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

Commentary at a glance:

-We thought summer was going to be boring!

-Two major international events drove the global financial markets.

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

-Earnings season is picking up steam.

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

 

Market Wrap-Up: Last week saw all three of the major US indexes move higher for the week, shrugging off two major international situations. This move higher was done on average one-year volume and indicates the staying power of these markets in the face of adversity. While none of the indexes technically broke out to the upside, it could have been a lot worse. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 7-21-14

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

 

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

 

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

 

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

Philly Fed 7-21-14

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

 

Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see, it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green. If a company was scheduled to report earnings, but pushed the release date back they are labeled “Pushed.”

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Healthcare Providers 2.46% Biotechnology -2.48%
Broker Dealers 2.23% Regional Banks -2.33%
Telecommunications 1.59% Home Construction -1.22%
Technology 1.49% Medical Devices -0.95%
Transportation 1.47% Pharmaceuticals -0.86%

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

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

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

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

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

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

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

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

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

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

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

 

We made no changes to our models during the week last week as there seemed to be many reactions in the market arising from the situations in Ukraine and Israel. We did, however, move closer to buying our first step of biotechnology as the sector fell by more than four percent. One aspect of the sector that makes me a little weary is the fact that it was called out by the Federal Reserve as a potential bubble. Any time the Fed makes an outright call on a sector of the financial markets it is worth taking a very hard look at the sector to see if there is any value. I do see value in the sector, just not at the current prices. I would rather buy in at a lower price and have a bit of wiggle room in case it moves lower than purchase now and have it decline further.

 

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

 

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

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

 

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

 

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

 

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

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

 

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

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

 

Commentary at a glance:

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

-The VIX finally moved off the floor.

-Fed minutes indicated October end to QE program.

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

 

Market Wrap-Up: Technically, we saw a few warning flags go up last week as traders returned from the holiday week and started to pull profits, thus pushing the markets lower. From a technical standpoint, the Dow looks the strongest and the NASDAQ and S&P 500 both look equally weak. Something to be a little concerned about that developed last week was a very large jump upward in the VIX, given such a small move in the overall markets. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 7-14-14

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

 

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

 

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

 

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

 

Below is a table of the better-known companies that released earnings last week and the amount by which they either exceeded or fell short of expectations. As you can see it was a pretty mixed bag of results last week. Negative earnings surprises are highlighted in red while positive surprises in excess of 10 percent are highlighted in green. If a company was scheduled to report earnings, but pushed the release date back, they are labeled “Pushed.”

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

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

 

We made no changes to our models over the course of the previous week as there continues to be a visible ebb and flow into and out of the types of investments we own. Stock that are financially sound and pay dividends move into and out of favor quickly in a market such as the one we currently find ourselves investing in. Last week they were in favor as investors dumped technology stocks and moved toward safety. Two weeks ago the safe stocks were very out of favor and were dumped in favor of the technology stocks. In a market environment such as this, investors need to look past the noise for the underlying changes being made at companies they own. The vast majority of the companies we own, for instance, have been performing very well from a business stand point in that they are building up their businesses at a time when others are struggling and positioning themselves to make it through any hardships that may come without significant troubles.

 

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

 

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

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

 

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

 

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

 

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

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

 

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

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

Second Quarter in Review: The second quarter of 2014 was pretty eventful and the market reacted differently than expected to many unfolding events. The main driving force behind the global financial markets continues to be central bankers as they enact various stages of quantitative easing. Here in the US the Federal Reserve is maintaining their program of tapering bond purchases by $10 billion per month, a program that started in January of this year. In Europe, European Central Bank (ECB) President Mario Draghi is still formulating how and when the ECB will start another round of quantitative easing, in this case called Outright Monetary Transactions (OMT). In Japan, an elusive third arrow of Abenomics is currently being concocted in an effort to finally pull the country out of the economic slide they have been in for the better part of 30 years. In Russia, the central bankers are trying to figure out what can be done to keep the Russian economy afloat as international sanctions against the country for its actions in Ukraine are starting to be felt. Through all of this, the global financial markets, for the most part, moved higher as investors cheered every step as financial progress.

