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

For a PDF version of the below commentary please click here Weekly Letter 8-4-2014

Commentary at a glance:

-No new all time highs last week!

-Has the correction that people have been waiting for started?

-Oops, Argentina has done it again.

-Earnings season weakened a little with last week’s announcements.

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

 

Market Wrap-Up: Last week saw all three of the major US indexes move noticeably lower, while volume overall was above average with the highest volume being seen on the NASDAQ. Technically, two of the three indexes fell off the proverbial cliff last week while one is hanging on, though just barely. Meanwhile, the VIX spiked upward as expected after being at such a low level. 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 8-4-14

As you can see above, the S&P 500 (upper left pane above) broke down through its newly drawn trading channel and continued to fall into no man’s land the day after breaking down. The Dow (upper right pane above) simply went over the edge and looks like it will be down for an extended period of time; to borrow a great line from Fed Chair Janet Yellen. The NASDAQ (lower left pane above), on the other hand, has the greatest chance of being able to hold up as it has moved to the lower bound of it trading channel without breaking though, meaning there is still hope that it will bounce higher. It was only two weeks ago that investors were ecstatic that the Dow was closing above 17,000 for the first time ever and doing so for more than a week. We now find the Dow trading a bit lower, currently sitting under 16,500. It is amazing how fast the financial markets can turn on a dime. While the financial markets appear to have hit a rough patch, the VIX is certainly high flying as it had one of its best weeks in a very long time last week, thanks in large part to the nearly 30 percent spike upwards on Thursday. The VIX has now broken well above the average level it has been at for the past year and looks like it may stay elevated for some time to come. The main reason for the sustained elevation is that typically in a short term spike the VIX jumps higher one day, then falls immediately the next day due to an overreaction to the upside. However, this spike did not fade away the following day, but instead actually moved higher. It will take a few days at the elevated level to say it could be more than a spike, so we will have to just wait and see how things turn out for the VIX.

 

National News: National news last week initially focused on earnings releases for the second quarter, but completely changed on Thursday as everyone wondered what was happening to the markets. Earnings have very noticeably impacted the direction of the market as several of the bellwether companies in various industries have been pushing around the indexes. Last week was the busiest week of the earnings season. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see, it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

3D Systems -27% Hilton Worldwide 5% Public Storage 1%
Aetna 5% Humana 0% Rayonier -83%
Aflac 4% Hyatt Hotels 7% Southern 1%
Allstate 26% International Paper 16% Spirit Airlines 1%
American Express 7% Iron Mountain 5% Sturm Ruger -13%
Arrow Electronics 1% J&J Snack Foods 5% Tesla Motors 33%
Arthur J. Gallagher -3% Kellogg 0% The Goodyear Tire & Rubber 0%
Big 5 Sporting Goods -18% Kraft Foods Group -4% Time Warner Cable -2%
Booz Allen Hamilton 25% L-3 Communications -2% T-Mobile US 0%
BorgWarner 2% Level 3 Communications 12% Trulia 10%
Burger King 9% LinkedIn 0% Twitter 18%
CBRE Group 3% Manitowoc Company -15% Tyson Foods -10%
Chevron 11% Marriott International 6% United Parcel Service -2%
Clorox 4% MasterCard 4% United States Steel 152%
Coach Pushed Merck & Co 5% Waste Management 2%
Colgate-Palmolive 0% Newmont Mining 0% WellPoint 7%
ConocoPhillips 1% Oshkosh -11% Western Digital 6%
Denny’s 13% Owens & Minor -13% Western Union 0%
Equity Residential 1% PACCAR 1% Weyerhaeuser 18%
Expedia 38% Panera Bread -1% Whole Foods Market 5%
Exxon Mobil 7% Pfizer 4% World Wrestling Entertainment -6%
Hertz Global Pushed Phillips 66 -11% Wynn Resorts Ltd 1%
Hess 15% Procter & Gamble 4% Xcel Energy -5%

 

According to Factset Research, we have now seen 75 percent of the component companies of the S&P 500 release their second quarter 2014 earnings figures and things continue to look pretty good, although results are slightly weaker than this same time last week. 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. We 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. Revenues of the companies that have released earnings have weakened a bit since last week with now only 65 percent having beat estimates while 35 percent have missed revenue expectations. This is opposed to more than 72 percent beating on revenues just two 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. We really only have about two more weeks that we could see meaningful changes in the overall earnings and revenue numbers, after which time it mathematically becomes very difficult for just a few companies to move the overall needle for the quarter.

 

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 of. Below is a table of the better known companies announcing earnings with the potentially most impactful releases highlighted in green:

 

AOL Hillshire Brands Ralph Lauren
Aqua America Jack In The Box Rosetta Stone
Archer Daniels Midland LeapFrog Enterprises SolarCity
CenturyLink Loews South Jersey Industries
Coach Mannkind St. Joe
Consolidated Edison McDermott International Teekay
Cooper Tire & Rubber MGM Resorts International Time
CVS Caremark Molson Coors Brewing Time Warner
Diebold Office Depot Walt Disney
DISH Network Papa John’s International Wendys
Groupon Prudential Financial Zillow

 

As long as none of the companies highlighted above miss their earnings by a very wide mark there should be less market reaction to earnings than in previous weeks as the trend and rough outline of companies either meeting or missing earnings has been pretty well figured out at this point for the second quarter earnings season.

 

Earnings took a back seat to market movements on Thursday as the Dow lost more than 300 points in the single trading session as investors seemed to be spooked and headed for the sidelines. There are several theories about why the market moved down so fast, but in the end it seems to have just been because investors wanted out. The most common theory is that the labor market data released on Thursday seems to increase the likelihood that the Federal Reserve could raise interest rates sooner than many investors were anticipating. This theory has some merit as the Fed taking away the punch bowl of low interest rates will be a major market moving event, but why the reaction to just one data point? Fed Chair Yellen has made it very clear that she is looking at many data points and that interest rates will remain low for an “extended period of time.” I do not think a single data point will change her mind. Earnings results are also being looked at as a catalyst for the decline, but quite frankly there were just not enough negative results to push the market around that much. Kellogg was one of the larger companies that had something negative to say when they lowered their full year 2014 guidance, causing the shares to fall more than 6 percent. Micron Technologies also took it on the chin to the tune of more than 6 percent after their main competitor Samsung said they are increasing production of their DRAM unit. Other interesting earnings of the day included ConocoPhillips and Time Warner, both of which were not all that bad, but still the stocks moved noticeably lower. The final aspect of the decline that was mentioned was the overnight default of Argentina for the second time in the past 13 years. While the default was widely expected, there were hopes that the country would be able to work something out with the holdout investors prior to actually going into a technical default again.

 

International News: International financial news last week focused on Argentina as the country officially went into default for the second time in the past 13 years, only this time it was different. Argentina has said that it does want to make the payment due on their current debts; they have even gone as far as sending the funds to the Bank of New York as proof that they do have the funds. The problem is that there are still holdout investors from 13 years ago that got a US judge to say that they needed to be made whole prior to any money being paid out on the current bonds. Although mediators from both sides worked up until the deadline (they only met once near the deadline) they came up empty handed as the holdout investors would not budge. At issue is the fact that back in 2001 when Argentina defaulted there were a few very large hedge funds that owned a lot of Argentinean debt and did not accept the 33 cents on the dollar payouts that were offered in 2005 and 2010; they want full payment plus interest of $1.5 billion. In a recent Supreme Court ruling the judge sided with the holdout hedge funds and a district court judge upheld the ruling, effectively blocking any interest payments until the holdouts had been made whole. Argentina will surely be further locked out of the capital markets, although it never really did make it into the mainstream financial markets after 2001. To Argentina’s credit, they tried to make their payments on time, but the US court system blocked them from doing so, making the technical default not their fault in their eyes. With both sides still fighting about it, it looks like this fight will remain a legal battle that could drag on for many more years, only now there are many other investors who have seen their payments dry up from Argentina.

