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

Commentary at a glance:

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

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

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

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

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

 

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

4 charts 10-27-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

VIX trend 10-27-14

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

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week:

 

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

Source:fleur-de-coin.com

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

Commentary at a glance:

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

-Greece has once again made negative international headlines.

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

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

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

 

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

4 charts 10-20-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

VIX Spike 10-20-14

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

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week:

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

 

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

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

Commentary at a glance:

-Wild ride last week in the equity markets!

-Europe scared the markets weeks before Halloween.

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

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

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

 

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

4 charts 10-13-14

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

10-13-14 Eurozone PMI

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

 

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

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

VIX Spike 10-13-14

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

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

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

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

Fun fact of the week:

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

 

Source: National Postal Museum

For a PDF version of the below commentary please click here Third Quarter 2014 in Review

Third Quarter in Review: Third quarter started out with the markets moving higher and the VIX making multiyear lows. About a month into the quarter geopolitical tensions rose sharply and, with them, the VIX spiked higher and the global financial markets moved lower. The key geopolitical hot spots during the quarter include Israel, Ukraine and Iraq. In Israel, the Israeli government launched a ground offensive into Gaza to destroy terrorist elements firing rockets into Israel on a daily basis. In Ukraine, fighting erupted between the rebels (backed by Russia) and the Ukrainian government. In Iraq, ISIL made headlines as they swept into large areas of northern Iraq. As tensions rose the markets became less and less stable, ending the quarter with increasing volatility. In fact, we saw 5 days in a row near the end of September where the Dow moved by more than 100 points each. With uncertainty surrounding various risks to the global financial system, investors were left on a roller coaster with certain areas of the markets performing very well while others declined for no apparent reason.

 

The following figures demonstrate just how wide the divergence in performance was during the quarter. The NASDAQ was up 1.93 percent, the S&P 500 was up 0.62 percent and the Dow was up 1.29 percent. All of these numbers were tame. The Russell 2000 (small caps) declined 5.11 percent, Utilities declined 4.05 percent, Gold fell 9.24 percent and global materials sank 7.18 percent. On a global basis, there were more indexes that declined during the third quarter than advanced. Overall, the MSCI All Cap World Index declined by 2.78 percent during the quarter. Fixed income also had an interesting quarter with the majority of US government bonds increasing, while the inflation protected bonds known as TIPS declined by more than 2 percent. So what was going on with investors’ behavior during the quarter?

 

Investors seemed to be holding on to equity investments in the US and preferring higher quality companies over more risky investments. Investors also preferred to own dividend paying stocks during volatile times; this was likely caused by the very low interest rates being seen on fixed income investments as investors continued to stretch for yield. Russia seemed to be a hot potato during the quarter as events in Ukraine such as the shooting down of the Malaysian Airline and the imposition of international sanctions against Russia caused investor sentiment towards the country to ebb and flow. Throughout the quarter central banks around the world also played a crucial part in the financial markets.

 

The US Federal Reserve continued with its tapering plans, in which it slowly took down the amount of bonds being purchased on a monthly basis. Meanwhile across the Atlantic, the European Central Bank (ECB) announced new plans for the bank to purchase assets, an initial start to quantitative easing after talking about it for the past two years. With the tapering program drawing to an end in the US one of the main topics that moved the markets during the quarter was the question of when the Fed will raise interest rates. There was a lot of speculation as to what signals and data points Chair Yellen is watching to determine when to raise rates, but in the end she maintained that interest rates would remain low for an extended period of time and would not commit to a specific time as to when they would start to raise. The consensus estimate of economists is that rates will be increased during the first half of 2015. One of the major driving factors behind the rate increase is that the US economy continues to move forward, albeit at a much slower pace than many economists and investors would like.

 

During the third quarter manufacturing data noticeably picked up, helping to drive up the GDP estimates to 4.6 percent for the second quarter from -2.9 percent during the first quarter. Consumer spending and sentiment increased during the quarter and the large decline in the price of oil reduced the price of gas at the pump. The overall unemployment rate in the US was shown to have declined from 6.2 percent in July down to 5.9 percent is September. Lastly, while the economic data is pointing to an expansion, prices have remained relatively stable with inflation not being seen in any of the data.

 

Looking ahead: Looking ahead to the rest of 2014, the markets will likely remain choppy and potentially become choppier than they were at the end of the third quarter. One of the driving forces behind this dynamic is that geopolitical tensions around the world have only been increasing and it does not look like they will be dissipating any time soon. The area of the world currently being very closely watched is Hong Kong as the unrest against the political figures in the country has lead to massive protests that have so far been largely peaceful. But China has a history of smashing protests it feels threatened by or does not agree with. With the world watching we will have to see how Beijing acts to get Hong Kong back under control. In Ukraine, Russia is obviously winning with the calendar slowly ticking more and more into winter, when negotiations between Europe and Russia will be very different as Europe relies heavily on gas from Russia for heat. In the Middle East we will likely see continued violence between Islamic State (IS) and the rest of the world as the coalition attempts to defeat the extremist group without disrupting the flow of oil in the region.

 

Here in the US, third quarter earnings will be in the spot light to start the fourth quarter. Expectations are high, but they have been actively moving lower over the past few weeks. This type of action is pretty common, as companies like to set a low bar that is easy to jump over and in turn makes the companies look better. Speculation about the potential Fed action coming in 2015 will likely continue to push around the bond market as new data is digested. Yields will likely remain low during the quarter although they could creep higher as we get closer to the end of the year. Commodity prices will likely continue to decline as China continues to battle for high growth within its economy, while also dealing with the likely spread of political unrest. Aside from the US economy and Fed actions, the largest wildcard through the end of the year will likely be Europe as it fights to stay out of a recession and the ECB continues to take action.