 

Was the market movement during the second quarter really all that rational? Perhaps or perhaps not. Typically the market is “forward looking,” meaning the market takes into account all known information, looks ahead a few months and prices in various scenarios. One of the easiest ways to see this is to look at the VIX, which is a measure of fear in the markets. Despite all of the global events, the VIX near the end of the second quarter touched a low level not seen since early 2007. This was at the same time as the Dow and the S&P 500 were making all times highs, culminating with the Dow closing the quarter just shy of 17,000. Meanwhile, the economic data coming out during the second quarter (mostly about the first quarter) was decidedly poor, as illustrated by the dismal GDP print for the first quarter, which came in at -2.9 percent, signaling a contraction in overall gross domestic product. While it is true that the overall unemployment rate also came down during the quarter, the labor force participation rate moved lower as more and more workers simply dropped out of the working pool for one reason or another. Inflation, one of the two Federal Reserve mandates, remains in check in the US, but there are signs that it could start moving higher in the coming quarters, especially if the cost of energy keeps moving higher. One other aspect of the current markets that gives me pause is the fact that we have not had a correction of more than 10 percent on the Dow or the S&P 500 since the middle of 2011. Back then, one of the key driving forces behind the move in the market was the downgrade of the US credit rating, as well as unknown potential actions from the Federal Reserve in an attempt to put the financial system back on track. In total, it has been 2.86 years since a meaningful decline. This is a decline that historically happens once every 18 months. From a purely historical trading standpoint, it seems we could be on borrowed time. Through all of this, however, the financial markets persevered and moved higher in a somewhat lackadaisical fashion.

 

Looking ahead: In looking to what may come in the coming quarter and the rest of 2014, it is hard to see the financial markets continuing to move upward at the same pace they have been moving at for the first half of the year. If they were to continue the pace of the first half of the year, the Dow would end the year up around 6 percent, while the NASDAQ would be up 15 percent and the S&P 500 would turn in a gain of more than 17 percent. This, coming on the heels of the stellar year we saw in 2013 for the same three indexes. While such a move is not unprecedented, it has only historically happened during times of rapid expansion in the US economy. With so much of the expansion we have seen over the past few years being largely attributed to the Federal Reserve actions, and with those actions being wound down, it is hard to imagine that everything will continue to float higher. Even the Bank of International Settlements (BIS) called out the current situation, saying “it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally,” in their latest annual report. One of the main factors many professionals point to in order to explain why the markets are currently disconnected from the economy is the fact that retirees and savers alike are being punished by holding assets in savings accounts and fixed income, due to the abnormally low interest rates being paid on these financial instruments. This is very true as CD’s and savings accounts in particular are paying next to nothing. People who need current income have had to “stretch” into other investments to make up the difference of lost income. One area they have been moving into has been large blue chip stocks, such as the members of the Dow, since they can pick up on average a dividend yield of about 3 percent. I am sure these investors would rather be in the safety of US government bonds paying 3 percent, but these are just not to be found unless they lock up for an extended period of time. At some point when rates do “normalize” there will be a flight out of the equity dividend holdings and back into fixed income, but that is likely several years away and it will vary when investors make the switch based on personal preferences.

 

Going forward we will continue to allocate funds in our models to areas of the markets that look undervalued or like they can sustainably move higher in a reasonable market environment. Chasing after returns is a fool’s errand and does not consistently pay off in investing. While we were fairly conservatively allocated during much of the second quarter we still made a decent return. One area of the market that we have been lagging in is seen where “junk” investments thrive (i.e. companies with poor financial strength, pure speculation companies, and high yield bond spikes). These are merely trendy investments with “hot money” moving into and out of them with rapid succession. We own good, solid companies that will be around for a long time and will continue to pay their dividends on a regular basis. These companies will go in and out of the markets’ favor, but over the longer term there will be fewer large declines and the declines that do occur should be recovered in a timely fashion. I will close this letter with a quote that is fitting, given the level of greed that seems to currently exist in the markets. The quote is from Warren Buffett:

 

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”

 

 

Peter Johnson


 

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

 

Index 2nd Quarter 2014
VIX -16.64 %
NASDAQ 4.98 %
S&P 500 4.69 %
DJIA 2.24 %

 

Volume during the second quarter was pretty strong on the NASDAQ, about average on the S&P 500 and below average on the Dow. The quarterly volume on the Dow was so low that you have to go all of the way back to third quarter of 1999 to find a quarter with lower volume. We saw less than one quarter of the volume seen during the first quarter of 2009.

