; this year was not to be one of those years. The research and speeches presented at the conference held hardly any new information. Even Chair Yellen’s speech was lackluster as she towed the same lines she has been towing for the past few months: interest rates will need to rise, most likely during 2015. This rate increase will likely come after data comes out that indicates that the labor market is largely back to normal and inflation is starting to pick up. One interesting thing mentioned last week in Jackson Hole by one of the Fed Governors was the multiple between the U4 and the U6 unemployment rate. It seems that prior to the rise in unemployment due to the financial crisis in 2008, the multiple between the two rates was somewhere around 1.78x with U6 being higher. Currently the multiple is 2.03x and this is presenting the Fed with an unusually puzzling picture as to what to do about the way the labor market has been coming back this time around. While the conference in Jackson Hole was just getting under way, earnings season in the US for the second quarter of 2014 was quickly drawing to a close.

 

Last week was one of the last two weeks of earnings season for second quarter 2014 with this current week being the final week. Most of the numbers from last week came in very close to analyst expectations and created non market-moving events. 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:

 

Dick’s Sporting Goods 3% Intuit -200% Sears Holdings 0%
Dollar Tree -6% J M Smucker -2% Staples 0%
Foot Locker 19% Lowe’s Companies 2% Stein Mart 0%
Gap 1% Medtronic 1% Target 0%
Hewlett-Packard 0% PetSmart 4% TJX Companies 3%
Home Depot 6% Ross Stores 5% Tuesday Morning 0%
Hormel Foods 6% Salesforce.com 9.2% Urban Outfitters 0%

 

According to Factset Research, we have now seen 98 percent of the component companies of the S&P 500 release their second quarter 2014 earnings figures. Both earnings per share and revenues per share ticked up last week on stronger than expected figures from component companies. When looking at the companies that have released earnings, 74 percent of them have released earnings that met or exceeded analyst expectations, while 26 percent have missed expectations. The longer term historical average is for 72 percent of reports to have beaten expectations so the second quarter of 2014 by this metric is officially a better than average quarter. Revenues of the companies that have released earnings increased to 66 percent having beaten estimates, while 34 percent have missed revenue expectations. This figure of 66 percent beating expectations is much better than the longer run average, which according to Factset is only 57 percent of companies beating on revenues in any given quarter. So with the earnings season officially drawing to a close in this coming week, it looks like the second quarter of 2014 will go down as a quarter that saw both earnings and revenue estimates beaten by a large percentage of companies. Looking forward to the third quarter figures, 74 companies have so far lowered their expectations, while 27 companies have issued positive guidance for the third quarter of 2014.

 

This is the last week for a table of companies that will be announcing earnings during the current week as the second quarter earnings season has all but officially drawn to a close. Below is a table of the better known companies announcing earnings with the potentially most impactful releases highlighted in green:

 

Abercrombie & Fitch Dollar General GUESS?
Best Buy DSW Sanderson Farms
Big Lots Express Tiffany & Co
Brown Shoe Company Greif Williams-Sonoma

 

Much like last week, this week the focus of the earnings results will be on the retail sector as they are always the last to report. One of the more interesting companies announcing earnings is Dollar General as they recently had a bid for “Family Dollar” rejected. The question now becomes whether they up their bid or let Family Dollar go. Other retailers of the week include high fashion trendy national chains such as Express and Guess, both of which are expected to have had a pretty rough quarter during the second quarter of 2014 when consumers seemed to be making less higher-end purchases than first forecasted.

 

International News: International news last week focused on the continuing geopolitical situations as well as European Central Bank President Mario Draghi’s speech at the Jackson Hole economic summit. First in international news last week was the US’s reaction to the killing of a US journalist by members of Islamic State (IS). The US denounced the killing and stepped up their air support of the Iraqi and Kurdish military. The stepped up involvement of the US military quickly allowed the Kurdish forces to retake the Mosul dam, which is a very important strategic asset in Iraq that, if left in the wrong hands, could have caused massive damage down stream. The US also seems to have opened the door ever so slightly to the fact that we may have to send combat troops back to Iraq to secure a victory by the Iraqis over IS. While this is highly unpopular, it is looking more and more likely as Defense Secretary Chuck Hagel alluded to in some of his most recent comments about Iraq when he called the group by far the most sophisticated and well funded adversary the US has seen in a long time. For the time being it appears that US air support is all that is needed, but that could change very quickly. Another hot spot has been the border between Ukraine and Russia, which heated up a bit last week.

 

The Russian “aid convoy” that had been sitting idle at the boarder crossing for the past 7 days made an uninvited, and some are calling it illegal, move into Ukraine last week as the Russians said they were tired of waiting for official approval. The Red Cross has supposedly gone through about 37 of the more than 250 trucks in the convoy and the search was going very slowly. Nothing malicious was found in the search, according to the Red Cross, but they can only vouch for the trucks they looked at. Another thing that was a little odd was the fact that the trucks that were searched held very few items and most were about a tenth full. So what was on the remaining trucks that crossed the border into rebel held territory is anyone’s guess, but it seems more and more likely that it was not humanitarian goods and that the later trucks in the convoy were not mostly empty. All of the shenanigans at the boarder were also occurring on the main day of the Jackson Hole economic meeting, a meeting at which ECB president Draghi made a few waves that were noticed by the global markets.

