For a PDF version of the below commentary please click here Weekly Letter 12-15-2014

Commentary at a glance:

-Last week saw a precipitous drop in the US financial markets.

-The rout in oil continued, having a very negative impact on the markets.

-The House of Representative and the Senate passed a budget for the next year, but many dislike it.

-VIX spike last week was the third largest since 1986!

-Economic news releases came in above market expectations.

 

Market Wrap-Up: If December is going to be a positive month for market returns it sure is digging itself a big hole to climb out of. I made a change to my charts yet again this week as the channels I drew two weeks ago were all broken on Monday of last week as the markets started a fall that continued over the week. The charts below are of the three major US indexes in green with their respective levels of support being draw by the red lines, as well as the VIX and the average level of the VIX over the past one year draw with a red line on the lower right chart:

4 charts 12-15-14

Last week the headlines were all about the decline we were seeing in the price of oil and, in turn,the decline of the equity markets, but the real story was the resurgence of risk, especially risk as measured by the VIX. The VIX last week jumped by the third greatest amount since 1986; that includes all of the spikes during the 2008 melt down, the dotcom bubble and even the crash of 1987. It was truly a move for the record books on the VIX last week. In looking back historically at the top ten VIX spikes since 1986, the average decline in the indexes that resulted when the spike occurred was a loss of 7.42 percent. In this sense we were very lucky that last week saw a decline of less than 4 percent. The more pertinent question to ask is what comes next? In looking at the historical data, there are two outcomes after such a spike. The first is that there are two spikes in relatively short succession, as occurred in 1987 and 2010. The more likely is that the spike is a one-off event, as occurred in the other seven occurrences of a top ten VIX spikes. With this being December and the decline in oil looking like it is nearer the bottom than the half way point, it seems more likely that last week will go down as a one-off event for the VIX. While the VIX was spiking the indexes where holding up relatively well, but that did not stop one of the indexes from giving a very negative technical signal.

 

The S&P 500 broke down last week and did so in a big way. Not only did it break down through the trading channel I drew on the chart two weeks ago, but it also broke down through a major level of support. The support level was the previous high point from back in September, which had been tested twice before. Breaking down through this level, the S&P 500 now finds itself in a kind of no-man’s land with very few technical levels of support within the next 7 percent of potential downward movements. That is not to say the index will not find some support along the way, but from a technical standpoint it looks pretty bleak. The Dow is the second weakest of the three major indexes, but did manage to stop last week right at the key technical support level, meaning we could be in for a bounce higher if the support holds up. After last week, the NASDAQ is the strongest technically of the three major US indexes, staying about 1.3 percent above its major support level. This coming week will likely determine the technical strength of the major US indexes, and if the week continues on the trend set last week it could really be a struggle to remain where they are.

 

National News: Aside from the movements of the markets making many national headlines last week the major stories were coming out of Washington DC as politicians revisited an old fight—the Budget. With time running out and a potential government shutdown looming once again (it seems they do this for effect), the US House of Representatives came up with a bill that is a little over 1,600 pages that keeps the government open and is sure to make just about every American mad about something. There is so much pork and handouts in this bill that going through even the high or low points, depending on your perspective, would take far too long. So, I will focus on just the three items I think will cause the most frustration: the first dealing with campaign finance reform, the second dealing with Dodd-Frank and the third dealing with the funding horizon for the Department of Homeland Security. Snuck in on the last few pages of this massive bill is a rider that increases the campaign contribution limit an individual can give to a person running for office and it is no small increase. The limit goes from $32,400 all of the way up to $324,000, a tenfold increase. Why did the politicians do this with no objections expressed that I could find? It is in a sense a raise to each and every one of the politicians as they can now receive more money from fewer donors for their upcoming campaigns and spend a lot more money. This move will also give the wealthy, politically minded people in the US a lot more say in the upcoming elections as they can now give many times over the average total income of a regular American each election to make sure their interests are looked after. The other rider I will briefly touch on is the rider that allows big financial institutions and banks to bring derivatives trading back in-house rather than spinning it outside.

 

Derivative trading is the type of risks financial institutions and banks were taking prior to the decline of 2008, a decline that was exacerbated as huge derivative trades had to be unwound at a less than opportune time. According to the latest report produced by the Bank of International Settlement (BIS) there are more than $600 trillion in outstanding derivatives in use right now, as depicted by the chart to the right. With the new legislation we will likely see this figure grow even more as the financial institutions once again move into this area of the market, taking bets to make huge payoffs. They can take these otherwise risky bets because they know that if they really get into trouble in the future they are in fact too big to fail and will likely be bailed out by the government, much like they were during the crisis in 2008.

derivatives 12-15-14The third item in the bill that was fought over is the fact that the bill only funds the Department of Homeland Security through the middle of February. This was done since the department is the one that would be enforcing the changes to the immigration laws President Obama initiated through executive order. This allows the House and Senate to be in the control of the Republicans when the debate comes up again next year as the newly elected representatives will have been seated. It looks like immigration reform will be the first fight of the New Year between the White House and Congress. While some members of both parties argued the spending bill should not be passed, in the end it was passed with support from both sides of the aisle because not passing a bill would have meant another government shutdown. The bill passed the House on Thursday evening and the Senate on Saturday and is expected to be signed by the President shortly.

 

International News: International news last week was all about oil and the continually declining prices we have been seeing over the past few months. After the Saudis announced that oil would be okay near $60 per barrel we have seen oil move below $60 per barrel, as measured by WTI, and hovering just over $60 per barrel on Brent crude. We have now seen oil slide by more than 46 percent since the highs back in June. This decline in oil is a bit of a double-edged sword as falling prices mean more money for the average consumer in the US to be able to spend, but at the same time the prices have come down so fast that it risks disrupting the US energy industry as well as the energy industry in various other countries around the world that are at risk of becoming very unstable if prices stay low for very long. As mentioned in my commentary two weeks ago, there are numerous countries around the world that need prices to be substantially higher than they currently are to fund their various government programs. Venezuela remains the most at risk as the majority of the government’s revenues come from oil and the government run by Maduro is far less popular that the government ran by Hugo Chavez. Iran will be the second country to get into trouble if prices remain low, but this is partially what the Saudis would like as they are not exactly on the same religious page as Iran. Lastly, Russia is being backed more and more into a corner with the falling oil prices. If or when Putin starts to feel the political pressures from within his own country, who know what he will do to try to save his country from falling further into a recession or depression.

 

Falling oil prices around the world are not all bad. According to a report published by the Sierra Club and the League of Conservation Voters in 2011, each drop of $10 per barrel in the cost of oil should add 0.2 percent to the GDP of the US, primarily, from increased spending on goods and services that would have otherwise gone to oil producing countries around the world. In the end, falling prices are going to greatly benefit countries that are net importers of oil and hurt those that are net exporters. China may very well be one of the largest beneficiaries of lower oil and natural gas prices as it will see one of its major input costs lower. Europe, on the other hand, stands to be one of the developed regions that is hardest hit from falling prices, but not for the reason you may expect. With falling oil prices, Europe runs the risk of falling into a deflationary environment, an environment where prices are coming down rather than increasing. This type of a quagmire leads people to delay spending, as they could spend less tomorrow than they could today for the same product. This can be a real economy killer as governments and central banks have a very hard time coaxing people to spend in order to get their respective economies moving forward again.