 

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

 

Index 2nd Quarter 2014
India Se SENSEX Index 13.52 %
Russia Capped Index 9.59 %
Taiwan Weighted Index 6.15 %

 

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

 

Index 2nd Quarter 2014
Australia All Ordinaries -0.39 %
France CAC-40 Index 0.71 %
Shanghai Se Composite Index 0.74 %

It is interesting that Russia went from the poorest performing global index during the first quarter of 2014 to the second best performing global index in the second quarter, despite Russia causing trouble in Eastern Europe.

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 second quarter 2014:

 

Style /  Market Cap Value Blend Growth
Large Cap 3.80 % 2.94 % 7.07 %
Mid Cap 5.43 % 4.45 % 3.39 %
Small Cap 3.42 % 3.39 % 2.55 %

The performance attribution of the style boxes really shows that there was a lack of clear leadership during the second quarter as growth saw the best performance in the large cap space, while value performed best in both mid and small cap.

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

 

Sector Change
Oil and Gas Exploration 14.11 %
Natural Resources 12.73 %
Energy 11.42 %
Biotechnology 8.73 %
Semiconductors 8.67 %

Much of the increase in oil, and subsequently oil stocks, came in the later part of the second quarter, due to fears of further sanctions against Russia compounded with fears of further deterioration of the situation in Iraq as ISIL made advances within the country.

 

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

 

Sector Change
Telecommunications -5.68 %
Broker-Dealers -2.44 %
Aerospace and Defense -1.21 %
Regional Banking -0.92 %
Financial Services -0.54 %

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

Commodities Change
GSCI Commodity Index 2.88 %
Silver 6.36 %
Copper 6.36 %
Gold 3.58 %
Oil 3.75 %

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

 

Fixed Income Change
20+ Year Treasuries 4.05 %
10-20 Year Treasuries 2.46 %
7-10 Year Treasuries 1.82 %
3-7 Year Treasuries 0.90 %
1-3 Year Treasuries 0.13 %
TIPS 2.91 %

Overall, there were very few sustained surprises during the second quarter. Perhaps the largest surprise remains the strength of bonds while they are facing almost certainly higher interest rates in the coming years. For some reason investors are still piling into the them and accepting absurdly low interest rates for the long term.

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

Commentary at a glance:

-US indexes pushed higher last week on employment news.

-VIX hit a new low for 2014.

-No major developments in any of the main geo-political risks currently affecting the markets

-Economic news releases last week, on the whole, came in above market expectations.

 

Market Wrap-Up: During the shortened trading week last week we saw the S&P 500 (upper left pane above) and the NASDAQ (lower left pane above) break out of their respective trading channels to the upside. While all positive breakouts are nice, I am discounting these breakouts slightly because they were done on such poor trading volume. The volume last week was very low, as expected given the shortened holiday trading week. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 7-7-14

As mentioned above, trading volume was not present in the markets last week with the slack being due to the much shortened trading week. Looking back at other Fourth of July holiday weeks, however, volume was about average for the week. One change in leadership took place last week as the NASDAQ now looks to be the strongest of the three major indexes as investors seemed to be stepping up the risk and pulling profits out of the less risky Dow components. The S&P 500 is now the second strongest index of the three major indexes with the Dow coming in third. It should be very interesting to see how next week plays out with traders returning to the office and making portfolio changes now that we are into the third quarter of the year. Risk seems to be telling a very interesting story right now as the VIX closed out the week at 10.32, the lowest level seen on the VIX since February of 2007.  Where do the markets go from here? From a purely technical standpoint it looks like there is room for the markets to move higher, but from a fundamental standpoint we are moving into a somewhat risky earnings season with a lot riding on positive earnings results from the majority of companies.

 

National News: National news last week was largely non-existent as it is a very common time of year for everyone to take some time off and enjoy the start of summer. Financial news seemed to focus on whether the Dow could finally push past the 17,000 level, something it had not done before. Sure enough, riding on the back of strong employment figures, the Dow did break though to the upside during the shortened trading session on Thursday. The S&P 500 also made new all time highs, but failed to make it to the psychological 2,000 level. With all of the talk about new highs being made, I looked back to see if this is a rare occurrence or if this is just a byproduct of a long term bull market.