 

With Germany slowing down and being the most critical economy within Europe it is not surprising to see that a small stumble by Germany in GDP has quickly led to the ECB taking action across Europe. By purchasing assets the ECB is essentially engaging in the same actions the US Fed undertook a few years ago, actions which are just now finally drawing to a close. Whether or not the actions of the ECB are going to work will start to be seen during the fourth quarter. If things do not go well we could see this spread into a decline in the financial markets in the region and potentially around the world. We here in the US are due for a correction. There has been lots of talk about the length of time between 10 percent declines or the number of months this bull market has run. In the end these are all backwards looking signals, and the current market seems to have no problem climbing the proverbial wall of worry, at least it has not yet. But backwards looking signals do look at history and as Mark Twain so aptly said, “History doesn’t repeat itself, but it does rhyme.”

Time for the Third Quarter Numbers: The following is a numerical representation of the third quarter of 2014. I will start with the three major US indexes and the VIX, which turned in performance as follows:

 

Index 3rd Quarter 2014
VIX 40.88 %
NASDAQ 1.93 %
Dow 1.29 %
S&P 500 0.62 %

 

Volume during the third quarter was very weak on all three of the major indexes. The S&P 500 saw the lowest quarterly volume since the second quarter of 1998. The volume on the Dow was the lowest since the fourth quarter of 1998 and the NASDAQ saw the lowest quarterly volume since the third quarter of 2013.

 

Globally, the top three performing indexes for third quarter of 2014 were:

 

Index 3rd Quarter 2014
Shanghai Se Composite Index 15.40 %
Tokyo Nikkei Index 7.99 %
Mexican IPC Index 5.26 %

 

Globally, the bottom three performing indexes for third quarter of 2014 were:

 

Index 3rd Quarter 2014
Russia Capped Index -14.63 %
Taiwan Weighted Index -4.54 %
Germany Frankfurt Dax Index -3.65 %

 

Russia has been very interesting to watch this year as it went from the poorest performing global index during the first quarter of 2014 to the second best performing global index during the second quarter then right back down to the poorest performing global index during the third quarter. With all of the international sanctions starting to really bite, it is hard to not see the Russian economy starting to struggle more moving toward the end of the year.

 

For those of you who follow and are interested in the style box performance of various investments throughout the quarter, below is the standard style box performance for third quarter 2014:

 

Style /  Market Cap Value Blend Growth
Large Cap -0.14 % 1.18 % 2.03 %
Mid Cap -3.76 % -1.33 % -1.47 %
Small Cap -6.45 % -5.74 % -5.97 %

As you can see above, value was heavily out of favor during the quarter as was the small cap stocks. With so much uncertainty in the world large cap stocks were the safest place to wait things out. In many cases, large cap stocks also pay dividends, so in a sense investors were being paid to wait. With such a wide dispersion in performance within the style boxes it would not be unusual to see the winning sectors so far give back a little to the losing sectors in a bit of a mean reversion play at some point in the near future.

 

The following table gives the performances for the top-performing sectors for the third quarter of 2014:

Sector Change
Biotechnology 6.46 %
Healthcare 4.79 %
Financial Broker Dealers 4.25 %
Healthcare Providers 3.93 %
Pharmaceutical 3.88 %

 

The bottom-performing sectors for the third quarter of 2014 were as follows:

 

Sector Change
Oil & Gas Exploration -10.42 %
Natural Resources -10.41 %
Energy -9.65 %
Home Construction -9.31 %
Utilities -5.48 %

 

Commodities continued to see very volatile trading throughout the third quarter of 2014. Returns were as follows:

Commodities Change
GSCI Commodity Index -12.77 %
Silver -19.26 %
Copper -7.08 %
Gold -9.24 %
Oil -13.49 %

 

 Much of the decline in commodities was due to the continued slowdown in the Chinese economy and thus a lack of demand for raw materials. This was seen in countries that rely heavily on trading raw materials with China such as Australia, which moved lower during the quarter on fears of fewer shipments to China. Gold had an interesting quarter, declining in value despite the weakness in many of the global currencies. At this point gold seems to be under tremendous downward pressure and it does not look like it will come to an end any time soon. Oil, however, looks like it may have come down about as much as it will during this cycle as production has started to slow down and prices are getting down to where some oil producing countries cannot make as much money as they would like with their relatively high fixed costs. Less production means lower supply and higher prices.

 

Fixed-income had a great quarter during the third quarter of 2014 as the Fed continued its tapering program, despite the near certainty of higher interest rates during 2015:

 

Fixed Income Change
20+ Year Treasuries 2.42 %
10-20 Year Treasuries 0.82 %
7-10 Year Treasuries 0.04 %
3-7 Year Treasuries -0.39 %
1-3 Year Treasuries -0.06 %
TIPS -2.85 %

 

The fixed income markets have been very wild so far this year, with investors estimating at the start of the year that yields would be moving substantially higher and bond prices would be coming down. Instead, we have seen yields move very little and prices in some cases actually increase. The fixed income market will likely continue to see wild movements as investors try to outguess everyone else as to when the Fed will start to raise interest rates.

For a PDF version of the below commentary please click here Weekly Letter 10-6-2014

Commentary at a glance:

-Financial markets continued to push lower.

-Hong Kong continues to be very tense, but the protests are becoming smaller.

-Fighting between Russia and Ukraine is picking back up.

-The US is starting to gear up for third quarter earnings season.