 

Market Statistics: Eight weeks of consecutive gains on both the Dow and the S&P 500 was not to be, with the trend ending in spectacular fashion. Both the Dow and the S&P 500 fell by more than 3.5 percent, the worst weekly decline since November of 2011. Volume was above average on both the Dow and S&P 500 and approximately average on the NASDAQ:

 

Index Change Volume
NASDAQ -2.66% Average
S&P 500 -3.52% Above Average
Dow -3.78% Above Average

 

Leading up to last week, the NASDAQ had been showing more weakness than the other two indexes, but this trend flipped last week as the NASDAQ held up the best, while the Dow and S&P 500 suffered the most. One week is certainly not a trend; it is a single data point. However, the move that occurred last week is very concerning for the overall health of the markets moving into the end of the year.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Residential Real Estate 1.22% Energy -8.51%
Utilities -0.05% Oil & Gas Exploration -8.32%
 Preferred Stock -0.23% Natural Resources -7.99%
Biotechnology -0.88% Telecommunications -5.58%
Consumer Service -1.47% Aerospace & Defense -4.72%

It was not surprising to see last week that the more defensive sectors of the markets were the best performing, with real estate, utilities and preferred stocks rounding out the top of the performance list. One unexpected area that made the top 5 was Biotechnology, which fell by less than one percent when the sector normally moves in multiples of the major indexes. A few key drug announcements and a few mergers and acquisitions were the main driving forces behind the unusual performance of the Biotechnology sector. On the flipside it was not surprising to see that natural resources, such as oil, led the way down as they were really the main catalysts for the overall markets moving lower. One sector that was surprisingly in the top 5 of losses was Aerospace and Defense. Aerospace and Defense have been on a bit of a wild ride this year as investors try to weigh government spending going forward in a slow growth and potentially even deflationary environment in some countries around the world.

With such large declines being seen around the world in the equity markets, it was not surprising to see investors flee to the safest asset they know of: US government bonds. The upward move in US government bonds was nothing more than the fear trade last week as there were no changes in any underlying policies or even any changes in the speculation about when the Fed will start to increase interest rates:

Fixed Income Change
Long (20+ years) 4.30%
Middle (7-10 years) 1.82%
Short (less than 1 year) -0.01%
TIPS 0.70%

Last week the US dollar decreased in value by 1.18 percent against a basket of international currencies, in a move that was somewhat contrary given the movements in the overall markets. Some of the move can be explained by bottom fishing by currency investors who have seen currencies such as the Yen and the Euro fall as far as they believe the currencies will fall. The strongest of the currencies last week was the Japanese Yen as it gained 2.28 percent against the US dollar. The weakest of the major global currencies was the Canadian dollar as much of the Canadian economy is tied to natural resources and oil, which took a bit of a nose dive last week.

Commodities were mixed last week as oil continued to slide, while the metals jumped higher for the second week in a row:

Metals Change Commodities Change
Gold 2.60% Oil -12.68%
Silver 4.42% Livestock -2.01%
Copper 0.68% Grains 1.90%
Agriculture -0.67%

The overall Goldman Sachs Commodity Index turned in a loss of 6.21 percent last week, while the Dow Jones UBS Commodity Index declined by 1.27 percent. The massive difference in performance (one of the largest we have seen) is the fact that the Goldman index is much more heavily weighted toward oil and with oil moving such a large amount it singlehandedly caused the large difference between the two indexes. After a tame week of falling less than half of a percent two weeks ago, oil last week resumed its downward plummet. Over the course of just the past three weeks oil has now declined by nearly 25 percent and, with it, has brought into question the bull market that we have been experiencing in the equity markets all year. Gold, Silver and Copper all moved higher last week as the appetite for metals seemed to return to the markets as investors continue to jump out of oil heavy investments. Silver turned in the best performance, gaining 4.42 percent, while Copper gained 0.68 percent and Gold gained 2.60 percent.

China saw its financial markets jump higher last week for the third week in a row with the Shanghai based SE Composite Index gaining 0.02 percent, representing the only positive gain for the week of any of the major financial indexes around the world. The worst performance of the week last week was found in Russia with the MSCI Capped Index declining by 15.65 percent as the future of the country, which is so heavily dependent on oil and gas exports being above current price levels, seems to be calling into question the ability of President Putin to remain in power, despite his overwhelming popularity.

Uncertainty, as registered by the “fear gauge” of the market known as the VIX, spiked last week and it was a major spike, not just your average spike of 20 to 30 percent. In total, the VIX jumped by 78.34 percent in one of the largest single-week moves we have seen on the VIX. In fact, looking back to 1986, there have only been two weekly jumps greater than the move seen last week: late October of 1987 and early May of 2010. In numerical terms, last week the VIX went from under 12 (near the lowest levels of the year) up to more than 21, which is almost the highest level seen over the past two years. Fear has certainly made a comeback in the markets and comes at a very bad time. At the current level of 21.08, the VIX is implying a move of about 6.09 percent over the course of the next 30 day. As always, the direction of the move is unknown, but following what happened last week, let us all hope it is not a move down.

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

Last Week Year to Date
Aggressive Model -2.45 % 5.11 %
Aggressive Benchmark -3.40 % 0.09 %
Growth Model -2.09 % 5.95 %
Growth Benchmark -2.64 % 0.18 %
Moderate Model -1.67 % 6.20 %
Moderate Benchmark -1.90 % 0.24 %
Income Model -1.41 % 5.93 %
Income Benchmark -0.94 % 0.27 %

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

 

We made no changes to our models over the course of the previous week as the week was sort of a trendless week for many of our holdings. Oil continues to look like a good spot for future investments, but it continues to search for a bottom. We are currently watching all of our position very closely for signs of true breakdown and will adjust our models as needed. Currently, many of the sectors of the markets we had been looking at purchasing prior to the decline still look good on a relative basis, but they are becoming cheaper, and patience will likely be rewarded.

 

Economic News:  Last week was all about the retail consumer and the start of the holiday shopping season. In total there were two releases that beat expectations, highlighted in green, and one that significantly missed expectations, highlighted in red:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 12/11/2014 Initial Claims Previous Week 294K 295K
Negative 12/11/2014 Continuing Claims Previous Week 2514K 2350K
Positive 12/11/2014 Retail Sales November 2014 0.70% 0.40%
Neutral 12/11/2014 Retail Sales ex-auto November 2014 0.50% 0.20%
Neutral 12/12/2014 PPI November 2014 -0.20% -0.10%
Neutral 12/12/2014 Core PPI November 2014 0.00% 0.10%
Positive 12/12/2014 University of Michigan Consumer Sentiment Index December 2014 93.8 89.5

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

 

Last week started out late for economic news releases with Thursday’s standard weekly unemployment related figures being the first up. Continuing jobless claims missed expectations by nearly 200,000, which falls into the “big miss” category with more people staying out of work than was expected. This otherwise negative data point, however, was overshadowed by a retail sales figure that indicated that sales increased by 0.7 percent, while the market had been expecting only 0.4 percent. The report also seemed to indicate that the initial Black Friday and first holiday shopping weekend of the season were stronger than first reported. Even when auto sales are excluded from the calculation, retail sales were still strong. On Friday the Producer Price Index (PPI) for the month of November was released and showed, as expected, a decline in prices at the producer level with the majority of the decline being attributed to the decline in energy costs. The Core level of the PPI also showed no change over the course of the month. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of December (first estimate), which indicated that people were more upbeat about the economy and spending money than they were at the end of November. In fact, the 93.8 reading is the highest reading we have seen on the index since before the financial market meltdown of 2008.