 

Other international news last week was largely quiet as there continued to be fighting in Gaza between Israel and Hamas, and Russia continues to cause problems in Ukraine despite yet another round of heavy handed sanctions placed on the country by the international community. As President Obama said, we are not entering a new cold war, but the international community is not going to stand for the kinds of actions Russia has been taking in recent weeks within Ukraine. The final major international news story last week was the quickly spreading Ebola virus that is making its way through parts of Africa and there are fears that it could spread even further. With a death rate of higher than 90 percent, Ebola represents a major concern from a potential global healthcare crisis.

 

 

Market Statistics: Last week saw all three of the major US indexes move lower by more than two percent during a week that had very little reason for such a drastic decline to have taken place:

 

Index Change Volume
NASDAQ -2.18% +
S&P 500 -2.69% +
Dow -2.75% +

 

While the decline on Thursday is still a bit of a mystery as to why it happened, there were several theories to explain the decline, which I discussed in more detail above. One thing that is for sure is the fact that volume was above average, as the aggregate reaction to all of the theories seemed to involve more investors than just your average few choppy trading days. Remember that we are still fully in summer trading mode and had the same type of market move occurred during any other time of the year we would likely have seen volume spike higher instead of the muted above average volume we did see.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Telecommunications 0.66% Home Construction -4.24%
Semiconductors -1.03% Energy -4.23%
International Real Estate -1.05% Oil & Gas Exploration -4.19%
Residential Real Estate -1.12% Natural resources -4.16%
Healthcare -1.28% Insurance -3.67%

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

Fixed Income Change
Long (20+ years) -0.96%
Middle (7-10 years) -0.32%
Short (less than 1 year) 0.01%
TIPS -0.59%

As with most weeks when there is so much uncertainty in the financial markets the US dollar sees inflows as it is the “reserve” currency of the world and one of the safest currencies to invest in. Overall the US dollar gained 0.42 percent against a basket of international currencies. The strongest currency in the world last week was not surprisingly the Swiss Franc, which gained 0.42 percent against the US dollar.

Commodities all moved lower last week. The metals lost ground and oil took a plunge:

Metals Change Commodities Change
Gold -1.12% Oil -4.38%
Silver -1.76% Livestock -2.96%
Copper -0.81% Grains -2.23%
Agriculture -0.41%

The overall Goldman Sachs Commodity Index gained 3.09 percent for the week last week, while the Dow Jones UBS Commodity Index moved lower by 1.89 percent. The main driving force in the divergence of performance was the drastic decline in the price of oil, which is more heavily weighted in the Goldman Index than the Dow index. With the financial markets declining so sharply in most of the world it was not surprising to see that the vast majority of commodities followed suit and moved lower as well.

Last week saw primarily negative performance when looking at the global financial markets with Asia really being the only area of the markets that turned in positive performance for the week. The best performance last week was found in China for the second week in a row with the Shanghai based Se Composite Index gaining 2.76 percent. Russia was finally out of the dog house last week as Germany posted the highest global loss of the major exchanges with the Frankfurt based Dax Index falling by 4.50 percent on global financial concerns.

The VIX last week started out moving lower on Monday, followed by upticks the last four days of trading for the week. Thursday saw the largest of the upward moves with the VIX gaining 27.16 percent. This move on Thursday was the third jump of more than 25 percent upward that has occurred during 2014 with the other two occurring in January and early July. Overall, for the week the VIX increased by 34.20 percent, placing it among the top 25 upward moving weeks for the VIX looking all of the way back to 1986. For a little perspective, the VIX (modeled after the fact) would have been up an astonishing 171 percent for the week back in October 1987, during the “crash.” Back in current times the VIX easily broke above its most recent trading range with the move on Thursday, but we remain more than 20 percent below the previous “panic levels” of VIX spikes that we have seen over the past two years with the key level seemingly being 20 on the VIX where people really start to become scared. The current level of the VIX (17.03) implies that the options traders are looking for a move of nearly 5 percent in the S&P 500 over the course of the next 30 days. As always, the direction of the move is unknown. With the move in the VIX and the extended period of time since a real correction in the markets, we started to move toward safety in our portfolios just in case this is the start of something more meaningful than recent market corrections.

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

Last Week Year to Date
Aggressive Model -2.39 % -1.34 %
Aggressive Benchmark -2.12 %
  1. 74 %
Growth Model -2.28 % 0.02 %
Growth Benchmark -1.66 %
  1. 19 %
Moderate Model -2.06 % 1.35 %
Moderate Benchmark -1.18 %
  1. 63 %
Income Model -2.01 % 2.10 %
Income Benchmark -0.58 %
  1. 91 %

*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 with all of the changes being defensive in nature. On Tuesday, because the market looks like it will struggle going forward, we sold part of our highest risk position across the models, that being the Rydex Energy Service Fund (RYVIX). This increase in risk was realized much faster than we anticipated with the large decline seen on Thursday. Throughout the week we sold the remainder of our highest risk position (RYVIX) and sold part of our second highest risk position, Rydex Transportation (RYPIX). While we actively watched what was unfolding in the markets, it did not appear that any outright hedging of the stock positions in our models was called for as this really was a very small bump in an otherwise smooth and steady road. Some of the positions we had been watching to enter at the correct price were hit last week with the biotechnology and healthcare fund we have been watching falling by nearly four percent in the final two days of trading. The price is improving, but we are still not there in the areas of the market that look the most interesting.

 

Economic News:  With last week having a month end during the week there were a lot of month end economic data released, with some having an impact on the overall markets. Below is a table of the releases with the ones that significantly missed highlighted in red while the one that significantly beat expectations is highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 7/28/2014 Pending Home Sales June 2014 -1.10% -0.80%
Neutral 7/29/2014 Case-Shiller 20-city Index May 2014 9.30% 10.00%
Positive 7/29/2014 Consumer Confidence July 2014 90.9 85.6
Neutral 7/30/2014 ADP Employment Change July 2014 218K 215K
Slightly Positive 7/30/2014 GDP-Adv. Q2 2014 4.00% 3.20%
Neutral 7/31/2014 Initial Claims Previous Week 302K 310K
Neutral 7/31/2014 Continuing Claims Previous Week 2539K 2525K
Negative 7/31/2014 Chicago PMI July 2014 52.6 61.8
Slightly Negative 8/1/2014 Nonfarm Payrolls July 2014 209K 220K
Slightly Negative 8/1/2014 Nonfarm Private Payrolls July 2014 198K 225K
Slightly Negative 8/1/2014 Unemployment Rate July 2014 6.20% 6.10%
Neutral 8/1/2014 Personal Income June 2014 0.40% 0.40%
Neutral 8/1/2014 Personal Spending June 2014 0.40% 0.40%
Neutral 8/1/2014 PCE Prices – Core June 2014 0.10% 0.20%
Neutral 8/1/2014 University of Michigan Consumer Sentiment Index July 2014 81.8 82
Slightly Positive 8/1/2014 ISM Index July 2014 57.1 55.9

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

 

Last week started with pending home sales for the month of June, which declined as expected, but not by a large enough margin to cause concern. On Tuesday the Case-Shiller 20 City Home Price Index for the month of May was released and showed that home prices on a year over year basis increased by 9.3 percent, slightly below expectations, but still a near double digit gain for the year. The housing data, however, was over shadowed on Tuesday with the release of the Consumer Confidence Index, which handedly beat market expectations. On Wednesday, perhaps the potentially most impactful release of the week was released, that being the advanced estimate of GDP for the second quarter of 2014. Estimates had been for 3.2 percent, but the release showed 4.0 percent. While some of the data that went into the 4.0 percent growth is being questioned, it is what the government printed as a first guess. The first quarter final number was also revised at the same time from -2.9 percent up to -2.0 percent as the government received “better” data about the first quarter. Thursday saw the release of the standard weekly unemployment related figures with initial jobless claims missing expectations while continuing jobless claims came in slightly higher than expectations. The lone negative release of the week was the Chicago PMI, which missed expectations by nearly 15 percent. While this would normally be concerning, the other major city manufacturing data (New York and Philly) were so strong that the market seemed to disregard the poor print out of Chicago. On Friday there were a slew of releases along with everyone wondering what happened to the markets on Thursday. The day started out with the release of the nonfarm public and private payroll figures for the month of July, which both came in slightly below expectations making the overall unemployment rate tick up by one tenth of a percent up to 6.2 percent. Some of this uptick could be attributed to an uptick in the labor force participation rate during the month. Personal income, spending, PCE prices, and the University of Michigan’s Consumer Sentiment index for July all came in either at or very close to market expectations, thus having no noticeable impact on the markets. Wrapping up the week last week was the release of the overall ISM index for the month of July, which came in slightly above market expectations, but remained close enough to expectations that the markets hardly took notice of this release either, as the market was still trying to sort out what the driving force was behind the decline on Thursday.