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

 

Market Wrap-Up: With declines for a second week in a row last week and the previous trend lines being fairly meaningless given the declines we have seen, I made some changes to my charts below. Rather than drawing a resistance line on the three major indexes I have now drawn in the most recent trading channels with the red lines. The VIX chart remains unchanged, showing both the VIX level in green and the 52-week average level of the VIX in red:

 4 charts 10-6-14

Last week saw further technical deterioration in the markets as all three of the major indexes moved lower. In redrawing the technical lines above, however, two of the three indexes look technically stronger than the other. The Dow (upper right pane above) is the strongest of the three major indexes from a technical standpoint. With the trading channel drawn in red you can see that the index last week hit the lower bound and then proceeded to bounce higher, almost making it all of the way back to the upper bound of the range. One other aspect to note is that the most recent trading channel is very steep, which means that it is moving down quickly. If the Dow is going to remain stuck in the channel it is going to quickly move lower. This is unlikely as the Dow will probably either break above or below the channel very quickly. The NASDAQ (lower left pane above) is roughly the same as the Dow in that it is stuck in a downward trading channel, only it broke through the lower bound of the channel during the middle of last week. The break was very temporary as the index jumped right back up near its upper bound of the channel with the strong upward move on Friday. The weakest of the three major indexes is the S&P 500 (upper left pane above) as it broke down through the lower bound of its trading channel last week and had a pretty weak recovery last Friday, ending the week in the middle of its trading channel. Much like the other trading channels, the S&P 500 channel is very steep, making it also unlikely that it remains in the channel for an extended period of time.

 

With such a downward move in the markets over the past two weeks it would not be surprising to see the major indexes move upward a little this week, either in a full blown bull market move or in a bit of a dead cat bounce. Typically the markets move too much too fast and then retrace a movement as investors either return to or leave the markets. This goes right in line with the old saying of buying on the dips. As markets decline investors who are watching specific price points on stocks hit some of their buying points, triggering them to buy the stock. The buying of the stock is what causes the price to either decline slower or reverse course and move higher. If enough of this happens to a large number of stocks in an index, you get a bottoming out effect followed by the index moving higher. The dips we have seen so far in the indexes this year have been between 2 and 6 percent, which means that the decline of about 3 percent we have seen in the past two weeks puts us right in the middle of the size of declines we have seen during 2014.  Thus far this year the indexes have been very resilient and have bounced right back after such declines. I see little reason for this time to be different, as we are moving once again into an earnings season.

 

National News: National news last week focused on money moving and the upcoming earnings season. The money moving last week involved the massive flows being seen in a large variety of fixed income holdings as the management shift at PIMCO has really rattled parts of the fixed income markets. Two weeks ago “Bond King” Bill Gross made a surprise announcement that he was leaving PIMCO (an investment firm he founded) and going to Janus Funds (they happen to be headquartered here in Denver). There have been a lot of management changes at PIMCO this year as their performance has been really bad over the past few years, after being the best in class over the past few decades. Earlier this year Mohamed El Erain (he was the co-head of investments at PIMCO with Gross) announced that he was resigning; this announcement, combined with Gross now leaving, really puts PIMCO under a lot of pressure. This pressure spilled over into the fixed income markets as PIMCO, under Gross’s direction, managed close to $2 trillion in investments with most of it being in fixed income. Outflows from PIMCO products have been extensive over the past two weeks with billions of dollars flowing out each week. This has led to many interesting moves in the fixed income markets as traders try to get away from the large PIMCO holdings they know will become much less liquid once the management shift at PIMCO has been completed. Much of the commentary about the moves has been that the fixed income markets should be too big for any one person to move, as has always been the thought. But in seeing the effects of Bill Gross leaving, regulators and investors alike are seeing that the saying is not necessarily true. Aside from the shakeup in the fixed income market, the focus of the national news last week was on the upcoming earnings season.

 

Third quarter earnings season has pretty high expectations, but those expectations have been lowered over the recent weeks. According to Factset research, 82 companies have issued negative guidance, while 27 companies have issued positive guidance for the quarter. The current earnings growth rate is 4.6 percent; this is down from the 9.0 percent that was expected for the third quarter at the end of June. With all of the downward revisions, it seems the bar for the quarter has been set very low. That is either because of companies wanting to easily beat expectations and look good or because earnings during the third quarter of 2014 really were not very good. Third quarter earnings will go a long way toward helping investors decide about the true health of the economy. We have seen a general lagging in several key factors of the economy, but future earnings hopes seemed to be enough to really pull the markets higher. This third quarter is the first quarter that we should not hear about an impact of bad weather making a difference on earnings. In the first quarter the weather was bad. The second quarter saw increased demand due to the bad weather in the first quarter. The third quarter will have to stand on its own. All eyes will be watching earnings as they start to roll out this week. There are 12 well known companies that are posting their earnings this week, including Alcoa, the first of the major companies to announce. Below is a table of the better known companies that are announcing earnings this week with the potentially most impactful releases of the week highlighted in green:

 

Alcoa Fastenal PepsiCo
Container Store Helen of Troy Ruby Tuesday
Costco Wholesale IDT Safeway
Family Dollar Stores Monsanto Yum! Brands

 

There is a saying on Wall Street that if Alcoa beats earnings, the earnings quarter will be strong and if it misses, it will be a rough earning season. We will know how things kick off for earnings season by next week.

 

International News: International news last week was highlighted by the unrest in Hong Kong as it entered a second week of protests. The protesters are now calling for the resignation of the current CEO of Hong Kong, claiming he is nothing more than a puppet for the government in Beijing. Last week was a very tense week, particularly the last few days of the week as it was a holiday for many of the workers in Hong Kong and there were fears of mass demonstrations in the streets. While many people did show up at the rallies, they were largely peaceful. China was smart to wait this one out as the new work week has not started in Hong Kong. The crowds have dwindled way down and the police have had to take no major action against the crowds. According to the BBC, the main crowd remaining is under 1,000 people and several government buildings that had been surrounded by several thousand people are down to crowds of less than 100 people, in one case 10 people.  In a few more days it is likely that the protests will largely be over and Beijing has had to give relatively nothing in the form of concessions. The elections will go ahead in 2017 as planned and the candidates will have to be “approved” by Beijing, at least that is the current plan. While Hong Kong is settling back down and China has a small victory, the unrest in Ukraine seems to be picking back up.