 

This week is a typical week for economic news releases; the releases highlighted below have the potential to move the overall markets:

 

Date Release Release Range Market Expectation
12/15/2014 Empire Manufacturing December 2014 14.0
12/15/2014 NAHB Housing Market Index December 2014 58
12/16/2014 Housing Starts November 2014 1035K
12/16/2014 Building Permits November 2014 1060K
12/17/2014 CPI November 2014 -0.10%
12/17/2014 Core CPI November 2014 0.10%
12/18/2014 Initial Claims Previous Week 292K
12/18/2014 Continuing Claims Previous Week 2510K
12/18/2014 Philadelphia Fed December 2014 26.5

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

 

This week starts out on Monday with the release of the Empire Manufacturing Index for the month of December, which is expected to show a slight increase from the November level. The other release of the day on Monday will be the NAHB Housing Market Index for the month of December, which is expected to show no change over the November level as the US housing market appears to be leveling off. On Tuesday two more pieces of housing data are released with the housing starts and building permits figures both for the month of November being released. Housing starts is expected to have increased slightly over November while building permits are expected to have declined slightly, thanks in large part to winter setting in over many parts of the country and the natural decline in people wanting to pull permits to build houses. On Wednesday the Consumer Price Index (CPI) is set to be released with expectations that prices will have fallen a little, much like they did at the producer level last week. Just like the PPI, the majority of the decline will be attributed to the fall in the cost of energy and oil based products. On Thursday the standard weekly employment related figures are set to be released with expectations that both figures will have come down by a minuscule amount compared to the previous week. This week wraps up on Thursday with the release of the Philadelphia Fed Manufacturing Index, which will likely follow along the same lines as the Empire releases that came out a few days earlier. Expectations for this release are that it will fall from the lofty level of 40.8 in November back down to something more reasonable, around 26.5, for the month of December. It would take a wide deviation from these figures for the markets to really take notice of this release. In addition to the scheduled release the Fed is also meeting this week and will be issuing a statement; Fed Chair Yellen will also be making a statement. The big question that seems to be on everyone’s mind coming out of this meeting is whether the Fed will change the language of an “extended period of time” when talking about how long interest rates will remain low. If they take out this line, then it is a safe bet that a rate hike is likely to come during the first half of 2015. If they leave it in for this meeting, the odds move to a rate hike occurring during the second half of 2015. The market will very quickly dissect this release and adjustments to the Fed watchers’ projections will be posted, potentially moving the markets on Wednesday.

 

Fun fact of the week:

 

Nearly two-thirds of annual federal spending goes out the door without any vote by Congress.

 

Source: Wall Street Journal

For a PDF version (better formatting) of the below commentary please click here Weekly Letter 12-8-2014

Commentary at a glance:

-US markets almost made it seven weeks in a row of gains.

-Retail season started off slow.

-ECB meeting held some gloomy forecasts and no new bond buying.

-Saudi Arabia and OPEC continue to wage an oil war with other producers.

-Economic news releases came in above market expectations, thanks to solid payroll figures.

 

Market Wrap-Up: For the first trading week of December, the markets picked right back up where they left off going into the Thanksgiving Holiday. The charts below are of the three major US indexes in green with their respective trading channels represented by the red lines, as well as the VIX with the average level of the VIX over the past one year drawn as a red line in the lower right chart:

4 charts 12-8-14

As you can see in the above charts, all three of the major US indexes can be clearly drawn into trading channels at this point, given the steady rally of the past few weeks. A trading channel emerges when an investment or index is stuck within a well defined range (red lines on the index charts above). In this case, the ranges are all upward sloping and very narrow. When an investment is in a trading range there is said to be an upper level of resistance and a lower level of support and it is not uncommon to see the price of an investment or index bounce around between the two levels. Drawing the channels in hindsight makes it easy to cherry pick a good time period to draw, but any time a trading channel is tested both on the upside and downside a few times it becomes pretty well followed by computerized traders. As time goes on, whatever is being tracked has to continue to rise at a nearly constant rate to stay within the range. If the investment breaks up through the resistance line (upper red line) it is said to be a bullish breakout and technical investors expect the investment to move higher. If, however, the investment breaks down through the support level (lower red line) the investment is anticipated to move much lower by technical investors. While trading on the channels can be very difficult, it is nice to keep it in mind as there are a lot of traders who do follow such things and they can push the markets one way or the other, especially in the trading environment we currently find ourselves investing in.

 

From a technical standpoint, the Dow (upper right pane above) overtook the NASDAQ (lower left pane above) to technically become the strongest index last week. The S&P 500 (upper left pane above) stayed in the middle of the pack as the others flip-flopped. At this point the indexes look like they want to continue to bleed higher, meaning they will likely continue to move higher at a slow pace unless there is some major reason not to. Oil declining does not seem to be much of a worry for the markets, but it has been a killer is various aspects of the markets, such as the oil and gas exploration sector. The VIX (lower right pane above), meanwhile, seems perfectly content moving continually lower as it has now traded down to about the lowest level we have seen in 2014 and looks to finish out the year at one of the lowest levels in the past 5 years.

 

National News: National news last week held little of interest as the major media outlets tried to come up with stories that caught people’s attention in the absence of anything really meaningful. The 2014 holiday shopping season, while not a bust in total, has dug itself a pretty deep hole with the lack luster sales being reported from Black Friday and the first full week of the holiday shopping season. It seems shoppers are much smarter this year, comparing prices everywhere with their phones and getting the best deals. This is great for big retailers such as Amazon, which can update prices very quickly to adjust to a changing environment, but much more difficult for the big box retailers who have a hard time with change. The volume of goods sold during this time of year may very well be higher than they were last year or the year before, but it seems the discount prices being demanded by the savvy consumers will eat into the already slim margin retailers fight over. One aspect of the holiday season that is actually helping sales is the declining price of oil and the affect we have been seeing at the pump.

 

According to AAA’s fuel gauge report, the prices paid right now are the lowest we have seen since 2011. The chart to the right is from the AAA fuel gauge report website and shows the average price paid over the past four years. As you can see, this is the first time we have been below $3 as a nationwide average in a very long time. What does it mean for holiday sales? It means the average US consumer has more money in their pocket right now to spend than they would have had if they were still filling up their cars with gas prices above $3.25, as they were this time last year. To a family that is living paycheck to paycheck, this drop in fuel could amount to as much as $100 or more in a month, money that will likely be spent over the holidays. Also, it does not look like prices at the pump will be increasing any time soon as oil continues to decline as a small fuel war seems to be brewing between the Middle East and other major oil producers around the world.Fuel comparison 12-8-14

 

Last week wrapped up the majority of the well known companies that released their third quarter earnings figures, leaving us about a month away from the official start to the fourth quarter 2014 earnings season. Below is the final table of the better known companies for third quarter 2014 that released earnings last week and the amount by which they either exceeded or fell short of expectations. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green:

 

Abercrombie & Fitch 2% Express 6%
Aeropostale 0% GUESS? 33%
American Eagle Outfitters 0% Kroger 13%
Barnes & Noble -29% Sears 18%
Big Lots -20% Smith & Wesson 29%
Bob Evans Farms 6% Sportsman’s Warehouse 11%
Dollar General -1% Zumiez 8%

 

The interesting aspect to the companies that released earnings last week was the wide deviation in the performance of the retailers. Some easily beat expectations, such as Guess, Kroger, Sears and Smith and Wesson; while other such as Barnes & Noble and Big Lots seemed to fall flat on their collective faces. Barnes and Noble has been in trouble for a long time as book stores have largely become a thing of the past, but it was still surprising to see them miss such low expectations. As for comments about the holiday season from the above retailers, it seems most echoed the slightly softer sales than expected during the first weekend of the holiday shopping season. While Smith and Wesson beat current expectations, their outlook was not very strong as they have seen a continued decline in the number of fire arms purchased. This stock trades wildly when there is some kind of large scale gun violence, due to fears that the government may step in and limit the number and type of firearms that people are allowed to own. With Republicans back in control of both houses in Congress, it seems highly unlikely that any major adjustment to the current gun control laws will be passed over the course of the next two years.

 

This week there are only three companies announcing earnings that anyone would know about: AutoZone, Costco and Vail Resorts. Costco will be the one investors may watch even though holiday shopping is not a staple of their business.