 

So far during 2014 we have seen the S&P 500 make new highs 27 times, while the Dow has made new highs 14 times. Looking back to 1988, I found that the S&P 500 has on average experienced a “new all time high” 22 days per year, so we are above average there. The Dow, going back to 1988, has experienced a “new all time high” 19 days per year, so we are below average, but still pretty close. The NASDAQ, however, is the eye opener. It has experienced a “new all time high” on average 17 times per year since 1988 and so far during 2014 we have had zero days with new all time highs. In fact, we have not seen a new all time high on the NASDAAQ since the Technology bubble burst back in 2000. It has been 14 long years on the road toward recovery for the NASDAQ. For some perspective of just how bad the NASDAQ tumbled in the tech bubble, both the S&P 500 and the Dow recovered their losses from the tech bubble and made new all time highs in 2006, less than 6 full years from the top. So while it is nice to be making all time highs, it is not as big a deal as several commentators make it out to be, with one exception. When the NASDAQ finally makes a new all time high, it will be something to celebrate. With the NASDAQ being less than 10 percent away from its 2000 highs we could see this occur in the latter half of 2014, but I would not hold my breath waiting for it.

 

International News: International news last week saw very few new developments in any of the ongoing situations around the world that the global financial markets sporadically latch on to. One area of the world that did have a few developments was Israel and Palestine, as the violence between the two sides seems to have picked up in the last week with one American teenager being killed and another beaten by police. While there is little direct financial implication globally from Israel and Palestine fighting (they have been for many years), the real questions become who else will get involved (i.e. the US and Iran) and what would be a good outcome from the situation. We have already seen the US try to get involved in religious wars in the Middle East and the outcomes have been predominantly less than desirable in the medium to long term. Currently, the largest unknown that could affect the global markets remains the situation in Iraq as it could drastically affect the price of oil globally. Prices at the pump have been going up in recent weeks, explained in part by the situation in Iraq and in part by the start of the summer driving season. So far, while parts of Iraq have fallen to ISIL, they have by and large not been in parts of the country that are highly productive, instead consisting of small towns and nomadic lands. Baghdad and the south of Iraq is another story as these two regions are the financial heart and soul of the country and the largest oil producing areas within the country. With many of the global financial markets being propped up by central banks and slowly on the mend, it would not take much of an oil shock to derail some of the weaker economic recoveries we have been seeing around the world.

 

Market Statistics: Last week was a positive week for only one of the major indexes in the US, as both the Dow and the S&P 500 moved lower:

 

Index Change Volume
NASDAQ 2.00%
Dow 1.28%
S&P 500 1.25%

 

Volume last week was low on all three major indexes, largely attributed to the shortened trading 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 3.62% Utilities -3.21%
Semiconductors 3.46% Real Estate -0.42%
Materials 2.58% Aerospace and Defense -0.06%
Healthcare 2.26% Oil and Gas Exploration 0.03%
Broker-Dealers 2.16% Infrastructure 0.07%

The most interesting move of the week last week was the fall of Utilities, which for the first half of the year was up more than 18 percent. While everyone knew a selloff in the sector was likely, the speed with which it has happened is concerning. While declining for just three days is far too fast to be called a trend, it could be the start of deterioration in the group if the sector continues to slide next week, once trading is back to more normal levels.

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

Fixed Income Change
Long (20+ years) -2.26%
Middle (7-10 years) -1.04%
Short (less than 1 year) 0.00%
TIPS -1.07%

In currencies, the US dollar was up 0.23 percent against a basket of international currencies. The British Pound was the strongest currency of the week, gaining 0.70 percent against the US dollar, but volume overall was extremely low for the shortened trading week.

Commodities were mixed last week as metals performed well, while grains were the standout commodity that got hammered during the shortened trading week:

Metals Change Commodities Change
Gold 0.39% Oil -1.42%
Silver 0.59% Livestock 2.36%
Copper 3.88% Grains -6.47%
Agriculture -1.65%

The overall Goldman Sachs Commodity Index decreased by 1.70 percent. Oil traded lower last week as there were few new developments in Iraq and Russia that moved the price of oil.

Last week saw primarily positive performance when looking at the global financial markets with both emerging and developed markets experiencing gains. The best performance of the global indexes was in India with the Bombay based Se SENSEX Index gaining 2.88 percent. The worst performance last week was found in Brazil, for the second week in a row, with the Sao Paulo based Se BOVESPA Index gaining 0.60 percent.