 

Russia has for a long time wanted to drag out the situation in Ukraine into winter, when Europe is heavily dependent on Russian gas, even going as far as signing a cease fire with the Ukrainian government and the rebel groups. That ceasefire, however, is currently being tested as there have been near daily shellings of various areas in Ukraine by both the pro-Russian rebels and the Ukrainian government. One of the latest attacks occurred when the rebels shelled a Ukrainian military convoy, hitting an armored vehicle and directly and killing 17 soldiers. The Ukrainian government responded by shelling a rebel control region in Donetsk, but missed their target and hit very near a school with kids going back to school for their first day of classes. While no kids were killed in the attack, there were several bystanders who were killed. This now looks like it will be a very long and protracted fight between the two sides and thus the global financial markets have largely stopped pay attention, but they will surely notice if the gas flowing to Europe is turned off and the already weak European economies begin to struggle even more.

Market Statistics: Last week saw all three of the major US indexes move lower on average and above average volume as investors continued to move away from the most risky assets in favor of lower risk investments:

 

Index Change Volume
Dow -0.60% Average
S&P 500 -0.75% Above Average
NASDAQ -0.81% Above Average

 

With two weeks in a row of the broad based indexes declining, some investors and money managers are starting to wonder if the decline that everyone has been so aptly waiting for has started. While it is still far too early to tell, it does not seem like the down trend of the past two weeks will gain more steam. A more typical downturn in the markets that will end up being 10 percent or more happens relatively quickly, with some major catalyst pushing the market down in a matter of days. It is unusual, but not unheard of, to see a slow methodical march lower, a slow decline like we have seen over the past two weeks. We also still have several key support levels on the three major indexes that would need to be broken to see a meaningful decline. So far the markets have declined between 1.5 and 2.5 percent. The first significant support level is about 3 percent below current levels. If we break through that to the downside, the markets could decline to the magical 10 percent. Barring the break through support occurring, the recent small pull back looks like tame and healthy market movements.

 

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
Utilities 1.87% Oil & Gas Exploration -5.21%
Medical Devices 1.31% Materials -4.36%
Software 0.77% Energy -4.19%
Pharmaceuticals 0.74% Semiconductors -3.11%
Broker Dealers 0.03% International Real Estate -2.87%

With the markets declining for a second week in a row it was not surprising to see that Utilities saw the best performance of the sectors as they are historically the most defensive sector of the markets. The reverse is also true as the Oil and Gas Exploration is typically seen as one of the riskiest areas of the market and thus it sold off the most last week. The move in Materials continues to be on global growth concerns going forward and the demand for raw materials in China. This demand weakness cannot last forever and at some point may lead to a very good buying opportunity for the sector.

Fixed-income investments were mixed last week on average volume as investors continued to deal with the fallout of Bill Gross leaving PIMCO for Janus and the upcoming Fed decision on when to raise interest rates:

Fixed Income Change
Long (20+ years) 1.47%
Middle (7-10 years) 0.56%
Short (less than 1 year) -0.04%
TIPS 0.27%

With the economic strength of the European Union continuing to be called into question it was not surprising to see that the US dollar had a second great week in a row last week, gaining 1.23 percent against a basket of international currencies. Aside from the strength of the US dollar the next strongest currency last week was the Japanese Yen, which lost only 0.47 percent against the US dollar. The worst performing currency of the week was the British Pound as it slid 1.68 percent against the value of the US dollar, largely as a lagging affect of the Scottish vote from a few weeks ago.

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

Metals Change Commodities Change
Gold -2.09% Oil -3.91%
Silver -4.62% Livestock 1.16%
Copper -1.39% Grains 0.73%
Agriculture 1.62%

The overall Goldman Sachs Commodity Index turned in a loss of 2.74 percent last week, while the Dow Jones UBS Commodity Index declined by 1.30 percent. The decline in the commodity indexes last week was led by a slide in base metals and a decline of almost four percent in the price of oil. Oil continued to slide, having now fallen more than 16 percent since its most recent peak back in the middle of June. While we have not seen such a large decline in prices at the pump, if Oil continues to move lower we could see prices at the pump begin to meaningfully decline over the next few weeks. One factor that is likely keeping the price of gas at the pump relatively unchanged is the fact that we are moving into winter and several large oil refineries have transferred from making gasoline to heating fuel for the winter, as they do every year.

Last week was a mixed week for the global indexes with only two of the Asian markets advancing while the rest of the global indexes declined. The reason for the two Asian markets advancing was largely due to them being closed part of the week last week for national holidays. The best performance globally last week was found in Taiwan with the Taiwan Weighted Index gaining 1.30 percent. Brazil saw the worst performance of the week last week as concerns about the upcoming election picked up steam. The Sao Paulo based Se BOVESPA Index declined by 4.67 percent on very heavy volume as fears of a less business friendly leaning government seem to be taking hold.

The VIX started out the week moving higher for the first three days of trading, gaining 12.5 percent. After the first three days of trading the positive news about the employment situation in the US started to trickle out and the markets seemed to respond positively. The VIX plummeted by nearly 13 percent to end the week little changed, falling by 2.02 percent in aggregate. At the current level of 14.55 the VIX is implying a move of about 4.20 percent over the course of the next 30 days on the S&P 500. As always, the direction of the move is unknown.

For the trading week ending on 10/3/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.18 % 1.05 %
Aggressive Benchmark -1.78 % 0.67 %
Growth Model 0.03 % 1.80 %
Growth Benchmark -1.39 % 0.61 %
Moderate Model 0.21 % 2.59 %
Moderate Benchmark -1.00 % 0.51 %
Income Model 0.36 % 2.80 %
Income Benchmark -0.49 % 0.37 %

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

 

As the decline in the markets continued last week for the second week in a row we really started to see the diversification in our models start to pay off. While the broad based markets were declining, two thirds of the individual stocks we own were going up. This was most likely a function of investors moving toward safety in the equity markets, which are the relatively low volatility sectors of the market, such as consumer staples and utilities. Consumer staples and utilities are both over weight areas of our models and were the largest contributors to our out performance last week. The one area of our holdings hit last week was our holdings in aerospace and defense, companies such as Northrop Grumman and Raytheon, as the entire defense sector moved lower. Going forward we are maintaining well balanced models and will continue to monitor the markets for new investments if any investments present themselves and good deals.