 

International News: International news last week had two main focal points: one being the European Central Bank meeting held on Wednesday and Thursday and the ongoing struggle between Middle Eastern oil producers and the rest of the world’s oil producing nations. At the conclusion of the ECB meeting, the statement made held very little pertaining to concrete actions the ECB is planning on taking early next year to help stem the slide in the European economy, a slide that seems to be gaining speed. There was, however, another great one-liner from President Draghi when he said very enthusiastically that the ECB “Won’t tolerate!” low inflation or even deflation creeping into Europe. The sad part is that he may already be too late for several regions as price deflation seems to already be taking hold in several key economies. When asked about what the officials at the meeting discussed purchasing, President Draghi said they had discussed the potential for purchasing all assets classes, with the exception of gold. The current thinking is that the ECB will embark on a full scale quantitative easing program at the January 22nd meeting and that the program will include the purchases of a wide variety of financial instruments, such as asset backed bonds, as well as sovereign and potentially even corporate bonds. All of these actions will be undertaken in an attempt to stop deflation and to try to get the European economy growing, something that is becoming harder and harder to do given the latest projections from the ECB. The chart to the right was created with data from the ECB’s webpage under the meeting minutes and shows the downward revision the ECB made to the future growth of the region over the remainder of 2014, 2015 and 2016. The startling aspect of the chart is that the revisions are made to recent forecasts set at the end of the September meeting and the ECB has reduced GDP growth expectations for the full 2015 year by 0.6 percent. This also comes at a time when the costs of fuel and energy have been falling due to the massive decline in the price of oil. Europe really looks to be headed for some trouble and it appears President Draghi knows it, but why is the ECB taking so long to act? It seems President Draghi is waiting until after the holidays to embark on his quantitative easing, which means he is hoping by some miracle that Europe starts to right the ship on its own with the governments adjusting spending and businesses becoming more competitive on the international stage, but this seems to be a waste of time. He has now been talking about taking action for the better part of two years and the time is either now or drawing very near for him to make good on his pledge to do something about the faltering economic health of Europe. At least it looks like Germany will not try to hold up the asset purchases in court nor will any of the other countries that have threatened to do so in the past. While the ECB was discussing how to save their economy, in another part of the world OPEC was trying to figure out how to keep the group on the same page, as Saudi Arabia seems to be willing to do things other OPEC members cannot afford to do.

EU GDP estimates 12-8-14

With OPEC’s decision two weeks ago on Thanksgiving to not lower output, the fallout from OPEC’s meeting in Vienna is continuing as prices now look ready to decline even further. The cover of The Economist last week has a great cartoon accompanying a very interesting article about the oil dispute. The full article can be found here http://tinyurl.com/klhxbej. Last week Saudi Arabia announced that it expects to see oil stabilize around $60 per barrel, a decline of nearly 50 percent from the peak seen back in June. At the price of $60 per barrel the majority, if not all, of the OPEC countries are going to have a hard time funding their government spending with oil money. This decline will also likely lead to a shake out of weak companies in the oil industry around the world. There will likely be large scale protests in countries such as Iran and Venezuela, which were both already experiencing trouble prior to the decline in oil, which is the lifeblood of the countries. Russia will also likely suffer as the latest figures show that the country has already burned through more than $400 billion of its $1 trillion reserve account kept for rainy days when the price of oil is too far below what it costs them to get it out of the ground. Unrest is likely if the prices keep falling and remain low for an extended period of time, the key being an “extended period” of time. Short-term, most companies and countries can afford to keep everything going at these prices, but if we get a few months or quarters around $60 per barrel, it seems many smaller, more risky countries and companies will be at risk of power changes and or going out of business. In the end, Saudi Arabia wants to once against assert itself as relevant in the world’s oil markets and prove all of the excitement over the US energy independence to be short lived. It has now become a waiting game to see who blinks first.

 

Market Statistics: Seven weeks in a row of gains on all three of the major US indexes was not to be as the NASDAQ failed to move higher last week. Both the Dow and the S&P 500, however, did make it seven weeks in a row and booked new all time highs along the way last week. Volume was about average when looking across all three of the major indexes:

 

Index Change Volume
Dow 0.73% Average
S&P 500 0.38% Above Average
NASDAQ -0.23% Average

 

With the breakdown of the NASDAQ some traders are concerned that we could be moving into a little bit of a correction, but it is far too early for this call to be made at this point. While we have been in an upward moving market for the past few months there is no more reason to think this is the start of a correction than any of the other less-than-one-percent declines we have seen in the NASDAQ, of which there have recently been many.

 

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 3.66% Telecommunications -3.25%
Broker Dealers 3.56% Home Construction -1.39%
Regional Banks 2.43% Consumer Staples -1.22%
Financial Services 2.35% Consumer Goods -0.79%
Healthcare Providers 2.09% Oil & Gas Exploration -0.77%

Semiconductors made it two weeks in a row of being the best performing sector of the markets last week. Financials were the other standout group last week, taking over three of the top five sectors of the markets as banking conditions in the US and abroad continue to improve. With oil falling as it has been the last few months it was not very surprising to see oil and gas exploration on the top 5 decliners list. This sector of the markets has been beat up extensively over the past few months and there will likely be a great buying opportunity in the future, but for now it is best to let the various countries fight over the price of oil without being involved in it from an investment standpoint.

The broad US fixed income market moved lower last week, not so much on any news out about the US, but on the continued speculation about what the ECB will undertake in Europe:

Fixed Income Change
Long (20+ years) -1.14%
Middle (7-10 years) -1.03%
Short (less than 1 year) 0.00%
TIPS -1.11%

Last week the US dollar increased in value by 1.02 percent against a basket of international currencies, thanks to a sharp move upward on Friday after an otherwise pretty boring week. The strongest of the currencies last week was the Canadian dollar as it gave up only 0.18 percent against the US dollar. Japan once again saw the weakest currency globally last week with the Yen giving up 2.4 percent against the value of the US dollar. The chart to the right from Bloomberg shows just how fast the Japanese Yen is falling versus the US dollar; you can see the Yen was trading around 101 from June until mid-August, last week crossing over the 120 to one level, a decline of more than 20 percent in the value of the Yen. While this is great for companies that export goods from Japan it is very hard on the local economy as everything that is imported (many items in Japan) is seeing cost increases well beyond what everyday people can afford. Yen Dollar 12-8-14

Commodities were mixed last week as oil continued to slide, while the metals jumped higher:

Metals Change Commodities Change
Gold 2.07% Oil -0.47%
Silver 5.26% Livestock -2.92%
Copper 2.30% Grains 1.83%
Agriculture -0.67%

The overall Goldman Sachs Commodity Index turned in a loss of 2.76 percent last week, while the Dow Jones UBS Commodity Index declined by -0.12 percent. Oil had a pretty tame week considering the news out of Saudi Arabia that the country would not mind seeing oil at $60 per barrel. In total, oil only declined by 0.47 percent during the week. Livestock had a difficult week last week, falling for the third week in a row, this time by nearly three percent. Gold, Silver and Copper all moved higher last week as the appetite for metals seemed to return to the markets. Silver turned in the best performance, gaining more than five percent, while Copper gained 2.3 percent and Gold gained 2.07 percent.

China saw its financial markets jump higher last week for the second week in a row with the Shanghai based SE Composite Index gaining 9.50 percent in one of the largest weekly gains we have seen in the past two years. We have now seen the index increase by more than 18 percent in just the last 2 weeks. The worst performance of the week last week was found in Brazil with the Sao Paulo based Se BOVESPA Index declining by 4.89 percent as the political uncertainty moving into the new term for Dilma Rousseff remains very elevated.