ECB President Draghi has been known in the past to make remarks off script that really show what he is thinking and gives the markets some keen insight into what is coming. Many times he has said a few small sentences that had drastic impacts on the financial markets; such as his “we will do whatever it takes” line that lowered all borrowing cost across Europe in a heartbeat. This meeting was no different, only this time the off-the-cuff remarks he made dealt with inflation and the current lack of it in the European economy. He made note of the inflation rate having moved from 2.5 percent during the summer of 2012 all of the way down to 0.4 percent currently. This move would scare almost any central banker as deflation is kind of the ultimate bad economic situation for a country to find itself stuck in. With the ECB having a mandate of price stability, President Draghi was alluding to the fact that he will take action shortly in an attempt to raise inflation within the Euro zone. The real question becomes how is he will do it and when is he going to do it. He does not strike me as a person who is going to wait for the data to show an overall quarterly decline in prices. Draghi also made special note that the ECB cannot pull Europe out of the current situation alone and called on economies to reverse some of the destructive economic forces of austerity, saying there needed to be more fiscal flexibility. The comments made toward individual countries about fiscal flexibility in his speech were directed toward countries that have seen a drastic slowdown and in some cases, even a reversal in GDP during the second quarter of 2014. In the end it seems the ECB is ready to take action, but when there will be more action than talk is the big outstanding question.

 

Market Statistics: Last week saw all three of the major US indexes move higher on very low volume:

 

Index Change Volume
Dow 2.03% Very Low
S&P 500 1.71% Very Low
NASDAQ 1.65% Very Low

 

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 4.98% Materials -0.11%
Home Construction 4.88% Telecommunications 0.37%
Software 2.92% Consumer Staples 0.42%
Aerospace & Defense 2.90% Utilities 0.54%
Financial Services 2.84% Medical Devices 0.66%

Fixed-income investments were mixed last week on summer volume:

Fixed Income Change
Long (20+ years) -0.36%
Middle (7-10 years) -0.50%
Short (less than 1 year) 0.01%
TIPS -0.72%

Currency trading was pretty elevated last week as traders around the world tried to react to the news that the ECB is getting very close to launching some form of quantitative easing. Overall the US dollar gained 1.11 percent against a basket of international currencies. Aside from the strength of the US dollar, the next strongest currency last week was the Australian dollar, which gave up only 0.04 percent against the US dollar. The worst performing currency of the week was the Japanese Yen as it slid 1.50 percent against the value of the US dollar.

Commodities were almost all down last week as various economic data points pointed toward continued weakness in Europe and increasing questions about Asian growth. The soft commodities had been performing very well year-to-date until last week when it looks like some profit taking was going on. Prices were pushed lower on relatively light news pertaining to the industry:

Metals Change Commodities Change
Gold -1.82% Oil -4.09%
Silver -0.90% Livestock -1.19%
Copper 0.47% Grains -0.85%
Agriculture -1.29%

The overall Goldman Sachs Commodity Index turned in a loss of 0.58 percent for performance last week, while the Dow Jones UBS Commodity Index declined by 0.14 percent. The biggest driver of the overall performance of the indexes was the decline in the price of Oil following the Iraqi and Kurdish advances against IS in Iraq, helped by air support from the US. All of the precious metals moved lower for the week, while the more industrially used Copper increased slightly.

Last week saw a single global index decline in value while all others increased. The best performance globally last week was found in Germany with the Frankfurt based Dax Index gaining 2.71 percent. South Korea was the country that saw the lowest performance of the week with the KOSPI Index declining by 0.32 percent.

The VIX moved noticeably lower last week for the second week in a row as it declined by nearly 13 percent. This is after a decline of more than 16 percent last week. At this point the spike we saw at the end of July has been fully reversed and we are right back down at the same low level we saw ourselves at earlier this year. This very low level for the VIX seems to be indicative of a market that will continue to grind higher and do so on very low volatility. Despite the spike, we recently saw investors by and large not seem to take notice of the increased value of the VIX, vying instead for the thought that it was only a temporary phenomenon. This time they turned out to be correct. At the current level of 11.47 the VIX is implying a move of about 3.3 percent over the course of the next 30 days on the S&P 500. As always the direction of the move is unknown.

For the trading week ending on 8/22/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 1.07 % 1.22 %
Aggressive Benchmark 1.09 % 4.43 %
Growth Model 0.94 % 2.11 %
Growth Benchmark 0.86 % 3.50 %
Moderate Model 0.88 % 3.12 %
Moderate Benchmark 0.61 % 2.56 %
Income Model 0.79 % 3.54 %
Income Benchmark 0.31 % 1.37 %

*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 two key changes to our models over the course of the previous week, both of which were done to increase the exposure to the markets. The first move last week was to remove the partial hedging position we put on about two weeks prior; the position was sold at a loss. However, the underlying stock positions we were trying to offset the risk of holding out performed our expectations and led to a net gain when looking at both positions. The second trade, also done on Monday last week, was to add exposure to the broadly based NASDAQ as this has the best relative strength of the three broad US indexes. We gained exposure through the use to two different mutual funds, one that uses leverage and one that is unlevered, with the levered exposure going into our most aggressive models and all other models receiving unleveraged exposure. Going into last week we were statistically supposed to participate in between 50 and 75 percent of the upside market movements. After making the changes we are now expecting to participate in between 65 and 88 percent of the upside movements of the markets. As always, the models for participation are purely backward looking and anything can happen moving forward, but at least we have a range to watch for. Going forward, we are still fairly heavy in cash and are currently looking for areas of the market to allocate resources to. Currently, the most likely candidate areas of the market we are looking toward allocating to are healthcare and high yield municipal bonds.