 

Economic News:  Last week was a busy week for economic news releases pertaining to employment, but in aggregate the data came in at market expectations. Below is a table of the releases with the one that missed significantly highlighted in red and the one that significantly beat expectations highlighted in green:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 9/29/2014 Personal Income August 2014 0.30% 0.30%
Neutral 9/29/2014 Personal Spending August 2014 0.50% 0.40%
Slightly Negative 9/29/2014 Pending Home Sales August 2014 -1.00% -0.20%
Slightly Negative 9/30/2014 Case-Shiller 20-city Index July 2014 6.70% 7.40%
Neutral 9/30/2014 Chicago PMI September 2014 60.5 61.5
Negative 9/30/2014 Consumer Confidence September 2014 86 92
Neutral 10/1/2014 ADP Employment Change September 2014 213K 202K
Slightly Negative 10/1/2014 ISM Index September 2014 56.6 58.5
Neutral 10/2/2014 Initial Claims Previous Week 287K 297K
Slightly Positive 10/2/2014 Continuing Claims Previous Week 2398K 2458K
Slightly Positive 10/3/2014 Nonfarm Payrolls September 2014 248K 210K
Slightly Positive 10/3/2014 Nonfarm Private Payrolls September 2014 236K 205K
Positive 10/3/2014 Unemployment Rate September 2014 5.90% 6.10%
Neutral 10/3/2014 ISM Services September 2014 58.6 58.9

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

 

Last week the economic news releases started on Monday with the release of personal income and spending, both of which came in very close to market expectations and had little impact on the overall markets. Pending home sales for the month of August were also released on Monday and showed a decline of 1 percent, which is slightly worse than expected, but with it being only pending home sales the markets largely ignored the poor data. On Tuesday the Case-Shiller 20 City Home Price index came in slightly below expectations, adding a second yellow flag about the US housing market. But the housing data was largely overshadowed on Tuesday by the poor consumer confidence figure for the month of September, which was released on the same day. Consumer confidence had been expected to come down slightly during September, but instead it declined by more than 7 full points. This scared the markets a little and caused some selling to set in. On Wednesday the selling was largely stemmed as the first of the employment figures came in at 213,000 on the ADP employment change index, leading to investors increasing their hopes for a strong reading on the employment data being released on Friday. One downer released on Wednesday last week was the ISM index, which came in weaker than expected, showing that the strong manufacturing data we had been seeing over the past few months is once again slowing back down. On Thursday the standard weekly employment related figures both came in a little better than anticipated and thus provided more hope for the Friday figures. On Friday the Unemployment rate was shown to have declined all of the way down to 5.9 percent from the 6.1 percent seen during August. Nonfarm public and private payroll figures were also released and came in better than anticipated for September, adding further fuel to the markets, which saw one of the largest rallies we have seen in the past few months on the news. One thing that was largely overlooked in the jubilant news on Friday was the falling labor force participation rate in the US. The labor force participation rate fell to 62.7 percent, which is the lowest it has been for the past 20 years (February of 1978 to be precise). So while the headline numbers are looking good, there are still major issues that need to be worked out with the US employment situation. This issue is one that Fed Chair Janet Yellen is surely watching so despite the unemployment rate falling under 6 percent, it is unlikely this data point alone will force her to make any policy changes any faster than she otherwise would have. Wrapping up the week last week was the services side of the ISM ,which much like the overall ISM earlier in the week came in lower than anticipated, but not by enough to cause any alarm in the markets.

 

This week is a very slow week for economic news releases with really only one release that has the potential to move the markets. The economic news release that could potentially impact the market is highlighted in green:

 

Date Release Release Range Market Expectation
10/7/2014 Consumer Credit August 2014 $20.0B
10/8/2014 FOMC Minutes September Meeting
10/9/2014 Initial Claims Previous Week 295K
10/9/2014 Continuing Claims Previous Week 2425K

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

 

This week’s economic news releases start on Tuesday with the release of consumer credit for the month of August, which is expected to show an increase of $20 billion. While this figure, if it turns out to be correct, is below the $36 billion we saw in July, it is still a strong number and is indicative of a banking system that is loaning out money to help the economy grow. On Tuesday the latest FOMC meeting minutes are set to be released and the only reason this release could impact the overall markets is that the market will read a lot into any discussion about when to raise interest rates and could move as a result of the discussion. Chances are that the release will be very plain vanilla and not give any more clues as to when the Fed will start raising interest rates. This week wraps up on Thursday with the release of the standard weekly unemployment figures, both continuing and initial jobless claims. After such good numbers two weeks ago both initial and continuing jobless claims are expected to have increased slightly over the course of the previous week.

For a PDF version of the below commentary please click here Weekly Letter 9-29-2014

Commentary at a glance:

-Financial markets moved lower on average volume—thanks Apple!

-Unrest has now spread from the Middle East to Hong Kong.

-Germany continues to show weakness.

-The US continues to formulate and execute a plan for dealing with Islamic State.