 

After such a busy week last week this week is a slow week for economic news releases. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
8/5/2014 ISM Services July 2014 56.5
8/7/2014 Initial Claims Previous Week 308K
8/7/2014 Continuing Claims Previous Week 2525K
8/7/2014 Consumer Credit June 2014 $15.8B
8/8/2014 Wholesale Inventories June 2014 0.40%

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

 

This week starts out on Tuesday with the release of the ISM Services Index for the month of July which is expected to show very little change over the level seen during June. On Thursday the standard weekly unemployment related figures are set to be released with little change expected over last week’s numbers. Also released on Thursday is the Consumer Credit figure for the month of June, which is expected to show an expansion in credit of $15.8 billion during the month. This number could vary a bit with the concerns in the global banking system over the troubled Portuguese bank during the month. Wrapping up the week this week is the release of wholesale inventories for the month of June, which are expected to show very little change over the May levels.

For a PDF version of the below commentary please click here Weekly Letter 7-28-2014

Commentary at a glance:

-Mixed summer trading last week on earnings results.

-Israel remains on the offensive in Gaza; Russia continues to deny involvement.

-Earnings season is getting better and worse at the same time.

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

 

Market Wrap-Up: Last week saw two of the three major indexes move higher and one move lower. Volume overall last week was weak with the best volume being seen on the NASDAQ, primarily due to earnings results and investors’ reactions to a few key companies such as Amazon. Technically, there was only one change last week and it was negative for the Dow. 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 7-28-14

Last week saw the continuation of the choppy market we have been seeing for the past few months as the markets struggled for direction. Both the S&P 500 (upper left pane above) and the NASDAQ (lower left pane above) failed to make a run at their respective resistance levels. At this point the resistance levels are starting to be significantly higher than the current trading level, which means it would take even more of a surprise to the upside for the indexes to make it back above this key level. The Dow (upper right pane), however, did see a change last week and it was a breakdown of the index, falling below a key level of support. While breaking through to the downside is technically bad, the index did manage to stay very close to the support level, thus giving it a good chance to make it back into the trading range, as long as the index starts to move up in the next few trading days. With the breakdown of the Dow, it now looks like we are in for sideways movement at best and possibly even a bit of a downward move on the three major indexes through the remainder of the summer. If we do see a downward move it will likely be short lived and not very sharp as the VIX (lower right pane above) appears to only be pricing in a move of less than four percent in the next 30 days. The biggest potential catalysts for such a move will likely be a geopolitical event that is not on anyone’s radar or news that is totally unexpected out of the US Federal Reserve.

 

International News: International news last week lacked any major new developments in both geopolitical hot spots: Ukraine and Israel. In Ukraine, Russia continues to deny any involvement in the shooting down of Malaysian Air flight 17.  This proclamation occurs despite several images and even video of a BUK mobile missile launcher being moved around the rebel strong hold area. The video shows a launcher on a flat bed truck with one of the four missiles missing from the launcher pod; the truck was heading toward the Russian border. No matter who shot down the plane, it seems pretty clear that they were not trying to bring down a civilian airplane and mistook the plane for a military transport aircraft. Another development in the situation is that the international community has agreed to come down harder on Russia with various sanctions. So far, past sanctions have done very little to hamper Putin’s plans. The other major international news items of the week last week revolved around Israel.

 

Israel continues to launch their ground offensive against Hamas in Gaza, with both sides continuing to fight while members of the international community try quickly to cobble together a cease fire. Cease fires have been in place and broken several times over the past few days as Hamas demands that a border crossing be opened and Israel expresses no intention of conceding. At this point there is little direct market movement that can be attributed to the fighting in Gaza, but the most likely mover would be oil as investors may fear the spread of violence in the region.

 

National News: National news last week was focused on second quarter earnings results as we are in the middle of summer with very little occurring on the political front. Earnings have been having a very noticeable impact on the direction of the market as several of the bellwether companies in various industries have pushed around the indexes. Last week was the second busiest week of the earnings season, exceeded only by this coming week in terms of number of companies announcing earnings. Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

3M 0% Eli Lilly and 3% Northrop Grumman -7%
Allegheny Technologies 250% Ethan Allen Interiors 19% O’Reilly Automotive 3%
Amazon.com -108% Facebook 15% PepsiCo 7%
American Airlines Group 2% First Bancorp 200% PulteGroup -4%
AmerisourceBergen 10% Ford Motor 8% Raytheon -11%
Apple 5% Freeport-McMoRan 18% Rent-A-Center 0%
Aptargroup -4% General Dynamics 7% Simon Property Group 1%
AT&T -2% General Motors -26% Six Flags Entertainment 0%
Barnes Group 0% Genuine Parts 2% Skechers USA 66%
Boeing 20% Gilead Sciences 44% Southwest Airlines 15%
Broadcom 10% Halliburton -1% Starbucks 2%
Brown & Brown -7% Hanesbrands 14% Starwood Hotels 1%
Cabela’s 20% Harley-Davidson 11% Texas Instruments 5%
Caterpillar 12% Hershey 0% Coca-Cola 2%
Chipotle Mexican Grill 15% Ingersoll-Rand PLC 2% Travelers Companies -6%
Chubb -11% Kimberly-Clark 0% Under Armour 0%
Comcast 4% Lexmark International 8% Union Pacific 1%
D.R. Horton -35% Lockheed Martin 4% United Technologies 3%
Domino’s Pizza 3% Manpower Group 2% Verizon Communications 1%
Dow Chemical 3% Marriott Worldwide 16% Visa 4%
Dr Pepper Snapple Group 15% McDonald’s -2% Whirlpool -9%
E*TRADE Financial 4% Microsoft -3% Wyndham Worldwide 3%
Electronic Arts 177% Netflix 1% Xerox 4%

 

According to Factset Research we have now seen 46 percent of the component companies of the S&P 500 release their second quarter 2014 earnings figures and so far things are looking pretty good. When looking at the companies that have released earnings, 76 percent of them have released earnings that met or exceeded analyst expectations, while 24 percent have missed expectations. This is better than the average level of the past one- and four-year averages, in which 72 percent beat expectations. Revenues of the companies that have released earnings have weakened since last week with only 67 percent beating estimates while 23 percent have missed. Going into last week, 72 percent were beating revenues estimates. 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.