The VIX started out last week moving higher, easily jumping over the average level we have seen over the past year on Monday, only to follow up the move by declining the next four days in a row. The VIX ended the week at the lowest level we have seen in the middle of August, prior to the spike up over 25 during October. In total last week the VIX declined by 11.33 percent. At the current level of 11.82 the VIX is implying a move of about 3.41 percent over the course of the next 30 days. As always, the direction of the move is unknown. Going into the New Year the VIX looks set to be at the lowest level to start a new year since 2007, in a sign that the slow upward move in the US economy may be able to continue well into 2015.

For the trading week ending on 12/5/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.29 % 7.79 %
Aggressive Benchmark -0.22 % 3.62 %
Growth Model 0.22 % 8.23 %
Growth Benchmark -0.18 % 2.91 %
Moderate Model 0.12 % 8.02 %
Moderate Benchmark -0.12 % 2.18 %
Income Model 0.06 % 7.45 %
Income Benchmark -0.07 % 1.22 %

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

 

We made no changes to our models over the course of the previous week as the week was sort of a trendless week for many of our holdings. Oil continues to look like a good spot for future investments, but currently it would be like trying to catch a falling knife. It is typically much better to let the knife hit the floor and then pick it up. Our holding in the rising US dollar continues to perform well as do the majority of our other positions. We are still positioned for a market that is far more choppy than it has been recently so we should be well positioned if the market decides to move up or down between now and the end of the year.

 

Economic News:  Last week was all about employment and the slow but steady recovery we have been seeing in the US for the past few years. In total there were two releases that beat expectations, (highlighted in green) and one that significantly missed expectations (highlighted in red below):

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 12/1/2014 ISM Index November 2014 58.7 58.0
Neutral 12/3/2014 ADP Employment Change November 2014 208K 225K
Slightly Positive 12/3/2014 ISM Services November 2014 59.3 57.5
Neutral 12/4/2014 Initial Claims Previous Week 297K 295K
Neutral 12/4/2014 Continuing Claims Previous Week 2362K 2350K
Positive 12/5/2014 Nonfarm Payrolls November 2014 321K 230K
Positive 12/5/2014 Nonfarm Private Payrolls November 2014 314K 235K
Neutral 12/5/2014 Unemployment Rate November 2014 5.80% 5.80%
Negative 12/5/2014 Factory Orders October 2014 -0.70% 0.20%
Neutral 12/5/2014 Consumer Credit October 2014 $13.2B $16.5B

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

 

The week started off on Monday with the release of the ISM Index for the month of November, which came in just slightly above market expectations, but it was not enough for the markets to get excited about. On Wednesday the ADP employment change figure gave a misleading number, indicating that fewer jobs than expected had been reported during November. This negative jobs number, however, did not hold through the end of the week. Also during the day on Wednesday the services side of the ISM was released and came in slightly better than anticipated, much like the overall ISM released on Monday. On Thursday the standard weekly unemployment releases held nothing new as both came in very close to market expectations. On Friday the nonfarm payroll numbers, both public and private, beat market expectations and did so by a wide margin. Both figures came in well above 300,000; this was the first reading over 300,000 since June of 2010 on both the public and private payroll figures. When the payroll figures came out there was a collective “wow” on Wall Street as both figures beat expectations by such a wide margin that everyone was caught by surprise. Despite the strong showing on the payroll figures, however, the overall unemployment rate failed to move, staying at 5.8 percent for the month of November, just like it was during October. The labor force participation rate failed to move much, staying at a very low level (62.8 percent), a sign that despite the overall unemployment rate being under six percent the US still has a long way to go to get back to the employment level seen prior to the decline in 2008. Factory orders for the month of October were the sole downer on Friday, coming in well below expectations, with the number actually being a negative 0.7 percent, while expectations had been for a slight increase of 0.2 percent. Factory orders turning negative so close to the holiday shopping season is concerning given that the holiday sales season did not start as strong as many would have liked. Last week wrapped up on Friday with the release of the Consumer Credit report for the month of October, which showed that credit expanded by slightly less than anticipated, but did not slow enough to cause alarm.

 

This week is a very slow week for economic news releases; the releases highlighted below have the potential to move the overall markets:

 

Date Release Release Range Market Expectation
12/11/2014 Initial Claims Previous Week 295K
12/11/2014 Continuing Claims Previous Week 2350K
12/11/2014 Retail Sales November 2014 0.40%
12/11/2014 Retail Sales ex-auto November 2014 0.20%
12/12/2014 PPI November 2014 -0.10%
12/12/2014 Core PPI November 2014 0.10%
12/12/2014 University of Michigan Consumer Sentiment Index December 2014 89.5

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

 

This week starts on Thursday with the release of the standard weekly unemployment related figures, with initial jobless claims expected to have declined a little while continuing jobless claims are expected to have declined by 12,000. The bigger release of the day on Thursday will be the retail sales figure for the month of November, as this release includes Black Friday as well as the first full weekend of the holiday shopping season. Expectations are for a 0.4 percent increase, but with the figures we saw about Black Friday it would not be surprising to see this release significantly miss market expectations. If we get a negative reading on either the overall retail sales or retail sales excluding auto sales figures the market will likely react poorly; at least that is what most people would think it would do. But with the Fed starting to raise interest rates on the horizon, it is anyone’s guess what would happen to a negative print on retail sales. The market might jump higher in anticipation of the poor sales leading the Fed to hold off increasing interest rates a little longer. On Friday the Producer Price Index (PPI) for the month of November is set to be released with expectations of a small decline of one tenth of a percent, due in large part to the continued decline in the price of energy and oil specifically. When energy, food and fuel as well as a few other items are removed from the calculation you arrive at the Core PPI number, a number that is historically much more stable and, this time, is expected to increase by one tenth of a percent. Wrapping up the week on Friday this week is the release of the University of Michigan’s Consumer Sentiment Index, which is expected to increase slightly from 88.8 up to 89.5. If we see a reading of 89.5 it would be the highest reading on the index that we have seen over the past 6 years. With no members of the US Federal reserve expected to make any statements this week, Fed watchers will be watching Europe closely for any type of statements or speeches out of the ECB about what it plans on doing going forward with its bond buying program.

 

Fun fact of the week: A picture (and accompanying table) can be worth a thousand words!

oil reserves 12-8-14

Source:US Energy Information Administration

 

While the US is touting energy independence, remember we are far smaller in term of proven oil reserves than many of the oil powerhouses around the world.

For a PDF version of the below commentary please click here Weekly Letter 12-1-2014

Commentary At-a-Glance

 

 

  • US markets make it six weeks in a row of gains.
  • Black Friday 2014 is being called Bleak Friday.
  • OPEC surprises many with its decision on oil output.
  • ECB continues to talk about buying bonds while buying very few.
  • Economic news releases in aggregate came in slightly below market expectations.

Market Wrap-Up

With last week being only a three  and  a half day trading week (trading ended early on Friday after being closed on Thursday for Thanksgiving), not too much  should be read into the movements of the markets since participation was very low. The charts below are of the three  major US indexes in green with their respective most recent technical support levels in red, as well as the VIX and the average level of the VIX over the past  one  year drawn with a red line on the lower right chart:

4 charts 12-1-14

As you can see above, all three  of the major US indexes moved  higher for the week and all three remain well above their most recent levels of support. However, there  does appear to be a bit of a rolling over taking place on both the Dow (upper  right chart  above) and the S&P 500 (upper  left chart  above) as both indexes have slowed  to near  horizontal movement. Despite this seemingly horizontal movement, both the S&P 500 and the Dow did manage to make  new all time highs a few times during the short trading week.  The NASDAQ (lower left pane above) remains the strongest of the three  major US indexes as it is still climbing higher.  But while the S&P and  the Dow are enjoying new all time highs the NASADQ still has a little more than 5 percent that it would need to increase in order  to get back  to the all time high level seen just before  the Technology bubble burst back  in March  of 2000. While these nice upward  moves were  being made on the three  major indexes, the VIX (lower right pane above) chugged lower throughout the week until Friday when it made up more than  the losses experienced during the first part of the week.  After briefly touching 12

The biggest drivers of performance last week included the official end to earnings season, the OPEC output decision and more announcements out of the European Central Bank about its plan to buy bonds across a wide spectrum of categories.

on Wednesday, the VIX closed out the week at 13.33,  still below the 52-week average, but higher  than  the low levels seen earlier during the year.  The biggest drivers of performance last week included the official end  to earnings season, the OPEC output decision and  more announcements out of the European Central Bank (ECB) about  its plan to buy bonds across a wide spectrum of categories.