 

Economic News:  Last week was a pretty average week for economic news releases during the doldrums of summer. Below is a table of the releases with the ones that missed significantly 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
Slightly Positive 8/18/2014 NAHB Housing Market Index August 2014 55 53
Neutral 8/19/2014 CPI July 2014 0.10% 0.10%
Neutral 8/19/2014 Core CPI July 2014 0.10% 0.10%
Neutral 8/19/2014 Housing Starts July 2014 1093K 964K
Neutral 8/19/2014 Building Permits July 2014 1052K 1001K
Neutral 8/21/2014 Initial Claims Previous Week 298K 308K
Neutral 8/21/2014 Continuing Claims Previous Week 2500K 2530K
Neutral 8/21/2014 Existing Home Sales July 2014 5.15M 5.00M
Positive 8/21/2014 Philadelphia Fed August 2014 28 15.5

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

 

Last week started out on Monday with the release of a slightly better than expected reading on the National Housing Market Index, which indicated that the US housing market remains strong. This is a positive development for the overall health of the US economy since a person’s house is typically their single largest asset, and when home prices are rising they feel wealthier and in turn spend a little more. On Tuesday the Consumer Price Index (CPI) indicated that prices at the consumer level remained relatively stable during the month of July. Housing starts and building permits added to the positive housing news on Tuesday when both of these figures beat market expectations. On Thursday the standard weekly unemployment related figures were released with initial jobless claims dipping back below 300,000 and continuing claims landing at 2.5 million on the dot. While neither of these figures were great, they did not show any deterioration in the labor market, which means the Fed is still a go for raising interest rates some time during 2015. Finishing up the positive news of the week about the US housing market was the release of existing home sales for the month of July on Thursday, which showed that 5.15 million units were sold during the month, compared to expectations of only 5 million; this further added to the positive atmosphere surrounding the US housing market recovery. Wrapping up the week on Thursday last week was the Philadelphia Fed Manufacturing index, which came in much higher than anticipated and provided a positive boost to trading. The reading of 28 was the second highest reading we have seen on the index since late 2004, as the chart below indicates:

Philly fed

This week is a pretty exciting week for economic news releases as this week ends the trading month of August, so there are numerous monthly figures set to be released. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
8/25/2014 New Home Sales July 2014 427K
8/26/2014 Durable Orders July 2014 7.00%
8/26/2014 Durable Goods -ex transportation July 2014 0.60%
8/26/2014 Case-Shiller 20-city Index June 2014 8.30%
8/26/2014 Consumer Confidence August 2014 88.3
8/28/2014 Initial Claims Previous Week 302K
8/28/2014 Continuing Claims Previous Week 2520K
8/28/2014 GDP – Second Estimate Q2 2014 4.00%
8/28/2014 Pending Home Sales July 2014 0.50%
8/29/2014 Personal Income July 2014 0.30%
8/29/2014 Personal Spending July 2014 0.10%
8/29/2014 PCE Prices – Core July 2014 0.10%
8/29/2014 Chicago PMI August 2014 54.8
8/29/2014 University of Michigan

Consumer Sentiment Index

August 2014 80

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

 

This week starts off on Monday with the release of new home sales for the month of July, which is expected to be fairly strong following on the heels of such positive housing related figures released last week. On Tuesday the first of the major releases of the week is set to be released, that being the durable goods orders for the month of July, which are expected to show a 7 percent month over month increase. This seems like a pretty lofty goal, but there were a large number of airline orders placed during the month at a few key air shows around the world so that could be what boosted this number so high. Also released on Tuesday is the Consumer Confidence index, as measured by the US government for the month of August. Expectations are for a slightly lower reading in August than we saw in July, so this could be a positive surprise to the market if the figure meaningfully beats to the upside. On Thursday the standard weekly unemployment related figures kick off a pretty busy day. Expectations are for both initial and continuing jobless claims to have ticked higher over the course of the previous week. The big news of the day will be the second estimate of the second quarter GDP figure for the US economy. While expectations are for no change over the first release of 4.0 percent, I think we will see this figure downwardly revised and by a meaningful amount. This could provide for some downside risk to the overall markets, but it will surely be short lived. Friday is a busy day for news releases as personal income and spending are set to be released, as are the PCE prices, all of which are expected to show very little change during the month of July and should have no impact on the overall market. Later during the day on Friday the Chicago PMI is set to be released with expectations of little change during August when compared to July; with such a strong number out of Philly last week I would not be surprised to see this figure beat on the upside. Wrapping up the week on Friday this week is the release of the University of Michigan’s Consumer Sentiment Index for the month of August (final estimate) and it is expected to show a slight uptick for the month when compared to the early monthly estimate. It would take a major difference in this figure for the market to take notice as consumer spending is a very finicky item to track.

 

Fun fact of the week: According to some basic math, more than a quarter of a million people are having the best day of their lives right now.

 

The math breaks down this way:

7 billion people with an average life span of 70 years

Only 1 day can be the luckiest of someone life

70 years is equal to 25,567.5 days

7 billion divided by 25,567.5 days is 273,785 people!

For a PDF version of the below commentary please click here Weekly Letter 8-18-2014

Commentary at a glance:

-Financial markets rallied on very low volume.

-Earnings season continues to draw to a close.

-Europe is still not out of the woods; will Draghi act?

-Iraq continues to be very unstable.

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

 

Market Wrap-Up: Ukraine relief rally is one way to describe what occur in the financial markets last week as there were no new major escalations in the situation and Russian President Putin made it seem he would be interested in a peaceful end to the situation. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 8-18-14

From a technical standpoint, the NASDAQ (lower left pane above) is by far the strongest of the major US indexes as it has managed to move all of the way back up to the top of its most recent trading range and is currently attempting to move above it. The S&P 500 (upper left pane above) is the second strongest index of the three majors as it has managed to move all of the way back to its trading range and is currently trying to break into the range. At the current level it looks like the S&P 500 could be hitting some resistance, which if it holds could indicate that a downward move may be coming in the near future. The Dow (upper right pane above) has been the laggard in the most recent rally after being the hardest hit index back in late July. The Dow continues to struggle to gain upward momentum, but has been moving in the correct direction over the past two weeks. One caveat to the otherwise strong looking moves is that the moves were done on very low volume last week. The volume has been very lopsided in the recent rally as we have seen about 20 percent less volume coming back up than we did going down in late July. As the participation number wanes investors will be calling into question the validity of the rally, as there are far fewer people participating to the upside.  Volatility, as measured by the VIX (lower right pane above), however, seems to be pointing to smooth sailing at this point as the spike we saw to start the month has now mostly abated. With the VIX being back below the one year average level and the markets looking like they want to move higher it seems the rally we have been seeing over the past few weeks could continue to gain traction. The rally, however, will remain weak in nature unless we actually see more participants, indicated by volume picking up to the upside. With all that is occurring around the world it is likely that volatility will again pick up at some point in the near future as events we currently don’t see coming will invariably happen and the global financial markets will react.