 

This week is the busiest week of the second quarter earnings season with more than 1,500 companies announcing earnings, including several industry bellwethers that could move the markets. Below is a table of the better known companies announcing earnings with the potentially most impactful releases highlighted in green:

 

3D Systems Hilton Worldwide Public Storage
Aetna Humana Rayonier
Aflac Hyatt Hotels Southern
Allstate International Paper Spirit Airlines
American Express Iron Mountain Sturm Ruger
Arrow Electronics J&J Snack Foods Tesla Motors
Arthur J. Gallagher Kellogg The Goodyear Tire & Rubber
Big 5 Sporting Goods Kraft Foods Group Time Warner Cable
Booz Allen Hamilton L-3 Communications T-Mobile US
BorgWarner Level 3 Communications Trulia
Burger King LinkedIn Twitter
CBRE Group Manitowoc Company Tyson Foods
Chevron Marriott International United Parcel Service
Clorox MasterCard United States Steel
Coach Merck & Co Waste Management
Colgate-Palmolive Newmont Mining WellPoint
ConocoPhillips Oshkosh Western Digital
Denny’s Owens & Minor Western Union
Equity Residential PACCAR Weyerhaeuser
Expedia Panera Bread Whole Foods Market
Exxon Mobil Pfizer World Wrestling Entertainment
Hertz Global Phillips 66 Wynn Resorts Ltd
Hess Procter & Gamble Xcel Energy

 

The market will closely watch both MasterCard and American Express this week. As they process so many transactions across different sectors of the market, their data is sometimes the best data on the number of transactions US consumers make during a given period of time. UPS could also be an interesting company to watch this week as the shipment of packages is another sign of the economic times we find ourselves living in.

 

Market Statistics: Last week saw two of the major US indexes move higher and one move lower. Earnings reports from various component companies drove much of the market movements:

 

Index Change Volume
NASDAQ 0.39% average
S&P 500 0.01% -
Dow -0.82%

 

Much like the overall movement in the markets last week being driven by earnings announcements, volume was also primarily driven by the announcements. For example, on Friday Amazon was hammered for its quarterly results and became a major driving force behind the NASDAQ weekly volume moving up to average. Prior to Amazon’s move on Friday, volume on the NASDAQ was running below average for the week.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Broker Dealers 1.49% Semiconductors -4.73%
Biotechnology 1.47% Aerospace & Defense -2.11%
Medical Devices 1.16% Home Construction -1.74%
Oil&Gas Exploration 0.87% Insurance -1.21%
Regional Banks 0.86% Consumer Staples -0.98%

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

Fixed Income Change
Long (20+ years) 1.00%
Middle (7-10 years) 0.13%
Short (less than 1 year) -0.10%
TIPS 0.34%

In currencies, the US dollar was up 0.65 percent against a basket of international currencies. The Australian dollar was the strongest of the global currencies as it gained 0.06 percent against the US dollar.

Commodities were mixed last week as most metals lost ground while oil and other commodities gained:

Metals Change Commodities Change
Gold -0.27% Oil 0.41%
Silver -0.75% Livestock -0.34%
Copper 1.85% Grains -0.56%
Agriculture 1.37%

The overall Goldman Sachs Commodity Index gained 0.46 percent for the week last week, while the Dow Jones UBS Commodity Index advanced by 0.10 percent. After such a wild week in commodities two weeks ago with the escalation in Ukraine, last week was a gladly accepted slow week for global commodity trading. Industrial numbers out of China helped push Copper to a nice weekly gain and the continuing drought in California started to be seen again in various agricultural commodities.

Last week saw primarily positive performance when looking at the global financial markets with both emerging and developed markets experiencing gains. The best performance last week was found in China with the Shanghai based Se Composite Index gaining 3.28 percent. With the crash in Ukraine still making international headlines it was not surprising to see that Russia saw the worst performance of the week last week, dropping by 2.92 percent.

The VIX had an interesting week following the spike on the downed plane in Ukraine, as it started the week moving lower only to spike upward on Friday on poor earnings announcements from a few key companies. At the current level of 12.69 the VIX is implying a move of about 3.67 percent over the next 30 days on the S&P 500. As always the direction of the move is unknown.

For the trading week ending on 7/25/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.75 % 1.09 %
Aggressive Benchmark 0.32 % 4.97 %
Growth Model -0.65 % 2.36 %
Growth Benchmark 0.26 % 3.92 %
Moderate Model -0.59 % 3.49 %
Moderate Benchmark 0.19 % 2.84 %
Income Model -0.54 % 4.21 %
Income Benchmark 0.09 % 1.50 %

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

 

We made no changes to any of our models over the course of the week. We continue to watch various sectors of the market for potential investment. Currently, the highest rated sectors of the market that we do not have exposure to are Biotechnology and Healthcare. Both Biotechnology and Healthcare look a little expensive at the current time, but the recent trend has been for declining prices in both sectors, so it is moving toward our purchase price valuation.

 

Economic News:  Last week was a pretty slow week for economic news releases, but one of the more watched releases of the week did surprise to the upside. 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
Neutral 7/22/2014 CPI June 2014 0.30% 0.30%
Neutral 7/22/2014 Core CPI June 2014 0.10% 0.20%
Neutral 7/22/2014 Existing Home Sales June 2014 5.04M 5.00M
Neutral 7/24/2014 Initial Claims Previous Week 284K 308K
Neutral 7/24/2014 Continuing Claims Previous Week 2500K 2533K
Slightly Negative 7/24/2014 New Home Sales June 2014 406K 475K
Positive 7/25/2014 Durable Orders June 2014 0.70% 0.30%
Neutral 7/25/2014 Durable Goods -ex transportation June 2014 0.80% 0.70%

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

 

Last week started out on Tuesday with the Consumer Price Index (CPI) indicating that prices at the consumer level during the month of June remained pretty flat; core prices (CPI minus food and energy) also remained very benign. On Thursday the standard weekly unemployment figures were released and came in better than expected on both initial and continuing jobless claims, with initial jobless claims falling to their lowest level since February of 2006, well before the financial downturn of 2008. The positive news on initial jobless claims, however, was slightly dampened by the dismal number that came out on the new home sales figure released later during the day on Thursday, which showed home sales falling much more than expected. On Friday durable goods orders for the month of June surprised the market, coming in more than double the expected growth rate. When transportation was removed from the equation, however, the figure for orders was much closer to expectations.

 

This week the focus will be on the American consumer and employment, with several economic news releases that could really drive the market movements. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
7/28/2014 Pending Home Sales June 2014 -0.80%
7/29/2014 Case-Shiller 20-city Index May 2014 10.00%
7/29/2014 Consumer Confidence July 2014 85.6
7/30/2014 ADP Employment Change July 2014 215K
7/30/2014 GDP-Adv. Q2 2014 3.20%
7/31/2014 Initial Claims Previous Week 310K
7/31/2014 Continuing Claims Previous Week 2525K
7/31/2014 Chicago PMI July 2014 61.8
8/1/2014 Nonfarm Payrolls July 2014 220K
8/1/2014 Nonfarm Private Payrolls July 2014 225K
8/1/2014 Unemployment Rate July 2014 6.10%
8/1/2014 Personal Income June 2014 0.40%
8/1/2014 Personal Spending June 2014 0.40%
8/1/2014 PCE Prices – Core June 2014 0.20%
8/1/2014 University of Michigan Consumer Sentiment Index July 2014 82
8/1/2014 ISM Index July 2014 55.9

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

 

This week kicks off on Monday with the release of pending home sales for the month of June and after the dismal new home sale figure last week the market may be watching this release pretty close. On Tuesday the first of the major releases of the week is released, that being the consumer confidence index for the month of July, which is expected to show little change over the level seen during June. On Wednesday the first of the employment figures of the week is set to be released with the ADP employment change figure for July, which is expected to show the addition of 215,000 new jobs during July. Also released on Wednesday is the potentially most impactful economic news release of the week, that being the advanced GDP estimate for the US economy during the second quarter of 2014. This release is the first release since the downright dismal number for the end o the first quarter, which you may remember came in at -2.9 percent. Expectations of a 3.2 percent GDP print seem a little high as it would represent a full 6 percent swing in GDP during just one quarter. From the data points that came out throughout the quarter, this big of a swing just does not seem likely. Thursday will be a pretty slow day unless the initial jobless claims figure manages to print below 300,000 for the second week in a row, but that is not the expectation of Wall Street and seems pretty unlikely. Friday is a very busy day for economic news releases with the government releasing the official unemployment rate in the US during the month of July as well as the nonfarm public and private payroll figures. The unemployment rate in the US is expected to have remained the same at 6.1 percent, but it would not be surprising to see a tenth of a percent change either way in the figure. As is always the case, watch the participation rate and payroll numbers for a more accurate look into the real state of the US unemployment rate. Likely to be largely ignored on Friday is public spending and income for the month of June, which are both expected to show a small increase of 0.4 percent. Later during the day on Friday the University of Michigan’s Consumer Sentiment Index for the month of July (final print) is expected to print a reading of 82, which is a slight increase over the June figure. Wrapping up the week on Friday will be the release of the ISM index for the month of July. Expectations are for a reading of 55.9, but this seems very low given the blow out figures we saw two weeks ago out of both New York and Philly. With all of these releases plus earnings this week we could see a very choppy and exciting market.