National News

National political news last week was very uneventful as most of the politicians in Washington DC left for the Thanksgiving holiday to return to their own states. The big uprising  over the executive actions taken  by the President to reform immigration have  largely dwindled, much  like the unrest in Ferguson after the release of the grand  jury evidence, which painted a very different picture  of the Michael Brown shooting than was first thought  by the general public. The only major headline to make  waves last week was the OPEC decision, discussed at length below in the international section. With only the US House of Representatives coming back  in session this week and  the Senate largely being done for the year it does not look like there  will be much  more activity on the Hill that could potentially move  the markets. There  was,  however, activity in the US as the official start to the holiday shopping season was Black Friday, or Grey Thursday or White Wednesday or Black Friday Week,  whichever you like.

 

Black Friday is very closely watched each year,  but the “holiday” has been diluted more and  more each year as retailers try to one  up each other by opening earlier or offering better  discounts. This year seems to be the year that shoppers finally said “enough already” and  held off going out and shopping. According to the early data out of the National Retail Federation (NRF), here  in the US consumers spent about  11 percent less this year  than they did last year,  and  you may remember that last year was not a stellar year for holiday shopping. More concerning than  the decline in spending is the fact that, according to the NRF, there  were  6 million fewer shoppers over the past  weekend than  expected. Maybe it was partially due to adverse weather, but it seems this could be the start of a much  bigger  trend.  Big screen TVs for $100 drew large lines, but in general it was a very quiet start to the holiday shopping season. What does this mean for the US economy?

 

According  to the early data out of the National Retail Federation, here in the US consumers spent about 11 percent less this year than they  did last year [during Black Friday], and you may remember that last year was not a stellar year for holiday shopping.

 

It means that companies and retailers specifically could struggle through  the end of the year;  it also  means that sales will likely improve the closer we get to Christmas due to heavy  markdowns to help retailers get rid of inventory. We will likely see the affects of the slowdown in sales in the fourth quarter earnings releases of many  companies, but they are  still a few months away as we are  still currently trying to wrap up the third quarter earnings season

 

Q3 2014 Earnings Releases

 

The third quarter earnings season is quickly drawing to a close as we have now seen 99 percent of the companies in the S&P 500 report their results. Below is a table of the eight better  known companies that

 

released earnings last week and  the amount by which they either exceeded or fell short of expectations. Results were  fairly mixed last week. Negative earnings surprises are highlighted in red, while positive surprises in excess of 10 percent are  highlighted in green:

 

 

Big Lots                                         Pushed Campbell Soup                                    1% Deere & Co                                        16% DSW                                                    10% Hewlett-Packard                              1% Hormel Foods                                -2% Sears                                                Pushed

Tiffany & Co                                        -1%

 

 

There  is nothing too surprising in the figures above other than  seeing two major retailers push  back  the release of their earnings. Sometimes earnings releases are  pushed for simple reasons and at other times the reasons for pushing an earnings release may not be so clear. We will have to wait until Big Lots and Sears release their earnings to see why they may have  been delayed.

 

According to Factset Research, we have  now seen 495 (99 percent) of the S&P 500 companies release their results. Of the 495 that have  released, 77 percent of them have  met or beaten earnings estimates, while 23 percent have  fallen short of expectations. This 77 percent of companies beating on earnings represents the highest percentage of companies beating expectations since the third quarter of 2010. When  looking at revenue we saw no change in the percentage of companies that have  beaten estimates, with the figure holding firm at 59 percent having reported beating estimates on a revenue basis, while 41 percent have  fallen short.  This 59 percent is slightly above the 1-year  average level and equals the 5-year  average. These figures above represent the final figures for the third quarter of 2014. In the end,  the third quarter earnings season held very few surprises, but revenues still seemed to be an issue for many  key companies. Going into holiday sales season, many  retailers will need a great  season to make  the year an average year and from the start we have seen so far it does not look like it will be a knockout holiday shopping season.

 

Although the official end to the third quarter earnings season has  been called, there  are  a few stragglers, mainly in the retail sector, that have  yet to post  their earnings for the third quarter. This week there are  14 such companies. Below is a table of the better  known companies that are  releasing earnings with the potentially most impactful releases highlighted in green:

 

 

Abercrombie & Fitch                            Express

 

Aeropostale                                       GUESS?

 

American Eagle Outfitters Kroger
Barnes & Noble Sears
Big Lots Smith & Wesson

Bob Evans Farms                             Sportsman’s Warehouse

 

Dollar General                                       Zumiez

 

 

 

The big nationwide retailers such as American Eagle, Express and Big Lots will be very closely watched this week as they will likely have  some firsthand information about  the start of retail sales, having a few days since Black Friday to tabulate how they have  done. While the information will not be part of the financials they are  reporting, it will likely come up during the management discussion and analysis. The market, already unsure due to the weakness at the start of the season, will be listening very closely for signs of weakness in the spending patterns of the US consumer.

 

International News

 

International news was the biggest mover  of the week last week with OPEC taking front and center stage. OPEC meets in an official capacity only twice per year,  once in June and once in November, unless there are  some extenuating circumstances that make it necessary for them to meet  between the scheduled meetings. The latest meeting was held in Vienna, Austria on Thursday the 27th of November. The most pertinent topic on the table at the meeting was whether OPEC should  change its output production as a group.  OPEC currently produces about 30 million barrels of oil per day and is the single largest cartel  in the world controlling oil. Going into the meeting there were  calls for OPEC to cut production by between 1 and 1.5 million barrels per day as the price of oil has  declined by nearly  33 percent so far this year.  In theory, a cut to the supply of oil while demand stays constant would lead to increasing prices and  stop the drastic decline we have seen so far during 2014.  OPEC was getting calls from Iran and Venezuela, specifically, as well as a few other member countries that oil prices need to be higher than  they are,  but despite the calls no action was taken  at the meeting. The global energy markets were shocked that no changes were  made to the output of oil OPEC releases every day, leading to free falling stocks in the energy sector as well as oil dropping by more than  $5 per barrel. Why the concern with falling oil prices? As I explained last week in my commentary, many oil producing countries

The global energy markets were shocked that no changes were made to the output of oil OPEC releases every  day, leading to free falling stocks in the energy sector as well as oil dropping by more than $5 per barrel.

 

around the world need oil to be above a certain point in order  to make  it viable for them to continue producing and also to keep  their governments running. Take Russia for example; the Russians need oil to be over $105 per barrel  by most estimates to make  money  selling oil and to have  enough money  to continue to fund government spending programs. The longer prices stay  under  the $105 level the harder it becomes for Russia to continue spending money  as it used to and  the harder it becomes for the Russian economy to do anything other than  fall into a recession. Much of the decision of OPEC depends on what Saudi Arabia wants as it is the single largest producer in the world and  of the group.  It seems the Saudis may not have the same goals in mind as the rest of OPEC and it would not be the first time the country  has bucked the trend.