 

National News: National news last week was largely quiet as we remain in the heart of the summer trading season when most traders take some time off and the markets experience very low trading volume. With that in mind and the fact the politicians take the entire month of August off from the Capital in favor of their own home states, the national news focused on the unrest in St Louis. After the shooting death of an unarmed black teenager by a white police officer the area of Ferguson seems to have erupted into a racial hotbed with nightly violence making headlines around the country. After the local police department was accused of using military style tactics to stop the protests, the governor decided to have the state patrol come in and see if they could simmer things down, but that looks like it has failed at this point. In the latest actions, the Governor of Missouri has called in the National Guard to restore peace to the community. While the situation in Ferguson makes for a lot of national headlines it did not have any impact on the overall financial markets here in the US, which were primarily focused on the second quarter earnings season drawing toward a close last week. 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:

 

Advance Auto Parts 3% Flowers Foods -13% Nordstrom 1%
Aramark 21% Hillshire Brands 27% Pinnacle Foods 0%
Cisco Systems 4% J C Penney Company 23% Priceline Group 5%
Cree 6% Jack Henry & Associates 2% Red Robin Gourmet Burgers -24%
Dean Foods -180% Kohl’s 6% SeaWorld Entertainment -28%
Deere & Co 6% Macy’s -7% Sysco 2%
Dillard’s -7% Mannkind -73% URS 80%
Estee Lauder 18% Noodles & Co -27% Wal-Mart Stores 0%

 

According to Factset Research, we have now seen 95 percent of the component companies of the S&P 500 release their second quarter 2014 earnings figures. There was virtually no change in the percentage of companies beating or missing both earnings and revenues when compared to the previous week. When looking at the companies that have released earnings, 73 percent have released earnings that met or exceeded analyst expectations, while 27 percent have missed expectations. The longer term historical average is for 72 percent of reports to beat expectations, so the second quarter of 2014 by this metric is officially a better than average quarter. Revenues of the companies that have released earnings stayed at 64 percent having beaten estimates, while 36 percent have missed. This figure of 643 percent beating expectations is much better than the longer run average, which according to Factset is only 57 percent of companies beating on revenues in any given quarter. So with the earnings season officially drawing to a close in the next week or so, it looks like the second quarter of 2014 will go down as a quarter that saw both earnings and revenue estimates being beaten by a large percentage of companies.

 

This week the slowdown in earnings season can really be seen as there are only about 400 companies in total releasing their earnings, compared to more than 1,500 each week for the past three weeks. While the majority of the companies announcing earnings this week are small or overseas companies there are several household names that are releasing earnings as well. Below is a table of the better known companies announcing earnings with the potentially most impactful releases highlighted in green:

 

Dick’s Sporting Goods Intuit Sears Holdings
Dollar Tree J M Smucker Staples
Foot Locker Lowe’s Companies Stein Mart
Gap Medtronic Target
Hewlett-Packard PetSmart TJX Companies
Home Depot Ross Stores Tuesday Morning
Hormel Foods Salesforce.com Urban Outfitters

 

This week the focus of earnings is big nationwide retailers, for the second week in a row. Target will likely be the focus of this week as Wal-Mart was the favorite last week. Home Depot and HP are two other names that will likely get a lot of time in the news when they announce their earnings this week as both are large players in their industries, industries that have been having very mixed results thus far during the second quarter earnings season.

 

International News: International news last week focused on one main geographic area of the world, that being Europe. First there was the release of the GDP figures for the various countries and regions in Europe last week, which pointed to continued weakness in the region. As you can see in the charts below from JP Morgan using Eurostat data, the main pillars of the European economy are really starting to struggle with the current economic situation:

europe GDP changes 8-18-14

In looking at the current situation outlined in the data, it seems like European Central Bank (ECB) President Mario Draghi may have to actually come to the table with his grand plans of how to boost the overall health of the European economy. So far he has spoken very big, saying the ECB will do “whatever it takes” and that it is ready to undertake outright monetary transactions if necessary. It appears the time has come to act on those words. Let’s all hope they have more of a plan than just talking about what they could do. Italy in particular is in a very precarious position as it is the weakest of the large European economies.

 

With the latest data about the Italian economy being taken into account, it is now safe to say that Italy is officially back in a recession, the third such recession since 2008. In fact, some would probably question the data point back in December of 2013 that “pulled” their economy out of a recession because aside from the single data point in December, Italy would have remained in a recession since the start of 2012, as the chart from global perspectives below indicates:

Italy GDP

The main issue with Italy is that, much like the rest of the Euro area, more than half of the outstanding government debts are held by foreigners, meaning that a problem in Italy could very quickly spread into a problem globally if its bonds are called into question. Given the poor economic situation in Italy it looks more and more likely that Italy will need some funding from the rest of Europe to keep its economy from moving notably lower. This comes at a time, however, when Germany and France are also experiencing an economic slowdown and may not be in the same position as before when other countries were asking for bailout funds. Despite Germany seeing a negative quarter of GDP contraction during the second quarter, it remains the best spot to park fixed income money in Europe, as seen last week by the German 10-year Bund falling to a yield below 1 percent for the first time. With all that is brewing in Europe it now seems like it is just a matter of time before the ECB steps in and takes action to try to remediate the situation.