For a PDF version of the below commentary please click here Weekly Letter 7-21-2014

Commentary at a glance:

-We thought summer was going to be boring!

-Two major international events drove the global financial markets.

-VIX spiked upward, but only up to the one year average.

-Earnings season is picking up steam.

-Economic news releases last week were minimal with none having an impact on the market.

 

Market Wrap-Up: Last week saw all three of the major US indexes move higher for the week, shrugging off two major international situations. This move higher was done on average one-year volume and indicates the staying power of these markets in the face of adversity. While none of the indexes technically broke out to the upside, it could have been a lot worse. 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 7-21-14

In the above charts you can see that after such a strong run upward over the past two months the NASDAQ (lower left pane) has stalled out. We remain a significant way away from a resistance level (red line) on the index and it looks much more likely that the NASDAQ will continue to wonder sideways or move lower in the near future. The S&P 500 (upper left pane) has also hit a bit of a speed bump over the last few weeks as it too is moving in a sideways fashion with a resistance line that is significantly above the current level. The Dow (upper right pane), looking like the turtle in the race, has moved once again into the strong technical position of the three major indexes. Some of this strength is likely due to individual investors owning many Dow component companies for their dividends not being able to afford selling them and moving into other financial instruments since there is no yield out there on much of anything. While the markets were moving around last week the VIX was on a very wild ride. After starting the week by moving lower, the VIX spiked upward on Thursday by more than 30 percent, making it one of the largest daily jumps in the VIX that we have seen in the past 2 years. This jump was entirely due to the airline crash in Ukraine and shows that the market does pay attention to current global events and not just 6 months into the future. This reaction on the VIX, however, was short lived as the VIX slid by almost 17 percent on Friday to end the week slightly lower than it started.

 

International News: International news last week was very quiet leading up to Thursday. Then the silence went by the way side as a Malaysian Airline flight was shot down over Ukraine. This happened late in the afternoon in Ukraine, which is mid-morning here in the US. Immediately, the global financial markets moved lower and the finger pointing began. The world jumped to the conclusion that Ukrainian separatists shot down the plane using advanced weaponry supplied by Russia. Russia said it had nothing to do with it and the Ukrainian separatists pointed fingers at the government of Ukraine. While the details of what happened are still being worked out, one thing is for sure, the weapons system that brought down the plane was very sophisticated as the plane was traveling more than 400 miles per hour at an altitude of more than 33,000 feet. While we may not know the exact person who hit the launch button, this is for sure a turning point in the conflict in Ukraine as the world is now against Russia and calling for Russia to put an end to the violence. The most direct impact of the situation was seen on the Russian exchange traded fund here in the US as it fell by nearly 10 percent intraday on Thursday. Oil prices moved higher and gold spiked upwards as the scare trade was in play. But, as time went on and more news came out the markets seemed to shrug its shoulders and move on to the next headline. That headline was about Israel.

 

On Thursday evening Israel launched a ground invasion of Gaza in an attempt to stop the nearly constant bombardment of rockets flying toward Israel, launched by Hamas in Gaza. While the offensive between Israel and Hamas had been ongoing for almost two weeks, last week was the official start to a ground operation. Prior to last week Israel had been relying on superior air power and the cover of darkness to bomb targets within Gaza. With this latest phase, Israel claims it is attempting to shutdown the vast network of tunnels built in Gaza that allows Hamas to freely move around weapons to be used to attack Israel. This move of the ground invasion came as a surprise to some as just a few hours earlier Israel had been at the negotiating table in Egypt trying to broker a cease fire between the two sides. With the world’s eye firmly glued to the situation in Ukraine with the downed plane, it seems the Israelis thought it would be the best time to launch an offensive and stay largely out of the global headlines. The global financial markets largely ignored the ground invasion of Gaza and kept on moving as if nothing was going on. Even the oil markets failed to react on Friday to the growing invasion. Either the markets are looking 6 months out and both the plane crash and the incursion into Gaza really are very minor one-off events that will not have lasting impacts or the markets are getting far too lackadaisical given the uncertainty in the world.

 

National News: National news was somewhat muted last week as the focus at the end of the week was decidedly toward the two main international events, but there were a few interesting news bytes that came out earlier in the week. The two main stories in the US last week pertained to manufacturing and the second quarter earnings season. Last week, manufacturing in the US was shown in the Empire and Philadelphia Fed’s manufacturing data to be much stronger than the vast majority of economists had expected. As you can see in the chart below showing the Philly Fed Manufacturing index (data provided by the Federal Reserve webpage), the June number pushed us to a multiyear high:

Philly Fed 7-21-14

With Manufacturing at a level not seen since we were just starting to recover from the great recession it looks like the US economy may finally be getting back to firm footing. Historically, strong manufacturing has led to strong economic growth and this is exactly what we need after the dismal first quarter GDP figure we saw a few weeks ago. Aside from strong manufacturing figures, last week was all about earnings and there were a number of them released.

 

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. If a company was scheduled to report earnings, but pushed the release date back they are labeled “Pushed.”

 

American Airlines Pushed Goldman Sachs 34% Piper Jaffray Pushed
Autoliv -6% Google -1% RLI 0%
Bank of New York 11% Honeywell International 1% SanDisk 1%
BlackRock 10% Intel 6% U.S. Bancorp 1%
Charles Schwab 0% IBM 0% United Rentals 15%
Citigroup 15% J B Hunt Transport Services 0% VF Corp 3%
CSX 2% Johnson & Johnson 8% Whirlpool Pushed
eBay -2% JPMorgan Chase & Co 12% Wolverine World Wide 15%
First Republic Bank -9% Kansas City Southern 3% Yahoo! 0%
General Electric 0% Las Vegas Sands -4% Yum! Brands 0%

 

According to Factset Research there have been 74 companies in the S&P 500 that have released earnings for the second quarter through last Friday. When looking at the 74 companies that have released earnings, 72 percent of them have released earnings that met or exceeded analyst expectations, while 28 percent have missed expectations. 72 percent of the companies meeting or beating expectations is in line with both the 1-year and 4-year average for quarterly reporting. Revenues also look pretty strong for the 74 companies that have released earnings; 73 percent have beaten estimates, while 27 percent have missed revenue expectations. According to Factset, energy and healthcare are the top two performing sectors of the market so far from an earnings perspective. If we can keep on this pace the second quarter would shape up to be pretty strong. One of the main drivers of the earnings so far seems to be cost cutting measures taking place across a vast array of industries. These types of measures typically have a short term impact as cost cutting at most firms cannot go on indefinitely.