 

Back in the early 1980’s OPEC was having a very hard  time getting member states to produce at levels that had  been agreed to, with some countries producing more and  others less than they were supposed to, based on the needs of the individual countries and where  they needed oil prices. Saudi Arabia was then the largest producer, as it is now, and acted as a kind of swing producer, either  making up production or curbing production so the OPEC price targets would be fairly closely met. In August,  Saudi  Arabia became tired of playing the swing member of OPEC and  decided to increase production, pushing oil prices down below $10 per barrel, a more than  50 percent decline in less than 2 months. Why did Saudi  Arabia do this? It wanted to purge  out some competition, particularly competition in the US that had been building new rigs and drilling for high cost  oil all around the US. The chart  below from WTRG economics shows the time period being discussed. It shows the price of oil as the green line and  the number of rigs being used in the US as the red line:

rig count oil prices 12-1-14

As you can see in the chart  on the previous page, when  the price of oil increases substantially the rig count increases as more wells are dug. The inverse is also true; when  oil prices fall the rig count  falls. The decline in the number of rigs seen during the early to middle 1980’s, punctuated by the large decline at the end  of 1985,  drove  many drillers out of business. Currently we find ourselves in the same situation yet again. With the new fracking technology being used heavily in the US the Saudis are  once again feeling threatened as the US moves closer and closer to true energy independence and potentially even  becoming a net exporter of oil and natural gas. So while the Saudis did not outright say production was kept to squeeze out some of the new US production, it is for sure  one  of the main reasons behind  the decision. At least Saudi Arabia did not officially increase production as it did in the 80’s. However, OPEC is notorious for over producing, even  beyond the stated figures. We will have  to wait and  see if the Saudis do in fact increase output or if the country  leaves output unchanged. Either way, the squeeze is on and we really do find the world in a giant game of chicken, seeing who will blink first as political pressures on all sides are  sure  to mount  over the coming months.

With the new fracking technology being used heavily in the US the Saudis are once  again feeling threatened as the US moves closer and closer to true energy independence and potentially even becoming a net exporter  of oil and natural gas.

Elsewhere in the world, Europe made a few headlines last week as the ECB headed into a week long period prior to its next meeting when  it will try not to have  any leaked information about what it plans  to do. We already know the ECB has been evaluating how and when it would launch bond buying programs designed to help pick up the failing European economy. At the conclusion of the meeting we will likely know much more about  what types  and when the buying will commence, but it seems safe to say  that the ECB is looking at all options right now.  The latest problem  for the ECB to contend with is falling prices. Deflation is one  of the things that keep  central bankers up at night as there  is not an easy roadmap to stopping falling prices. Last week Spain  showed that prices fell by 0.5 percent during the month of November, the fastest decline since early 2009.  Overall, the inflation rate in Europe is painfully close to zero,  hovering right around 0.3 percent in November according to the latest data. Oil prices declining will continue to add downward pressure to prices, so action needs to be taken  shortly if the ECB is to get ahead of deflation within Europe. One  of the goals of the ECB is to expand its balance sheet from about  2 trillion Euros up to 3 trillion Euros;  in much

The latest problem for the ECB to contend with is falling prices. Deflation is one of the things that keep central bankers up at night as there is not an easy roadmap to stopping falling prices.

 

the same manner as the US Federal Reserve did right after the crisis of 2008.  The trouble is the unknown  of whether the ECB can  expand its balance sheet, while at the same time not tanking  the value of the Euro, keeping all of Europe on the same growth trajectory going forward. The ECB has  a single standard, that being price stability and  so far it looks like this individual mandate will prove  much  harder to achieve than the US Federal Reserve’s mandate of full employment and  price stability.

 

 

 

Market Statistics

 

Equities

 

All three  of the major US indexes made it six weeks in a row last week for gains, despite the continuing falling price of oil and the near  panic  selling that took place on Friday in the energy sector. Volume was right about  average for Thanksgiving week looking back  over the past  few years:

 

 

Index Change Volume
NASDAQ 1.67% Average
S&P 500 0.20% Average
Dow 0.10% 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
Semiconductors 3.89% Oil & Gas Exploration -12.78%
Biotechnology 3.09% Energy -10.04%
Pharmaceuticals 2.98% Natural resources -9.87%
Consumer Service 2.80% Basic Materials -3.58%
Consumer Discretionary 2.20% Industrials -0.62%

 

The most interesting aspect to the sector movement last week was the cliff that energy as well as oil and gas  related stocks seemed to go over on Friday, following the announcement of the OPEC decision on Thursday. The decline in oil even  spilled over into other areas of the global economy such as natural resource miners who have nothing to do with oil and natural gas  at all. While oil and  drillers have  been in a steep decline now for several months the downward move  on Friday was surprising as the rate of decline accelerated more than  most analysts expected. While energy was having a tough time last week, one  area of the market  that continued to shine  was the semiconductor space, which enjoyed a gain of nearly  4 percent, thanks to strong  moves from key chip makers such as Intel and Applied Materials.

 

Fixed Income

 

The broad  US fixed income market  was very uneventful last week during the shortened trading week,  but we did see a bit of a fear trade  toward US debt and the US dollar on Friday as oil declined:

 

 

Fixed Income Change
Long (20+ years) 1.99%
Middle (7-10 years) 0.92%
Short (less than  1 year) -0.01%
TIPS 0.18%

 

Last week the value of the US dollar increased by 0.04 percent against a basket of international currencies, with much  of this move occurring on Friday. The US dollar declined steadily for the first three  days  of trading last week,  but the OPEC decision saw a massive flight from international currencies into the US dollar on Friday, more than  making up the lost ground  from the previous three trading days. The strongest of the currencies last week was the Euro as it gained 0.51 percent against the US dollar, thanks in large part to continued information flow about  the plans  of the ECB in the coming weeks and months to help stabilize the European economy. With the decline seen in natural resources last week it was not surprising to see that

the Australian Dollar had the hardest time last week as it declined by 1.88 percent against the US dollar.

The Australian economy is heavily dependant on natural  resource exports to countries like China and  Japan and  if demand looks questionable going forward or weakness is seen in those two economies it typically leads to poor performance in Australia.

 

Commodities

 

Commodities were  mixed last week as the grains  saw small gains, while all of the other commodities declined in value.

 

 

Metals Change Commodities Change
Gold -2.84% Oil -13.54%
Silver -6.08% Livestock -2.03%
Copper -6.72% Grains 1.59%
Agriculture -0.58%

 

The overall Goldman Sachs  Commodity Index turned  in a loss of -7.26 percent last week, while the Dow Jones UBS Commodity Index declined by 4.72 percent. For the week oil got crushed by the OPEC decision, falling by 13.54  percent with West Texas Intermediary (WTI) spot  oil prices briefly hitting $66 per barrel  in the frantic trading on Friday, the lowest level since July of 2009.  The soft commodities fared much better  than  oil and metals last week with grains  seeing a 1.59 percent gain, while agriculture overall only

declined by 0.58 percent. Gold, Silver and  Copper all moved  lower last week with the more industrially used

Copper falling by 6.72 percent, while Gold, typically a safe haven asset, fell by 2.84 percent and  Silver slid

6.08 percent.

 

International Performance

 

China saw its financial markets jump higher last week with the Shanghai based SE Composite Index gaining 7.88 percent in one of the largest weekly gains  we have  seen in the past  two years. The worst performance of the week last week was found in Russia with the MSCI Russia Capped Index declining by

9.34 percent as the country  looks like it will have  a very hard  time coping  with the falling oil prices as well as the international sanctions that are  really starting to have  an impact on the economy.

 

Volatility

 

Last week was a choppy week for the VIX as it started out the week falling each of the first three  days of the week, only to come back  with a vengeance on Friday after Thanksgiving , making up more ground  than it lost at the start the week. Overall, the VIX gained 3.33 percent last week. After hitting a low of about  12 on Wednesday the VIX closed out the week at 13.33,  which is still below the 52-week average level. At the current level of 13.33  the VIX is implying a move of about  3.84 percent over the course of the next 30 days. As always, the direction of the move  is unknown.