 

The other major situation making international headlines last week was the situation in Iraq as the Prime Minister Nouri al-Maliki turned over the Prime Minister position to the newly selected Haider al-Abadi. This transition of power will hopefully bring an end to the political dysfunction in Baghdad, that has essentially paralyzed the government for the past few months, and unite everyone around fighting back the Islamic State (IS). IS continues to make inroads into various regions of the country, at one point last week taking control of a large dam above Mosul, a dam which if broken could have flooded the city of Mosul and sent water all of the way to Baghdad. With the help of US air support and tactical advice, the Kurdish military and the Iraqi army were able to take back control of this very strategic position over the weekend. So far the impact of the IS movement into Iraq has been very minimal as the oil fields in the south have not been adversely affected at all, but it seems one of IS’s goals in the future would be to extend control all of the way down to the southern oil fields. While this is something the US will surely attempt to stop, it could provide a bit of a short term bump in the global price of oil and potential decline in the global financial markets, were it to occur.

 

Market Statistics: Last week saw all three of the major US indexes move higher on well below average volume:

 

Index Change Volume
NASDAQ 2.15% Below Average
S&P 500 1.22% Below Average
Dow 0.66% 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
Biotechnology 4.74% Oil & Gas Exploration -0.81%
Semiconductors 3.13% Technology -0.27%
Industrial Office 2.62% Energy -0.18%
Infrastructure 2.60% Natural resources -0.10%
Healthcare 2.40% Financial Services 0.38%

Fixed-income investments were mixed last week on summer volume:

Fixed Income Change
Long (20+ years) 1.90%
Middle (7-10 years) 0.74%
Short (less than 1 year) -0.01%
TIPS 0.34%

Currency trading picked up a little last week as institutional investors weighed the odds of which central banks were going to have to raise interest rates first. Overall, the US dollar was unchanged when looking at week to week points. The strongest of the global currencies was the Canadian dollar, which increased 0.70 percent against the US dollar. The worst performing currency of the week was the British pound as it slid 0.48 percent against the value of the US dollar.

Commodities were mostly down last week as various economic data points pointed toward mixed global growth and consumption forecasts. It seemed the soft commodities, such as the grains and agriculture performed well last week after a few global reports came out about crops, including one that looked at the lack of supply of wheat in eastern Europe going into the fall and winter:

Metals Change Commodities Change
Gold -0.56% Oil -0.31%
Silver -1.72% Livestock -1.90%
Copper -2.11% Grains 0.26%
Agriculture 0.46%

The overall Goldman Sachs Commodity Index turned in a loss of 1.42 percent for performance last week, while the Dow Jones UBS Commodity Index declined by 1.07 percent. All of the precious and semi precious metals moved lower for the week after slowing demand in both India and China were shown in an independent commodity demand report.

Last week saw only positive performance when looking at the global financial markets with Asia seeing the best performance. The best non-US performance last week was found in Japan with the Tokyo based Nikkei Index gaining 3.65 percent. Canada was the country that saw the lowest performance of the week with the Toronto based TSX Index advancing by 0.71 percent.

Last week the VIX fell apart a bit as we saw four down days on the VIX followed by one lone up day on Friday; in total the VIX was down more than 16.6 percent for the week. As you can see in the chart to the right, the end of July and August (to-date) has been an exciting time for the VIX as we have seen the index move from around 10.5 all of the way up to 17 (red arrow) and then fall all of the way back down to 12.5 in the span of about 20 days (green arrow). At this point it is very difficult to say what direction the VIX will move in during the coming weeks as it looks like it wants to head all of the way back down to the range it was stuck in prior to the spike. At the current level of 13.15 the VIX is implying that a move of about 3.8 percent is likely in store over the next thirty days, but as always, the direction of such a move is unknown.

VIX with Arrows 8-18-14

For the trading week ending on 8/15/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.76 % 0.15 %
Aggressive Benchmark
  1. 41 %
  2. 30 %
Growth Model 0.58 % 1.15 %
Growth Benchmark
  1. 08 %
  2. 62 %
Moderate Model 0.42 % 2.21 %
Moderate Benchmark
  1. 77 %
  2. 94 %
Income Model 0.26 % 2.72 %
Income Benchmark
  1. 39 %
  2. 06 %

*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 model allocation over the course of the previous week as we remain in a defensive posture. Throughout the week I looked at our hedging position and determined it was worth the carrying costs of the position given the strength we have recently been seeing in our underlying stock holdings. As the stock positions move higher the need becomes less for the hedge position to remain in place and toward the end of the week we were very close to getting a technical signal that it would be okay to remove the hedging position, but the signal failed to materialize, so we kept the hedging position.

 

Economic News:  Last week was a pretty eventful week for economic news releases, but there were no releases that significantly either missed or exceeded expectations. Below is a table of the releases with the ones that missed significantly highlighted in red (there were none), while the ones that significantly beat expectations are highlighted in green (there were none):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 8/13/2014 Retail Sales July 2014 0.00% 0.30%
Slightly Negative 8/13/2014 Retail Sales ex-auto July 2014 0.10% 0.30%
Neutral 8/14/2014 Initial Claims Previous Week 311K 305K
Neutral 8/14/2014 Continuing Claims Previous Week 2544K 2523K
Neutral 8/15/2014 PPI July 2014 0.10% 0.20%
Neutral 8/15/2014 Core PPI July 2014 0.20% 0.20%
Slightly Negative 8/15/2014 Empire Manufacturing August 2014 14.7 15.5
Slightly Negative 8/15/2014 University of Michigan Consumer Sentiment Index August 2014 79.2 81.7

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

 

Last week kicked off on Wednesday with the release of the retail sales figure for the month of July, which came in slightly below market expectations, posting a zero for the month versus the expected 0.3 percent. When auto sales were removed from the figure the number was still low, coming in at 0.1 percent versus expectations of 0.3 percent. These weaker than expected retail sales figures are the weakest growth figures we have seen in the past 6 months and should give some economists concern about the overall health of the US economy and its ability to post a strong overall GDP figure for 2014. The key in this release was that a zero does not mean there was any less spending; it means that spending remained the same during the June and July time period. We will have to wait and see if this trend continues in the next few months. On Thursday the standard weekly unemployment related figures both came in slightly higher than expected with the initial jobless claims hitting a 6 week high. While some investors were concerned about the increase, it looks more like a sideways trading range is being set up and not something more concerning like an uptrend starting in unemployment claims. On Friday the Producer Price Index (PPI) and the Core PPI for the month of July were released with both figures coming in very close to market expectations. The Empire Manufacturing index for the month of August was released a little later during the day on Friday and missed expectations, tumbling from the July level of 25.6 all of the way down to 14.7. Much like the retail sales figures earlier in the week, however, the index is designed so that a positive number means more manufacturing during the month than the previous month, so while the growth in manufacturing was much slower during August than during July, it was still strong growth. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of August (first estimate), which showed a little bit of weakness, but not enough to cause alarm in the overall markets.