 

This week is the busiest week of the second quarter earnings season with more than 1,000 companies announcing earnings, including several industry bellwethers that could move the markets. Below is a table of the better known companies announcing earnings with the potentially most impactful releases highlighted in green:

 

3M Eli Lilly and Northrop Grumman
Allegheny Technologies Ethan Allen Interiors O’Reilly Automotive
Amazon.com Facebook PepsiCo
American Airlines Group First Bancorp PulteGroup
AmerisourceBergen Ford Motor Raytheon
Apple Freeport-McMoRan Rent-A-Center
Aptargroup General Dynamics Simon Property Group
AT&T General Motors Six Flags Entertainment
Barnes Group Genuine Parts Skechers USA
Boeing Gilead Sciences Southwest Airlines
Broadcom Halliburton Starbucks
Brown & Brown Hanesbrands Starwood Hotels
Cabela’s Harley-Davidson Texas Instruments
Caterpillar Hershey Coca-Cola
Chipotle Mexican Grill Ingersoll-Rand PLC Travelers Companies
Chubb Kimberly-Clark Under Armour
Comcast Lexmark International Union Pacific
D.R. Horton Lockheed Martin United Technologies
Domino’s Pizza ManpowerGroup Verizon Communications
Dow Chemical Marriott Worldwide Visa
Dr Pepper Snapple Group McDonald’s Whirlpool
E*TRADE Financial Microsoft Wyndham Worldwide
Electronic Arts Netflix Xerox

 

Of particular interest since they have been in the news so much during the second quarter will be Apple, Facebook and Amazon. Their results always have the potential to move the markets, but it seems there is even more movement potential this time around as technology firms have been running hot so far this year. Pay particularly close attention to the forward looking guidance as this is typically more impactful on earnings release day than the actual earnings number. So far the forward looking guidance is fairly mixed.

 

 

Market Statistics: Last week saw all three of the major US indexes move higher, despite the situation in Ukraine and in Israel:

 

Index Change Volume
Dow 0.92% average
S&P 500 0.54% average
NASDAQ 0.38% average

 

Average volume was perhaps one of the most interesting aspects of trading last week. As the global events unfolded we did not see much of a market reaction. The markets did not react as I would have expected. Maybe it has to do with all of the uncertainty surrounding the situation in Ukraine, but to see the markets bounce right back on Friday after the losses seen on Thursday was a bit surprising.

 

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
Healthcare Providers 2.46% Biotechnology -2.48%
Broker Dealers 2.23% Regional Banks -2.33%
Telecommunications 1.59% Home Construction -1.22%
Technology 1.49% Medical Devices -0.95%
Transportation 1.47% Pharmaceuticals -0.86%

Fixed-income investments were mixed last week as investors continue to try to guess exactly when the Fed will raise interest rates in 2015:

Fixed Income Change
Long (20+ years) 0.83%
Middle (7-10 years) 0.21%
Short (less than 1 year) 0.01%
TIPS -0.01%

In currencies, the US dollar was up 0.47 percent against a basket of international currencies. The Japanese Yen was the strongest of the global currencies as it gained 0.03 percent against the US dollar.

Commodities were mixed last week as most metals lost ground, while oil and other commodities gained:

Metals Change Commodities Change
Gold -2.06% Oil 1.17%
Silver -2.67% Livestock 0.65%
Copper -1.57% Grains -0.30%
Agriculture 0.92%

The overall Goldman Sachs Commodity Index turned in a zero percentage move for the week last week, while the Dow Jones UBS Commodity Index fell by 0.74 percent. The deviation in performance between the two main commodity indexes is largely explained by the heavy over weighting on the Goldman index toward oil, which saw a strong week of performance last week, while the Dow Commodity index is much more evenly weighted and hence was affected by the negative performance of metals. Many of the moves last week were heavily influenced by the plane crash in Ukraine as we saw gold spike upwards intraday on fears of a war between the west and Russia, while global oil moved higher on thoughts that further sanctions would likely be coming against Russia as the rest of the world unites behind Ukraine.

Last week saw primarily positive performance when looking at the global financial markets with both emerging and developed markets experiencing gains. The best performance last week was found in Brazil, for the second week in a row, with the Sao Paulo based Se BOVESPA Index gaining 4.06 percent, giving the index a two week run of 6.6 percent, thanks in large part to the World Cup going off without incident. With the crash in Ukraine it is not surprising to see that Russia saw the worst performance of the week last week, dropping by 5.16 percent, with nearly all of the decline occurring on Thursday.

Last week I said that a key level to watch on the VIX was 13.90 as that was the 52-week moving average level of the VIX. Last Thursday the VIX had no problem whatsoever jumping right up above the 13.90 level as the VIX opened at 11.00 and closed the day at 14.54. This move of more than 32 percent in a single day was something we have not seen since April 15th of 2013, a day when the VIX spiked 43 percent in a single day. Given the severity of the spike that we saw in the VIX it was surprising that we did not see a much larger sell off on the major US indexes. My guess as to why we did not see such a sell off is twofold: the first being that Ukraine does not directly impact the global financial markets very much and the second being that investors did not want to over react to a situation with so many unknowns. The VIX did settle down on Friday last week, giving up more than 18 percent to end the week below the 52-week average, thus ending the very short lived spike that turned out to be just a single day event. At the current level of 12.06 the VIX is implying a move of about 3.5 percent over the next 30 days on the S&P 500. As always, the direction of the move is unknown.

For the trading week ending on 7/18/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week Year to Date
Aggressive Model 0.32 % 1.86 %
Aggressive Benchmark 0.43 % 4.63 %
Growth Model 0.23 % 3.04 %
Growth Benchmark 0.33 % 3.64 %
Moderate Model 0.14 % 4.06 %
Moderate Benchmark 0.24 % 2.65 %
Income Model 0.00 % 4.84 %
Income Benchmark 0.12 % 1.40 %

*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 during the week last week as there seemed to be many reactions in the market arising from the situations in Ukraine and Israel. We did, however, move closer to buying our first step of biotechnology as the sector fell by more than four percent. One aspect of the sector that makes me a little weary is the fact that it was called out by the Federal Reserve as a potential bubble. Any time the Fed makes an outright call on a sector of the financial markets it is worth taking a very hard look at the sector to see if there is any value. I do see value in the sector, just not at the current prices. I would rather buy in at a lower price and have a bit of wiggle room in case it moves lower than purchase now and have it decline further.

 

Economic News:  Last week was a very exciting week for economic news releases with several releases that exceeded or missed expectations. Below is a table of the releases with the ones that missed significantly highlighted in red, while the one that significantly beat expectations are highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Negative 7/15/2014 Retail Sales June 2014 0.20% 0.70%
Negative 7/15/2014 Retail Sales ex-auto June 2014 0.40% 0.60%
Positive 7/15/2014 Empire Manufacturing July 2014 25.6 13.2
Slightly Negative 7/16/2014 PPI June 2014 0.40% 0.20%
Neutral 7/16/2014 Core PPI June 2014 0.20% 0.20%
Slightly Positive 7/16/2014 NAHB Housing Market Index July 2014 53 50
Neutral 7/17/2014 Initial Claims Previous Week 302K 311K
Neutral 7/17/2014 Continuing Claims Previous Week 2507K 2563K
Slightly Negative 7/17/2014 Housing Starts June 2014 893K 1020K
Slightly Negative 7/17/2014 Building Permits June 2014 963K 1037K
Positive 7/17/2014 Philadelphia Fed July 2014 23.9 12.5
Slightly Negative 7/18/2014 University of Michigan Consumer Sentiment July 2014 81.3 84

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

 

Last week started out with a bit of a downer for economic news releases with the retail sales figure on Tuesday significantly missing expectations. Overall, retail sales had been expected to increase by 0.7 percent, but instead came in at only 0.2 percent. When auto sales were excluded from the calculation, retail sales increased by only 0.4 percent. Both of these figures are a little concerning, especially when we need a strong second quarter in the US economy to avoid a technical recession. This very low reading in retail sales also brings in some questions as to whether the Fed can actually raise interest rates early next year as a strong economy is necessary for increasing rates. Helping to offset the negative news on sales on Tuesday was a stronger than expected reading on the Empire Manufacturing Index, which came in more than double expectations, with all of the various aspects to the release looking very positive during July. On Wednesday the Producer Price Index (PPI) was released and showed that prices at the producer level are increasing, but increasing very slowly, with the main increase being seen in the cost of energy.  Also on Wednesday the NAHB released the latest housing Market Index for the month of July, which came in better than expected and helped to lift the home builders. On Thursday were several releases that came out, but hardly anyone noticed them as Malaysian Air flight 17 had just gone down in Ukraine and the global news focus was on the story. Both initial and continuing jobless claims came in better than expected. Housing starts missed expectations, as did building permits, but the major economic news release of the day was the Philadelphia Fed’s manufacturing index, which came in at double expectations, just like the Empire Index released earlier in the week. These two releases seem to indicate that manufacturing in the US is really starting to pick up ahead of the major holiday season. Last week wrapped up on Friday with the release of the University of Michigan’s consumer Sentiment Index for the month of July, which came in slightly lower than expected. The lower reading on sentiment was being echoed by the slower sales and spending figures we have seen over the past few months. Let’s hope the manufacturers are correct and spending picks up dramatically over the second half of 2014.