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

 

Market Wrap-Up: After seeing gains on the three major indexes two weeks ago, last week was a week to give back those gains (keeping with the recent pattern) and true to form the indexes declined. Some of the blame is being laid on Apple, but that seems like an easy scapegoat for investors who have become increasingly skeptical about the recent rise in the markets. Below are my standard charts with the key indexes represented by the green lines and the most recent trend lines on the three major indexes and the 52-week average level of the VIX represented by the red lines:

4 charts 9-26-14

As you can see in the above charts, all three of the major US indexes are in a chopping trend that is slightly tilted downward. Up until last week the Dow (upper right pane above) had been making good efforts to break above its most recent trend line, but the pressure to decline just seemed to be too much last week as the index fell apart. The weakness also spread into both the S&P 500 (upper left pane above) and the NASDAQ (lower left pane above) as both indexes moved further and further away from their trend lines. At this point the NASDAQ is the strongest of the three major indexes from a technical standpoint. It also happens to be the index that has been experiencing the least amount of volatility over the past few weeks. Remember that volatility is measured both on the upside and the downside although most investors only really care about volatility when an investment is moving lower. Last week’s broad decline was done on average volume as opposed to the above average volume we saw two weeks ago when the Dow and the S&P 500 pushed to new all time highs. With that in mind, it seems like the sell off last week was just a one-off event that will likely not continue. Maybe it had something to do with the quarter end being this week or maybe it was just investors rebalancing their position, but whatever the reason it seems like the decline will be short lived. The VIX even had a relatively muted day (up 17 percent) on Thursday when the Dow dropped by more than 260 points. In looking back since October of 2012, on days when the Dow has declined by more than 260 points in a single day the average move for the VIX has been to gain 24 percent, with the largest jump on the VIX during that time being 43 percent on April 15th, 2013. There were a few driving factors in the decline last week, one that is concerning and others that were mainly noise.

 

The first factor that helped drive the decline in the US markets last week was a report showing that weakness is likely to continue in Europe well into the third quarter. While this is bad it has been largely known for the past several months as much of the data has been dismal enough for the ECB to actually take action after talking about action for the better part of two years. A second factor that I see largely as noise was the news about troubles with the new iPhone from Apple, including some operating system issues that are still being worked out. In the grand scheme of things, Apple is a small part of a much larger global economy and I am sure the issues that arose last week will be worked out in very short order. The final aspect being blamed for the decline last week addresses the geopolitical hot spots in the Middle East and Eastern Europe. This again is not new news, so why it affected the markets last week all at once is anyone’s guess.

 

National News: National news last week was dominated by the response by the US to the threat of Islamic State (IS) and by a few issues Apple ran into with some of its software and hardware. IS received the majority of the headlines because the US really seems to have been caught not paying attention to what was developing in Syria over the past few years with the strengthening of this group. President Obama said as much last night on 60 Minutes in a rare interview he gave in which he passed some of the blame for the current situation on the US Intelligence community. Over the past two weeks the US has been pushing hard to form an international coalition to help combat IS and so far support has been strong. The Europeans have started to fly missions over Iraq and various countries in the Middle East have also started to help. The big question that remains, however, is who will go on the ground with the Iraqi and Syrian forces and help defeat IS. President Obama has said there will be no US boots on the ground, but members of Congress and the intelligence community are having a very hard time seeing how IS may be defeated without US troops on the ground. The current thought is that the US will arm rebels in Syria and the Iraqi army as well as soldiers from neighboring countries such as Saudi Arabia, Qatar and Bahrain; and that this group of soldiers will be able to defeat IS on the ground with air support from the US and other members of the coalition. This seems like a tall order for these countries, countries not clearly established as friend or foe to the US and US allies, but it is almost the only way to move forward. The impact of the ongoing issues with IS was seen last week in the price of Oil as oil prices moved higher after announcements that the US had hit IS controlled oil fields in both Syria and Iraq. While none of the oil fields control by IS are “officially” shipping oil onto the international market, the fear that there could be a bit of a pinch in oil due to the conflict helped raise the price. The other major news story of the week last week had to do with one of the largest companies in the world: Apple.

 

Apple found itself in the hot seat last week after it rolled out the latest generation of smart phones, the iPhone 6 and iPhone 6 Plus. First, there were a few tweets and blog posts about new iPhones that were bending if they were sat on (in a back pocket) or if enough force was applied to the phone. At first this was thought to be one-off phones, but then an onslaught of users began reporting the same issues and it has now turned into a full blown crisis for the company. While it is the latest phone and there are not many of them on the market yet, it is the phone CEO Tim Cook bragged about selling 10 million of during the first weekend of sales. Adding to the issues at Apple was the announcement that Apple was having issues with their latest operating system upgrade called iOS 8.0.1 after many users ran into issues involving a lack of service following the upgrade. With both of these issues really coming to a head late Wednesday and into Thursday it was not surprising to see that Apple falling 3.8 percent had a very negative effect on the overall performance of the NASDAQ on Thursday. After all, the company is more than 13 percent of the total NASDAQ 100 index.  This fear in the NASDAQ decline spilled over onto the other US indexes and could have been one the catalysts to the large decline seen during the day.

 

International News: International news last week focused on a few different items with one of the main items being the slowdown in Europe after a new poll of German consumer confidence showed that things are not improving. Last week, the GfK institute, a well known market research firm in Germany, released their latest poll findings that showed that the German consumer is currently more fearful about the situation in Ukraine and the economic uncertainty in Europe than in the recent past. With Germany already having posted a decline of 0.2 percent in GDP during the second quarter of 2014, such statements and polls really have a negative impact. The reason for the negative impact is that Germany could be headed for a technical recession, along with many other European countries. If Germany goes into a recession it is highly likely the rest of Europe will also enter a recession. The question then becomes whether the economic slowdown will spread to other countries or remain largely a European issue. The US doesn’t have that many ties to Europe as far as trade or financial connections, so it is unlikely that a recession in Europe will mean a recession for the US. However, there are many ancillary ties between Europe and many of the US’s largest trading partners, partners that are also slowing down, such as China. The real fear is not that Europe will go down, it is that the small push from Europe will be enough to push an already weak global economy back into a recession. One country that made a lot of headlines last week was Hong Kong as civil unrest seems to have spread there much as it did in Northern Africa over the past two years.