 

This week is a slow week for economic news releases as far as number, but there are a few releases that have the potential to be market moving. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
8/18/2014 NAHB Housing Market Index August 2014 53
8/19/2014 CPI July 2014 0.10%
8/19/2014 Core CPI July 2014 0.10%
8/19/2014 Housing Starts July 2014 964K
8/19/2014 Building Permits July 2014 1001K
8/21/2014 Initial Claims Previous Week 308K
8/21/2014 Continuing Claims Previous Week 2530K
8/21/2014 Existing Home Sales July 2014 5.00M
8/21/2014 Philadelphia Fed August 2014 15.5

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

 

This week kicks off on Monday with the release of the NAHB Housing Market index, which is expected to be flat when compared to the level seen during July. On Tuesday the Consumer Price Index (CPI) and the core CPI are both set to be released with expectations of a very small one tenth of a percent increase in prices being seen during July at the consumer level. This small increase in prices is a combination of lower energy costs and increased food costs during the month. Also released on Tuesday are the housing start and building permits figures, both for the month of July, with expectations that both figures will be very close to 1 million units. If we see a significant miss on the either of these figures, the listed home builders could have a bit of a tough time trading though the day. On Thursday the standard weekly unemployment related figures are set to be released with expectations that both initial and continuing jobless claims will be lower this week than they were last. Later during the day on Thursday the third key housing related figure of the week is released, the existing home sales figure for the month of July, which is expected to come in at 5 million units during the month. Wrapping up the week on Thursday is the release of the Philadelphia Fed Index for the month of August, which is expected to come in at 15.5, down significantly from the 23.9 seen in July. Much like the Empire manufacturing number seen last week, the Philly number is expected to still indicate that business and manufacturing in the greater Philly area is expanding.

 

Fun fact of the week: Rhode Island is the smallest state (land 1,033.81 square miles, water 511.07 square miles) with the longest name. The official name, used on all state documents, is “Rhode Island and Providence Plantations.”

Source: US Census Bureau

For a PDF version of the below commentary please click here Weekly Letter 8-11-2014

Commentary at a glance:

-Financial markets struggled for clear direction.

-Major changes to our investment allocations; we have moved much more defensive.

-Earnings season is quickly drawing to a close.

-Russia continues to amass troops at the border.

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

 

Market Wrap-Up: Last week was a very choppy weak for the US financial markets with the week’s positive performance being saved by a strong rally on Friday. Volume overall was a little below average across the board and the VIX moved lower, but failed to move back to the low levels seen two weeks ago. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

chart 4

From a technical standpoint, the NASDAQ is the strongest of the three major indexes as it successfully moved back into its most recent trading range. The S&P 500 is the second strongest index of the major three, but still has a very long way to move upward to make it back into its most recent trading range. The Dow is the laggard of the three major indexes, from a technical standpoint, as we need to see a move in excess of 3 percent for the Dow to get back into its most recent trading range. The VIX had a choppy week last week, but the key thing is that it looks like the VIX has started a new horizontal trading range; this range is about 40 percent above the previous major trading range. With all of the geopolitical tensions around the world, the general lack of standout earnings and slow economic recovery globally, it is hard to make the case that the markets should be significantly higher than the current levels. It is much easier to point out the fact that these markets are still a bit over valued, despite the recent decline. When I scan through the investable universe I find very few companies that are trading cheaply on any fundamental basis. The few that are trading at that level are there because of some new developments at the company that justifies the cheap valuations. With summer currently in full swing and politicians having vacated Washington DC for the month of August it seems the markets will continue to meander, with a bias toward the down side. In light of these market conditions we have moved our models toward wealth preservation, rather than wealth accumulation, as 300 point declines like the one seen at the end of July are likely to continue with more regularity as they are virtually never one-off events. If we do continue to see prices come back down to reasonable levels in specific areas of the markets we will have the cash available to make purchases, but it will bear fruit to wait rather than to jump in for the sake of being in the market.

 

National News: With Congress being on recess for the month of August there was very little going on in national US news as there were very few odd punch lines put out by politicians for the media to latch onto. With this shortage, the media focused on earnings season as there continued to be a very large number of US companies announcing earnings. We are now well into the back half of earnings for the quarter. 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:

 

AOL 10% Hillshire Brands Pushed Ralph Lauren 3%
Aqua America 3% Jack In The Box 14% Rosetta Stone -270%
Archer Daniels Midland 3% LeapFrog Enterprises -5% SolarCity 4%
CenturyLink 13% Loews 18% South Jersey Industries 67%
Coach 9% Mannkind Pushed St. Joe Pushed
Consolidated Edison 19% McDermott International 0% Teekay -63%
Cooper Tire & Rubber -26% MGM Resorts International 75% Time 329%
CVS Caremark 3% Molson Coors Brewing 9% Time Warner 17%
Diebold 21% Office Depot 0% Walt Disney 9%
DISH Network -12% Papa John’s International -2% Wendys 0%
Groupon 50% Prudential Financial 6% Zillow -13%

 

According to Factset Research we have now seen 90 percent of the component companies of the S&P 500 release their second quarter 2014 earnings figures and things remain looking pretty good, although results are slightly weaker than this same time last week. When looking at the companies that have released earnings, 73 percent of them have released earnings that met or exceeded analyst expectations, while 27 percent have missed expectations. We still seem to be drifting downward to the historical average of 72 percent beating and 28 missing that we have seen over the past few years, as each week it seems like we are about a percentage point closer. Revenues of the companies that have released earnings have weakened a bit since last week, with now only 64 percent having beaten expectations while 36 percent have missed revenue expectations. This is opposed to more than 72 percent beating on revenues just three weeks ago. According to Factset, healthcare remains the top performance sector of the market when looking at both earnings and revenue beats for the second quarter of 2014. After this week’s earnings, we should be near 98 percent of the component companies of the S&P 500 having reported earnings for the second quarter of 2014. In aggregate, the earnings growth of the S&P 500 companies have beaten expectations going into the quarter by the widest margin since late 2011, which is a good sign for the overall health of the US economy.