 

This week the focus will be on earnings results, with economic news releases taking a bit of a backseat. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
7/22/2014 CPI June 2014 0.30%
7/22/2014 Core CPI June 2014 0.20%
7/22/2014 Existing Home Sales June 2014 5.00M
7/24/2014 Initial Claims Previous Week 308K
7/24/2014 Continuing Claims Previous Week 2533K
7/24/2014 New Home Sales June 2014 475K
7/25/2014 Durable Orders June 2014 0.30%
7/25/2014 Durable Goods -ex transportation June 2014 0.70%

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

 

This week starts out on Tuesday with the release of the Consumer Price Index (CPI), which is expected to show that prices at the consumer level increased by three tenths of a percent when including volatile things like food and energy and two tenths of a percent when the volatile assets are excluded from the calculation. This release is highly unlikely to move the markets unless there is some very wide deviation from expectations. The number makes traders wonder if the Fed can continue their scheduled plan of action for raising interest rates. Later during the day on Tuesday the latest existing home sales figure for the month of June is set to be released with expectations of 5 million units having been sold during the month. If this number comes to fruition it would be a positive development for the US housing market. On Thursday the standard weekly unemployment related figures are set to be released with both numbers expected to be slightly higher than they were last week. Later during the day on Thursday another housing related number is set to be released, that being the new home sales figure for the month of June, which is expected to come in at 475,000 units. This housing figure will likely move in the same direction as the existing home sales figure, so it should not surprise the market. On Friday the big release of the week, the durable goods orders for the month of June, is set to be released with expectations of a very slight increase of 0.3 percent expected; this release could be either negative or positive. With the number expected being so close to zero it is not impossible to imagine that we see a decline in orders, thus a negative number, but the other June spending figures would lean towards a positive month, so we may see an upside surprise. The more important number is the durable goods orders minus transportation, since planes and cars can greatly skew the figures on a monthly basis. Expectations of 0.7 percent on orders less transportation seems like a fairly safe figure to be expecting.

For a PDF version of the below commentary please click here Weekly Letter 7-14-2014

 

Commentary at a glance:

-US indexes rolled over last week, declining during three of the five trading days.

-The VIX finally moved off the floor.

-Fed minutes indicated October end to QE program.

-Economic news releases last week were minimal, with none impacting the market.

 

Market Wrap-Up: Technically, we saw a few warning flags go up last week as traders returned from the holiday week and started to pull profits, thus pushing the markets lower. From a technical standpoint, the Dow looks the strongest and the NASDAQ and S&P 500 both look equally weak. Something to be a little concerned about that developed last week was a very large jump upward in the VIX, given such a small move in the overall markets. 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 7-14-14

As you can see above, all three of the major US indexes struggled last week when all of the regular traders returned to work after the shortened Fourth of July trading week. Both the S&P 500 (upper left pane) and the NASDAQ (lower left pane) broke down through their most recent levels of support and resistance at almost the same time. Both indexes then tried to move back into or above the trading channel, but failed to do so. It now looks like we would need to see a few good days of performance out of both indexes to see them safely move back to the previous trading channel. The Dow, on the other hand (upper right pane), remains in its most recent trading channel, despite a slight breakdown last week. The recent trading channel on the Dow is much wider that it is on the other two indexes, so at this point it has not given a technical sell signal. With a sell signal being given on both the S&P 500 and the NASDAQ, caution is needed at this point in the market cycle as we could be at an inflection point. One item that seems to be showing that caution is needed is the VIX, which spiked upward last week for the first time in several months.

 

While the move in the market was somewhat muted, in that the indexes were all down less than two percent, the VIX popped by more than 17 percent. This much of a move in the VIX is typically reserved for a more than 2 percent change in the indexes. What does this mean? It most likely means the indexes are very over bought and institutional investors are closely watching for a tipping point that will push this market into a correction. One way to protect on the downside is to buy volatility, such as the VIX, as it should go up as the markets move lower. Last week saw a lot of people buying volatility as protection and the price of the protection has moved up accordingly. However, the VIX started last week at an ultra low level so the move last week could also be seen as the start of a move toward normalcy on the VIX. For example, the average level of the VIX over the past year has been just under 14 and yet we are sitting at 12, even after the 17 percent jump last week. If you believe in revision to the mean, the move in the VIX does not look dire as it is just the normal course of the VIX to move higher toward the average.

 

National News: National news last week focused on two main topics: the Federal Reserve minutes (along with potential actions coming) and the start to the second quarter earnings season. The Federal Reserve released their June meeting minutes on Wednesday and the minutes confirmed that the quantitative easing program would draw to an end in October, as the Fed would end the bond buying program with a $15 billion step. There was some speculation as to whether the Fed was going to either take a $10 billion step in October and a $5 billion remaining step later or do it all at once. So October it is; now on to the next question of when interest rates will be raised. The question of when the Fed will start to raise interest rates has captivated investors ever since the Fed moved interest rates to their lower bound of zero to 0.25 percent. Everyone knows the rates have to increase; the questions are when and how will the Fed go about doing it? From the meeting minutes it looks like there is no consensus concerning when to raise rates, but there are a majority of Fed members who think interest rates will increase during the first part of 2015. The short end of the yield curve looks the most susceptible to rate actions as the long end of the yield curve is much higher than the short; a flattening of the yield curve will likely take place over the next 18 months.  Aside from the Fed meeting minutes, other news last week surrounded the start of the second quarter 2014 earnings season as Alcoa unofficially kicked things off.

 

There is a lot riding on a strong showing for second quarter earnings as it has been dubbed the recovery quarter, following the dismal first quarter results of many companies due to inclement weather. According to Factset Research, expectations for the quarter are for earnings to have grown at 4.6 percent, with the Telecommunications companies leading the way higher. But as we have seen the past few quarters, the bar has been reset lower, as is evident by the 86 companies that have issued negative guidance compared to the 27 companies that have issued positive guidance for the quarter. Overall, seven of the ten major sectors of the market have lower growth expectations now than they did at the end of the first 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. If a company was scheduled to report earnings, but pushed the release date back, they are labeled “Pushed.”

 

Alcoa 38% Family Dollar -6% Progressive 28%
Bob Evans Farms 45% Fastenal 0% WD-40 -4%
Container Store -17% Helen of Troy -13% Wells Fargo 0%

 

As you can see from the small sampling above, we have a mixed bag to start off the earnings season. Of particular concern out of the announcements last week is the retail companies that seemed to have a very hard quarter. The Container Store and Family Dollar, in particular, did not see the amount of shopping increase they had expected after the weird weather in the first quarter of 2014. This could be a very big warning sign for the remainder of the quarter as well as the second quarter GDP print, signaling that things are not as strong as first thought.

 

This week is a fairly busy week for earnings announcements as there are almost 300 companies announcing earnings with several industry bellwethers that could move the markets. Below is a table of the better known companies announcing earnings, with the potentially most impactful releases highlighted in green:

 

American Airlines Group Goldman Sachs Piper Jaffray Companies
Autoliv Google RLI
Bank of New York Mellon Honeywell International SanDisk
BlackRock Intel U.S. Bancorp
Charles Schwab International Business Machines United Rentals
Citigroup J B Hunt Transport Services VF Corp
CSX Johnson & Johnson Whirlpool
eBay JPMorgan Chase & Co Wolverine World Wide
First Republic Bank Kansas City Southern Yahoo!
General Electric Las Vegas Sands Yum! Brands

 

Let’s hope this week goes better than last week for earnings announcements. Watch the financials in particular as there have been a high number of punitive penalties assessed against various institutions over the past quarter that could have an adverse impact on operations.