 

Hong Kong is an Asian island country that officially acts as a “Special Administrative Region” of China and it seems the people of Hong Kong now want to break even further away from China. The only problem is that the current leadership in Hong Kong was handpicked by Beijing and answers fully to Beijing and the Chinese government. The issue right now is who the people of Hong Kong may vote on and whether that person can lead to more autonomy for the country from China. Right now votes are cast by a committee that is made up of 1,200 voters in Hong Kong, voters who are largely aligned with China and would therefore never vote against China indirectly controlling Hong Kong. The people of Hong Kong want truly democratic elections held where candidates are picked by the people and voted on by the people without interference by China. Currently China has agreed to a vote by the people of Hong Kong, but only if China is allowed to pick all of the candidates. It is not surprising to see that people in Hong Kong who want a free and transparent election see this as a circumvention of true democracy by the Chinese government. If this unrest goes the way other unrest in China has gone in the past it will likely be dealt with in a very heavy handed manner by the officials in Beijing in a relatively short period of time. The potential impact of this unrest on the global economy is relatively small, but if the unrest spreads to other regions of China and the Chinese government starts to lose some control it could have very deep impacts on the global economy since China plays such a key role in many countries of the world. The leadership in China may have a vested interest in clearing up the disturbance quickly as the first week of October is a weeklong national holiday that closes many of the financial markets in the region.

Market Statistics: Last week saw all three of the major US indexes move lower on average volume as investors seemed to get spooked all at once about problems that have been well documented in the media over the past few months:

 

Index Change Volume
Dow -0.96% Average
S&P 500 -1.37% Average
NASDAQ -1.48% Average

 

Despite the large decline in the markets, especially on Thursday, last week overall was a very choppy week that happened to end lower than it started. Volume last week was much lower than it was two weeks ago when the markets moved higher, and with volume being low on such a down week for the markets it means there was less participation in the selling than there was in the buying. This lack of volume on the downside may indicate that investors are “buying on the dips” and were bargain hunting last 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
Biotechnology 0.43% Home Construction -3.41%
Pharmaceuticals -0.74% Regional Banks -3.33%
Healthcare -0.77% Telecommunications -3.07%
Semiconductors -1.23% Oil & Gas Exploration -3.03%
Utilities -1.30% Broker Dealers -2.75%

During weeks of large declines it is interesting to see what sectors move the most, both positive and negative. Biotechnology, Pharmaceuticals and Healthcare were somewhat surprising to see at the top of the good performance list as they have been the strongest performing sectors of the markets and there are lots of gains to be taken if investors choose to do so. Typically in a downward trending market investors sell their winners to “book the gains,” especially if the gains are on very volatile sectors of the markets such as Biotech. But that was not the case last week as the risky inflated sectors held up really well. On the negative side it was a little surprising to see Home Builders at the top of the list given the relatively good numbers we saw on the economic news releases that pertained to housing last week.

Fixed-income investments were all up last week on average volume as investors tried to gauge the potential timing of the first interest rate increase by the US fed next year:

Fixed Income Change
Long (20+ years) 1.22%
Middle (7-10 years) 0.42%
Short (less than 1 year) 0.01%
TIPS 0.06%

With the economic strength of the European Union being called into question it was not surprising to see that the US dollar had a great week last week, gaining 1.11 percent against a basket of international currencies. Overall, the US dollar gained 0.58 percent against a basket of international currencies. Aside from the strength of the US dollar the next strongest currency last week was the Japanese Yen, which lost only 0.19 percent against the US dollar. The worst performing currency of the week was the Australian dollar as it slid 1.80 percent against the value of the US dollar, largely on the falling commodity prices due to the slowdown in China.

Commodities were mixed last week as investors tried to make sense of what is happening in the global economy and the various geopolitical threats that remain:

Metals Change Commodities Change
Gold -0.03% Oil 1.87%
Silver -1.69% Livestock 1.17%
Copper -1.79% Grains -2.43%
Agriculture 0.64%

The overall Goldman Sachs Commodity Index turned in a loss of 0.07 percent last week, while the Dow Jones UBS Commodity Index declined by 0.54 percent. The decline in the commodity indexes last week was driven by the plummeting value of metals as global economic growth was called into question. Oil turned in a gain as the US continued to hit IS targets in both Iraq and Syria with the help of a global coalition. With so much oil being produced in the region it was not surprising to see that as the bombing stepped up, more and more concern arose about the potential impact on global oil supplies. Oil had seen a steady decline, falling 7 of the past 9 weeks prior to the almost 2 percent gains seen last week. Even after including last week’s advance, oil has declined by more than 12 percent since the middle of June.

Last week was a mixed week for the global indexes with only three of the Asian markets advancing while the rest of the global indexes declined. The best performance globally last week was found in China with the Shanghai based Se Composite Index gaining 0.78 percent. Germany was the country that saw the lowest performance of the week with the Frankfurt based Dax Index declining by 3.15 percent. The decline in Germany was also mirrored in many parts of Europe as uncertainty over the economic strength of the European countries was questioned and the situation in Ukraine remained largely unsettled.

After declining two weeks ago the VIX made a comeback last week, gaining more than 22 percent. The majority of the gain was made on Thursday when the VIX jumped 18 percent, thanks to a large sell off, which was partially attributed to a 3.8 percent decline in Apple. With the jump last week the VIX is now easily over its average one-year level, but it still remains well below the previous four spikes we have seen so far during 2014, as depicted in the chart to the right. While the recent move we have seen does count as a spike it still has a long way to go before there is truly “fear” in the markets. At the current level of 14.85 the VIX is implying a move of about 4.29 percent over the course of the next 30 days on the S&P 500. As always, the direction of the move is unknown.

VIX spikes with arrows 9-29-14

For the trading week ending on 9/29/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -1.06 % 1.23 %
Aggressive Benchmark -1.78 % 2.50 %
Growth Model -0.94 % 1.76 %
Growth Benchmark -1.38 % 2.02 %
Moderate Model -0.89 % 2.38 %
Moderate Benchmark -0.99 % 1.52 %
Income Model -0.98 % 2.42 %
Income Benchmark -0.49 % 0.87 %

*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.