 

This week is the start of the slowdown in companies releasing their second quarter earnings figures. While the number of companies releasing earnings remains very high (over 1,500) a large percentage of those are very small or foreign companies that very few people have ever heard about. Below is a table of the better known companies announcing earnings with the potentially most impactful releases highlighted in green:

 

Advance Auto Parts Flowers Foods Nordstrom
Aramark Hillshire Brands Pinnacle Foods
Cisco Systems J C Penney Company Priceline Group
Cree Jack Henry & Associates Red Robin Gourmet Burgers
Dean Foods Kohl’s SeaWorld Entertainment
Deere & Co Macy’s Sysco
Dillard’s Mannkind URS
Estee Lauder Noodles & Co Wal-Mart Stores

 

This week the focus of earnings is big nationwide retailers. The largest retailer in the US will be the spotlight of attention as Wal-Mart releases its numbers for the second quarter of 2014. John Deere is also releasing its second quarter figures and should shed some light on company spending for heavy machinery in agriculture and mining.

 

International News: International news last week focused on a few different topics, with the most potentially impactful news being out of Iraq. Islamic State (IS), which used to be known as Islamic State of Iraq and the Levant (ISIL) and the Islamic State of Iraq and Syria (ISIS), continues to make headway in taking control of vast parts of Iraq. The US became directly involved last week as the military dropped food and water on a remote mountain top where are small religious group of up to 40,000 people have been stranded with IS surrounding the base of the mountain. The US also stepped up military strikes on strategic IS equipment as we attempt to slow their progress in trying to take over Iraq and, most importantly, the oil fields of Iraq. President Obama made the announcements that IS will not be allowed to advance up the mountain where the Yazidi are stuck and that the US would continue to make strikes in the region if the fighting continued. What most people in the US are concerned about is being drawn back into a religious conflict that has no clear end game. The other major concern is the stability and production of the Iraqi oil fields, which were off line for a long period of time when the US went in to over throw Saddam Hussein back in 2003. So far oil prices have come down to below $100 per barrel on the announcement that the US will get involved in Iraq, but we will have a to wait and see if the prices can stay under $100. Another potential major supply issue for energy is Russia and the ongoing conflict in Ukraine.

 

Russia continues to amass ground troops and heavy artillery on the Ukrainian border, in what looks like preparations for a ground invasion of Ukraine. As troops appear to be building, the global community continues to apply pressure in the form of sanctions on Russia and many of the businesses operating in Russia. These sanctions appear to be starting to have an impact as Russia lashed out last week at the international community with their own set of import bans on various products coming from a number of countries. A majority of the bans focused on food items and are likely to only really impact the lower classes of society in Russia, as the wealthy elites will continue to have access to anything they want through the black market. The hardest hit region with the new Russian bans will likely be the Nordic region, including Finland, Sweden and Denmark; and well as Estonia, Lithuania and Latvia; as these countries depend very heavily on exporting goods to Russia and importing raw materials from Russia. Finland in particular is vulnerable as it is already in a weakened state trying to pull out of its second recession since 2008 and depending on Russia for more than 14 percent of its total economy. It seems Finland may turn its back on the EU sanctions and establish its own trading deals with Russia. One thing to keep in mind is the fact that all of these sanctions by Europe have been done during the summer months. Once winter rolls around, Russia will have a major upper hand as it can turn off and on the gas that Europe needs to keep warm during the winter months. We will have to wait and see how the situation plays out, but for now the markets will remain on edge about Russia potentially invading Ukraine.

 

 

Market Statistics: Last week saw all three of the major US indexes move up on lower volume than they had moved down on two weeks ago:

 

Index Change Volume
NASDAQ 0.42% Average
Dow 0.37% Below Average
S&P 500 0.33% 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
Home Construction 2.57% Telecommunications -2.81%
Global Real Estate 1.69% Infrastructure -1.28%
Consumer Goods 1.65% Healthcare -0.95%
Oil&Gas Exploration 1.40% Financials -0.75%
Basic Materials 1.03% Medical Devices -0.74%

Fixed-income investments were mixed last week on summer volume:

Fixed Income Change
Long (20+ years) 0.84%
Middle (7-10 years) 0.56%
Short (less than 1 year) 0.01%
TIPS 0.32%

Currency trading was relatively muted last week as it seemed most traders took the week off. Overall, the US dollar lost 0.05 percent against a basket of international currencies. The strongest of the global currencies was the Japanese Yen, which increased 0.54 percent against the US dollar after the “third arrow” of Abenomics seems to be coming together and it looks like the plan could actually work in helping Japan regain its economic footing.

Commodities were mixed last week as various economic data points pointed toward mixed global growth and consumption forecasts. Commodities that had some of the largest gains of the year going into last week were the hardest hit this past week with Livestock declining by the greatest amount:

Metals Change Commodities Change
Gold 1.46% Oil 0.03%
Silver -1.69% Livestock -4.54%
Copper -1.45% Grains 1.41%
Agriculture -1.73%

The overall Goldman Sachs Commodity Index turned in a goose egg for performance last week, while the Dow Jones UBS Commodity Index moved higher by 0.60 percent. Gold was the interesting mover of the week as it seemed many investors were running to the safe haven, possibly out of fear of Argentina and Russia hurting the global currencies.