 

International News: International news last week shifted focus away from Iraq and Russia to the ongoing situation in Israel, as fighting between Israel and Hamas has intensified. It has now been more than a week of heavy fighting in Palestine and Israel as the Israeli military is flexing their might against Hamas with pin point military strikes. Hamas, in retaliation to the strikes, has stepped up their rocket attacks along the border. So far the international community has largely stayed out of the situation, other than to call for less military action and more diplomatic action to settle the current dispute. There will likely be very few direct impacts on the global financial markets, as long as the fighting remains between Israel and Palestine and does not pull in countries like the US and Iran. News out of Iraq has gone eerily silent; in doing so we have seen the price of oil creep lower and, with it, the price of gasoline.

 

Market Statistics: Last week saw all three of the major US indexes move lower after having two of the three indexes push to new all time highs just two weeks ago:

 

Index Change Volume
Dow -0.73% -
S&P 500 -0.90% -
NASDAQ -1.57% -

 

Volume last week was below average on all three of the major US indexes, despite last week being the first full week after the Fourth of July Holiday and typically a high volume summer week.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Real Estate 1.15% Home Construction -4.49%
Utilities 0.78% Small Cap Growth -4.05%
Consumer Products -0.21% Broker Dealers -3.92%
Telecommunications -0.26% Biotechnology -3.48%
Transportation -0.52% Software -3.30%

Fixed-income investments all lost ground last week as a number of analyst reports came out that indicated that the Fed should probably raise interest rates sooner than next year:

Fixed Income Change
Long (20+ years) 2.62%
Middle (7-10 years) 1.10%
Short (less than 1 year) -0.01%
TIPS 1.03%

In currencies, the US dollar was up 0.05 percent against a basket of international currencies. Aside from the US dollar the Euro was the strongest currency of the week, giving up only 0.01 percent against the US dollar.

Commodities were mixed last week as most metals performed well, while grains were the standout commodity that got hammered for the second week in a row:

Metals Change Commodities Change
Gold 1.27% Oil -3.60%
Silver 1.38% Livestock -3.32%
Copper -0.34% Grains -7.66%
Agriculture -4.60%

The overall Goldman Sachs Commodity Index decreased by 3.07 percent, while the Dow Jones UBS Commodity Index fell by 3.09 percent. Much of the decline in the broad commodity based indexes was due to oil declining 3.60 percent as there were few developments in the geopolitical risks that affect oil, particularly with the situation in Israel taking the majority of the International headlines.

Last week saw primarily positive performance when looking at the global financial markets, with both emerging and developed markets experiencing gains. The best performance last week was found in Brazil, after being the worst performing index the prior two weeks, with the Sao Paulo based Se BOVESPA Index gaining 2.45 percent. The worst performance last week was found in France with the Paris based CAC-40 Index giving up 3.86 percent.

We finally saw the VIX move upward on a weekly basis, as the VIX increased by more than 17 percent last week. Much of this increase seemed to be due to concerns that the market may finally be headed for the correction that so many investors have been waiting for. While the VIX is still very far from pricing in a full-on decline in the markets of more than 10 percent, the increase last week did catch the attention of some traders who had been waiting for a reversal on the VIX for some time. The key level to watch at this point on the VIX will be about 13.90 as this is the average level of the VIX over the past 12 months. If we can break above that, the VIX may continue to drift higher. If not, we will likely see it come right back down to a sub 11 level.

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

  Last Week Year to Date
Aggressive Model -0.70 % 1.53 %
Aggressive Benchmark -1.32 % 4.18 %
Growth Model -0.52 % 2.80 %
Growth Benchmark -1.02 % 3.30 %
Moderate Model -0.31 % 3.91 %
Moderate Benchmark -0.73 % 2.40 %
Income Model -0.13 % 4.84 %
Income Benchmark -0.37 % 1.28 %

*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 there continues to be a visible ebb and flow into and out of the types of investments we own. Stock that are financially sound and pay dividends move into and out of favor quickly in a market such as the one we currently find ourselves investing in. Last week they were in favor as investors dumped technology stocks and moved toward safety. Two weeks ago the safe stocks were very out of favor and were dumped in favor of the technology stocks. In a market environment such as this, investors need to look past the noise for the underlying changes being made at companies they own. The vast majority of the companies we own, for instance, have been performing very well from a business stand point in that they are building up their businesses at a time when others are struggling and positioning themselves to make it through any hardships that may come without significant troubles.

 

Economic News:  Last week was a very boring week for economic news releases with the release the market paid any attention to at all being the FOMC meeting minutes:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 7/9/2014 FOMC Minutes June Meeting - -
Neutral 7/10/2014 Initial Claims Previous Week 304K 312K
Neutral 7/10/2014 Continuing Claims Previous Week 2584K 2567K
Neutral 7/10/2014 Wholesale Inventories May 2014 0.50% 0.60%

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

 

Last week started off on Wednesday with the release of the Fed minutes from the June meeting, discussed above in the national news section. On Thursday the standard weekly unemployment related figures were released with initial jobless claims coming in just under expectations and continuing jobless claims coming in just above market expectations. Both figures were so close to market expectations that neither report was really noticed by the markets. Later during the day on Thursday the final economic news release of the week came out, that being the wholesale inventories figure for the month of May, which came in very close to market expectations, increasing 0.5 percent compared to expectations of 0.6 percent. Inventory build up at this point is a positive development for the economy as manufactures see enough demand going forward to actually add to inventories so they are ready in the future.

 

This week is a much more normal week than last week for economic news releases as there are a number of releases that could impact the overall movement of the markets. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
7/15/2014 Retail Sales June 2014 0.70%
7/15/2014 Retail Sales ex-auto June 2014 0.60%
7/15/2014 Empire Manufacturing July 2014 13.2
7/16/2014 PPI June 2014 0.20%
7/16/2014 Core PPI June 2014 0.20%
7/16/2014 NAHB Housing Market Index July 2014 50
7/17/2014 Initial Claims Previous Week 311K
7/17/2014 Continuing Claims Previous Week 2563K
7/17/2014 Housing Starts June 2014 1020K
7/17/2014 Building Permits June 2014 1037K
7/17/2014 Philadelphia Fed July 2014 12.5
7/18/2014 University of Michigan Consumer Sentiment July 2014 84

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

 

This week starts off on Tuesday with the release of retail sales for the month of June, which is expected to show a slight increase of 0.7 percent during the month. When auto sales are excluded from the calculation retail sales are expected to have increased by 0.6 percent. These releases will be closely watched by the markets as retail sales are what have to bear the brunt of the economic load for the US economic growth going forward. Also released on Tuesday is the Empire Manufacturing index for the month of July, which is expected to have fallen from 19.3 in June back down to 13.2 in July. While the number is still well above the all important zero level, a reading of 13 would mean much slower growth in the greater New York area during the month; not a contraction in growth, just a slow down. On Wednesday the Producer Price Index (PPI) for the month of June is set to be released with expectations that it will be very close to 0.2 percent. If we see a reading of 0.2 percent it will further fuel speculation that the Fed’s actions have not adversely affected inflation, as a 0.2 percent reading is well within the range of inflation that the Fed is comfortable with in the economy. Thursday is a busy day for economic news releases as the standard weekly jobless numbers are released as well as housing starts, building permits and the Philadelphia Fed index for the month of July. Overall, the majority of the releases on Thursday do not have the potential to be market moving, with the exception of the Philly Fed figure, which could be impactful if it either greatly misses or beats expectations. This week’s economic news releases wrap up on Friday with the release of the University of Michigan’s Consumer Sentiment Index for the month of July (first estimate). Expectations are for a slight increase up from 82.5 to 84.0. If this materializes it would be seen as positive for the US economy, but the release will be slightly discounted due to the lack of consumer spending we have been seeing in the past few months.

Follow

Get every new post delivered to your Inbox.