 

Performance

 

For the shortened trading week ending on 11/28/2014, returns in FSI’s hypothetical models* (net of a 1%

annual management fee) were  as follows:

 

 

Last Week Year to Date
Aggressive Model 0.98 % 7.47 %
Aggressive Benchmark 0.11 % 3.85 %
Growth Model 0.91 % 7.99 %
Growth Benchmark 0.09 % 3.09 %
Moderate Model 0.85 % 7.88 %
Moderate Benchmark 0.06 % 2.29 %
Income  Model 0.81 % 7.38 %
Income Benchmark 0.04 % 1.29 %

 

*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. The low volume we saw last week made any movements in the markets, with the exception of oil and energy, somewhat questionable as there  were just not that many  people working and assessing the various  changing aspects to the financial markets in the US. Despite the short week, semiconductors turned  in strong  performance, gaining nearly  6 percent, thanks in large part to large moves by a few key companies such as Intel and  Applied Materials. I have  been assessing oil and the oil drillers for a potential entry point, but after the large increase in volatility last week,  thanks to OPEC, it looks like I will wait a little longer to see if prices continue to move lower

before  working into a position.

 

Economic News

 

 

Week in Review

 

Last week was a pretty uneventful week for economic news releases with the Thanksgiving holiday taking precedent over the news, but there  was one  release that beat  expectations (highlighted in green) and one that significantly missed expectations (highlighted in red below):

 

Economic

Economic News

 

Impact Date Release Date Range         Actual         Expectation
Positive 11/25/2014 GDP – Second Estimate Q3 2014 3.9% 3.2%
Neutral 11/25/2014 Case-Shiller 20-city

Index

September

2014

4.9% 4.6%
 

Negative

 

11/25/2014

 

Consumer Confidenc

 

e

November

2014

 

88.7

 

96.0

Slightly Negative 11/26/2014 Initial Claims Previous Week 313K 288K
Neutral 11/26/2014 Continuing Claims Previous Week 2316K 2348K
Slightly Positive 11/26/2014 Durable Orders October 2014 0.4% -0.6%
 

Slightly Negative

 

11/26/2014

Durable Goods -ex

           transportation        

 

October 2014

 

-0.9%

 

0.5%

Neutral 11/26/2014 Personal Income October 2014 0.2% 0.4%
Neutral 11/26/2014 Personal Spending October 2014 0.2% 0.3%

  Slightly Negative                                       Chicago PMI                  November            60.8                63.0  

   11/26/2014                                                             2014   

University of Michigan

 

Neutral            11/26/2014

Consumer Sentiment

November

88.8                90.0

 

                   Index                              2014                       

          Neutral              11/26/2014          New Home Sales           October 2014       458K              470K      

 

Slightly Negative 11/26/2014 Pending Home Sales October 2014 -1.1% 0.5%

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

 

Last week economic news releases started off on Tuesday with the release of the second estimate of third quarter GDP for the US, which saw the figures revised up from 3.2 percent up to 3.9 percent. While an increase is a positive thing, it still seems this could be the high point in terms of GDP for the year.  At nearly  the same time as the GDP number was released, the latest government consumer confidence figure was released and came in well below market  expectations. The market  had  been expecting a reading of 96.0, but instead came out at 88.7, despite the decline in prices at the pump  helping to pad people’s wallets. This decline in confidence so close to the holiday shopping season could spell disaster for retailers in the coming  weeks. On Wednesday durable goods orders came in better  than  expected overall, but slightly worse than  expected when  transportation was removed from the equation. Personal income and spending were  both close to, but below, expectations and both new home sales and

pending homes sales came in slightly below expectations. Additionally, the Chicago area PMI and  the

University of Michigan’s Consumer Sentiment Index both came in slightly below expectations. In total, seven of eight consumer related economic news releases that came out on Wednesday lacked energy

and  indicated that the US consumer is probably getting a little bit tired given the slow economic growth

we have  been seeing globally.

 

Upcoming Releases

 

With this being the first week of December, the economic news releases for the week are weighted heavily toward  employment in the US. The releases highlighted below have the potential to move the overall markets:

 

Date Release Release Range Market Expectation
12/1/2014 ISM Index November 2014 58.0
12/3/2014 ADP Employment Change November 2014 225K
12/3/2014 ISM Services November 2014 57.5
12/4/2014 Initial Claims Previous Week 295K
12/4/2014 Continuing Claims Previous Week 2350K
12/5/2014 Nonfarm Payrolls November 2014 230K
12/5/2014 Nonfarm Private Payrolls November 2014 235K
12/5/2014 Unemployment Rate November 2014 5.80%
12/5/2014 Factory Orders October 2014 0.20%
12/5/2014 Consumer Credit October 2014 $16.5B

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

 

This week starts on Monday with the release of the ISM Index for the month of November. Expectations are for a slight decline from the October level of 59 down to 58, but we could see a bit of a wild number on this one  after the crazy numbers we have  been seeing from various  regions of the US for the same time period. On Wednesday the first of the employment figures for the week is set to be released, that being the ADP Employment Change figure for the month of November, which is expected to show  225,000 new jobs created during the month.  If this holds  true it could bode  well for the other employment figures released later during the week.  On Thursday the standard weekly unemployment related figures is set to be released with initial jobless claims expected to have come down, while continuing jobless claims is expected to have increased slightly. On Friday the government releases the latest official unemployment rate in the US, which is expected to remain unchanged at 5.8 percent, just like it was during October. But with the numbers that have  been trickling out during the month it seems we could see this figure tick down one  tenth of a percent to 5.7 percent without too much  trouble.  As always the nonfarm  public and private payroll figures will be more important and  potentially more impactful to the market  than  the overall unemployment rate as they

give a clearer picture as to what is going on in the US economy. Wrapping up the week are  the latest factory orders and consumer credit figures, both for the month of October and both so stale dated that it is highly

unlikely they will move  the financial markets. In addition to the scheduled economic news releases, this week also  holds several speeches by Federal Reserve board  members, including one  by chair Yellen that will be very closely watched by the markets.

 

 

 

Fun Fact of the Week

 

Is the Monday  after Thanksgiving the busiest online shopping day of the year in the U.S?

 

No, it is not the busiest online shopping day of the year. In fact, the busiest e-shopping day takes place on the Monday  or Tuesday a week (or two) before  the week in which Christmas falls and varies from year to year. Cyber Monday  really is only a thing of the past when  high speed internet was not readily available in people’s homes, so they  would go to work on Monday  after Thanksgiving to use their work internet speed to shop  around.  Now with internet speeds on mobile devices and at home there is even less need to shop  on “Cyber Monday.”

 

 

Source: Matt Tatham with Hitwise.com

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

Commentary at a glance:

-Onward and upward go the markets.

-Abe dissolves parliament in Japan.

-SURPRISE! China cut interest rates.

-Immigration reform presents the latest friction in Washington DC.

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

 

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

4 charts 11-24-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

 

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week as you are eating turkey:

 

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

 

Source: Guinness Book of Records

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

Commentary at a glance:

-The markets took a little breather last week.

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

-Europe is growing—just barely!

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

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

 

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

4 charts 11-17-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

Euro GDP Chnage 11-17-14

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

 

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week:

 

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

Source: Interstate Natural Gas Association of America

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

Commentary at a glance:

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

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

-Russia is once again meddling in Ukraine.

-Asia starts their annual APEC summit this week.

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

 

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

4 charts 11-10-14

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

 

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

voter turn out 11-10-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week:

Catalonia once stood alone. History revisited:

 

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

 

Source: Sussle.org

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

Commentary at a glance:

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

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

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

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

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

 

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

4 charts 11-3-14

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

 

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

election map 11-3-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week:

Voters speak in Brazil:

 

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

 

Source: New York Times

Follow

Get every new post delivered to your Inbox.