 

Last week we made no significant changes to any of our models as the positions we owned going into the week performed well in light of the decline in the broad based markets. One highlight from last week was the performance of Nike, which we own in our more aggressive models. Nike was up nearly 10 percent on the week after turning in very strong numbers for their first quarter revenues as well as lifting their estimates for the full year. With the markets having declined last week we did move closer to buying points on several investments that we have been watching for quite some time, one of which is the Eventide Healthcare and Life Sciences Fund (ETAHX).

 

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

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 9/22/2014 Existing Home Sales August 2014 5.05M 5.2M
Slightly Positive 9/24/2014 New Home Sales August 2014 504K 435K
Neutral 9/25/2014 Initial Claims Previous Week 293K 300K
Neutral 9/25/2014 Continuing Claims Previous Week 2439K 2470K
Neutral 9/25/2014 Durable Orders August 2014 -18.20% -16.30%
Neutral 9/25/2014 Durable Goods -ex transportation August 2014 0.70% 0.70%
Neutral 9/26/2014 GDP – Third Estimate Q2 2014 4.60% 4.60%
Neutral 9/26/2014 University of Michigan Consumer Sentiment Index September 2014 84.6 85.0

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

 

Last week started on Monday with the release of the existing home sales figures for the month of August, which came in a little below market expectations, but not by enough to have the markets take notice. On Wednesday new home sales slightly beat expectations, coming in about 80,000 units higher than market expectations. On Thursday both initial and continuing jobless claims came in slightly lower than expected, but much like the existing home sales figures both figures were close enough to estimates that they did not affect the markets. Also released on Thursday was the durable goods orders figures for the month of August, which showed a large drop off in the overall month to month figure of -18.20 percent, largely due to a decline in aircraft orders. When transportation is removed from the equation durable goods orders came in exactly as expected with a gain of 0.7 percent. On Friday the third estimate of second quarter GDP for 2014 was released and came in as expected at 4.6 percent after being revised upward from the second estimate of 4.2 percent given last month. Wrapping up the week last week was the release of the University of Michigan’s Consumer Sentiment Index for the month of September, which came in slightly below expectations, but much like many of the other releases of the week was close enough for the markets to not pay any attention to the miss.

 

With this week containing both the end of a month and the end of a quarter there are numerous economic news releases that could impact the overall movement of the markets; the primary focus of the week will be employment. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
9/29/2014 Personal Income August 2014 0.30%
9/29/2014 Personal Spending August 2014 0.40%
9/29/2014 Pending Home Sales August 2014 -0.20%
9/30/2014 Case-Shiller 20-city Index July 2014 7.40%
9/30/2014 Chicago PMI September 2014 61.5
9/30/2014 Consumer Confidence September 2014 92
10/1/2014 ADP Employment Change September 2014 202K
10/1/2014 ISM Index September 2014 58.5
10/2/2014 Initial Claims Previous Week 297K
10/2/2014 Continuing Claims Previous Week 2458K
10/3/2014 Nonfarm Payrolls September 2014 210K
10/3/2014 Nonfarm Private Payrolls September 2014 205K
10/3/2014 Unemployment Rate September 2014 6.10%
10/3/2014 ISM Services September 2014 58.9

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

 

This week starts out on Monday with the release of personal income and spending for the month of August, both of which are not expected to be much above zero. The markets will largely ignore these two releases unless something crazy happens with them. On Tuesday we start the potentially impactful releases of the week with the Chicago PMI and the Consumer Confidence Index, as measured by the government, both for the month of September. With expectations that both figures will have declined from the August levels it seems like the market has set a pretty low bar and could easily be surprised to the upside. On Wednesday, the first day on October, the first of the employment related figures is set to be released, that being the ADP Employment change figure for the month of September. Expectations are in the middle of the road on this one with the market looking for 202,000 new jobs during the month. The release will likely be very close to this if the past few months are any indication. Also released on Wednesday is the ISM Index for the month of September; with such strong performance on the index since the beginning of March it seems expectations may be a little low on this release as the various manufacturing data from different parts of the US for the same time period have been largely strong. On Thursday the standard weekly unemployment related figures are set to be released with expectations that both figures will have increased slightly over last weeks’ figures. On Friday there are several economic news releases that could impact the overall markets with the focus being on jobs. The official unemployment rate in the US during the month of September is set to be released with expectations of no change from the 6.1 percent we saw during August. As always the more important figures to watch are the nonfarm public and private payroll figures, both of which have lofty expectations after such poor numbers during August. Both figures expected to be about 100,000 jobs higher. If this comes true it would be likely that the unemployment rate in the US would move lower than the expected 6.1 percent. Wrapping up the week and largely going to be overshadowed by the unemployment information is the Services side of the ISM Index. As is typical, expectations are for about the same size movement relative to the overall ISM in August, but with services playing such a large role in the US economy we could see a bit of a reaction to this release if it is not as expected.

 

Fun fact of the week:

 

China is often considered the longest continuous civilization, with some historians marking 6000 B.C. as the dawn of Chinese civilization. It also has the world’s longest continuously used written language.

 

Source: Cotterell, Arthur. 2005. Ancient China

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

Commentary at a glance:

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

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

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

-Commodities all moved significantly lower last week.

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

 

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

4 charts 9-22-14

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

 

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

 

 

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

 

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

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

 

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

 

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

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Pharmaceuticals 2.60% Software -1.11%
Biotechnology 2.10% Networking Technology -0.48%
Broker Dealers 1.93% Real Estate -0.41%
Healthcare 1.91% Medical Devices -0.32%
Basic Materials 1.84% Natural resources -0.21%

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

 

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

 

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

 

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

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

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