Last week saw primarily negative performance when looking at the global financial markets with the US markets being more than half of all of the positive moves for the week. The best non-US performance last week was found in China for the third week in a row with the Shanghai based Se Composite Index gaining 0.42 percent. Sweden was the country that saw the worst performance of the week with the Stockholm based OMX 30 Index declining by 4.46 percent. Much of the decline in the Nordic region last week was based on the import bans put in place by Russian President Putin in retaliation for the sanctions imposed on Russia by the international community.

Last week the VIX bounced around a bit, but most importantly, the spike that occurred on Thursday the 31st was not fully reversed. It appears we could be seeing a new trading range for the VIX and the range is about 40 percent higher than it was back in late June and early July. With the current level of the VIX being 16.77, the VIX is implying a move of 4.85 percent over the course of the next 30 days. As is always the case, the direction of the move is unknown.

For the trading week ending on 8/8/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.73 % -0.62 %
Aggressive Benchmark -0.85 %
  1. 87 %
Growth Model 0.54 % 0.56 %
Growth Benchmark -0.65 %
  1. 53 %
Moderate Model 0.42 % 1.77 %
Moderate Benchmark -0.47 %
  1. 16 %
Income Model 0.32 % 2.44 %
Income Benchmark -0.24 %
  1. 67 %

*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 number of changes to our models over the course of the past week as several of our positions continued to break down and hit sell triggers. Over the course of the week we sold our remaining position in Rydex Transportation (RYPIX), Global Infrastructure (TOLLX), Forward Select Income Opportunities (FSONX) and one of our two preferred securities funds, Cohen and Steers Preferred (CPXAX). With all of the sales last week we put the vast majority of the proceeds into cash. We did, however, use a small amount of the proceeds to buy a partial hedging position to help offset any further declines that may occur in our individual stock baskets. At this point we have drastically reduced our exposure and market risk in our various models. Currently we are still not seeing many opportunities that look overly cheap and with the heightened levels of volatility we will likely remain in a defensive position until the markets develop stronger trends.

 

Economic News:  Last week was a very slow week for economic news releases as there were no releases that had a noticeable impact on the overall movements of the markets. Below is a table of the releases with the ones that missed significantly highlighted in red (there were none) and the ones that significantly beat expectations highlighted in green (there were none):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 8/5/2014 ISM Services July 2014 58.7 56.5
Neutral 8/7/2014 Initial Claims Previous Week 289K 308K
Neutral 8/7/2014 Continuing Claims Previous Week 2518K 2525K
Neutral 8/7/2014 Consumer Credit June 2014 $17.3B $15.8B
Neutral 8/8/2014 Wholesale Inventories June 2014 0.30% 0.40%

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

 

Last week started off on Tuesday with the release of the Services side of the ISM index, which posted a slightly higher than expected reading. While the reading was higher than expected it was not as large of a surprise as the overall ISM released two weeks ago. On Thursday the standard weekly jobless claim figures were released, with both numbers coming in slightly better than the markets had been expecting. Consumer credit was also released on Thursday and came in higher than expected, which is a positive sign for the overall health of the US economy. Credit expansion is normally a positive sign for the economy because it symbolizes that banks are willing to lend and that lending, in theory, will make its way back into the economy. On Friday Wholesale Inventories came in very close to market expectations after having risen by three tenths of a percent during the month of June. Overall, the past week’s market movements were not driven by economic releases, but rather by earnings results from a wide variety of companies.

 

This week is a slow week for economic news releases, as far as number, but there are a few releases that have the potential to be market moving. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
8/13/2014 Retail Sales July 2014 0.30%
8/13/2014 Retail Sales ex-auto July 2014 0.30%
8/14/2014 Initial Claims Previous Week 305K
8/14/2014 Continuing Claims Previous Week 2523K
8/15/2014 PPI July 2014 0.20%
8/15/2014 Core PPI July 2014 0.20%
8/15/2014 Empire Manufacturing August 2014 15.5
8/15/2014 University of Michigan Consumer Sentiment Index August 2014 81.7

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

 

This week kicks off on Wednesday with the release of retail sales, both including and excluding automobile sales. This release will be closely watched because it is the first major data point about the US consumer for the month of July, which is the start of the third quarter of the year. This data in turn will lead to some speculation about the strength of the third quarter GDP figure in the US; a figure we need to be very strong in order to make it to the current overall 2014 GDP projections being touted by most economists. With the expectation being so close to zero, we could see a large market reaction either up or down if this release misses by more than three tenths of a percent. On Thursday the standard weekly jobless claims figures will be released with both figures expected to be slightly higher than they were last week. Friday is a busy day for releases as the Producer Price Index (PPI) for the month of July will be released as well as the Empire Manufacturing data and the University of Michigan’s Consumer Sentiment Index. The PPI is expected to show very little gain during July, due in large part to the decline in the price of energy during the month. The Empire Manufacturing Index will be an interesting release. If you will remember, during July the figure was 25.6, while the market had only been expecting 13.2. So now, with expectations having been lowered, the market is looking for 15.5. It seems that if 15.5 is printed, it will be a little bit of a letdown after such a large upside surprise last month. Wrapping up the week on Friday is the University of Michigan’s Consumer Sentiment Index for the month of August (first estimate), which is expected to show no change from the end of July.

 

Fun fact of the week: The post office, for the second quarter of 2014, lost $2 billion. In honor of this, the fact of the week is from the USPS:

Most Unusual Delivery Method for mail still being used — mule train delivery in AZ.

Each mule carries about 130 pounds of mail, food, supplies and furniture down the

8-mile trail to the Havasupai Indians at the bottom of the Grand Canyon.

The mule trains average 4,000 pounds per day.

Source: about.USPS.com

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