With the markets moving higher last week during the shortened trading week it was not surprising to see the VIX move lower. What was surprising was the level the VIX moved down to. The VIX moved down last week to 10.32; this is the same VIX that started the year over 14 and hit a high of 21.5 during the first part of February. Since that high of 21.5, it has been all downhill for the VIX, save a few small one or two day spikes upward on mainly geo-political risks flaring up. When was the last time we saw a VIX reading this low? February 22nd of 2007, two days prior to a spike up to 18 in what turned out to be a chaotic march higher, culminating over 80 in late 2008. With the recent decline in the VIX it looks like the current fears in the markets are over blown, if the VIX is correct. But the VIX can be very finicky and moves in excess of 20 percent in a day are not unheard of, especially if the moves are originating near either extreme highs or lows. Given the current 10.32 level, the VIX is implying a move of less than three percent on the S&P 500 in the coming 30 days. As always, the direction of such moves is unknown.

For the shortened trading week ending on 7/3/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.06 % 2.25 %
Aggressive Benchmark 1.23 % 5.57 %
Growth Model -0.04 % 3.34 %
Growth Benchmark 0.94 % 4.36 %
Moderate Model -0.03 % 4.23 %
Moderate Benchmark 0.68 % 3.16 %
Income Model -0.09 % 4.98 %
Income Benchmark 0.35 % 1.65 %

*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 was an interesting week for our models as we saw some of our best performing individual stocks of the year (utilities) get hit hard by sellers on very low volume. While some of this may have been due to brokers window dressing accounts for the end of the quarter, it was unusual to not see purchases of the high flyers of the quarter. Other dividend paying companies also seemed to be unduly punished last week as there was a small flight toward risky assets. Over the course of the previous week we continued to step into the position we have been working on in Oil and Gas Exploration, as this is one of the strong sectors technically and one of the few sectors of the markets that could benefit from continued unrest in the Middle East and Ukraine. So far we have been stepping in on down days and are almost to a full position. If the reversal we saw last week lingers into next week we may be forced to back out of our position.

 

Economic News:  Last week was a shortened, but still important, week for economic news releases. In aggregate the economic news releases released last week came in above market expectations, with employment data being the highlight of the week:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 6/30/2014 Chicago PMI June 2014 62.6 61
Neutral 7/1/2014 ISM Index June 2014 55.3 55.8
Slightly Positive 7/2/2014 ADP Employment Change June 2014 281K 200K
Negative 7/2/2014 Factory Orders May 2014 -0.50% -0.40%
Slightly Positive 7/3/2014 Nonfarm Payrolls June 2014 288K 210K
Slightly Positive 7/3/2014 Nonfarm Private Payrolls June 2014 262K 213K
Slightly Positive 7/3/2014 Unemployment Rate June 2014 6.10% 6.30%
Neutral 7/3/2014 Initial Claims Previous Week 315K 315K
Neutral 7/3/2014 Continuing Claims Previous Week 2579K 2580K
Neutral 7/3/2014 ISM Services June 2014 56.0 56.5

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

 

Last week started out on Monday with the release of the Chicago PMI, which came in a little higher than expected, but not high enough for the market to really take notice; the key here was that it was better than expected and well above 50. On Tuesday the ISM Index for the month of June was released to show a reading of 55.3, very close to expectations of 55.8, but not a number that really shouts for a strong US economy. On Wednesday the ADP employment change index for June was released and showed a gain of 281,000 new jobs during the month. This was a bit better than expected and showed that the jobs market in the US is improving faster than some economists thought. Also released on Wednesday was the Factory Order data for the month of May, which showed that orders declined by half of a percent. This is a negative sign for the overall US economy because factory orders are typically a forward looking indicator, and this reading would mean slower demand in the near future. On Thursday the government released their latest report on Unemployment, which showed that the unemployment rate in the US declined from 6.3 down to 6.1 percent during the month of June. The markets cheered this release by pushing the Dow well over the 17,000 level for the first time ever. Even the underlying figures of the report look positive as the decline in the unemployment rate this time was not due to a decline in the labor force participation rate, but rather people really finding gainful employment. This was seen in the payroll figures also released on Thursday, which showed more than 250,000 jobs created in both the public and private sectors. Initial and continuing jobless claims were also released on Thursday, along with the ISM Services Index, but these releases were largely over shadowed by the Employment number and the early close for the Fourth of July Holiday.

 

This week has probably the fewest number of economic news releases of the year. The focus of the market will be on the meeting minutes of the Federal Reserve, which are set to be released on Wednesday. The economic news release that is potentially the most impactful is highlighted in green:

 

Date Release Release Range Market Expectation
7/9/2014 FOMC Minutes June Meeting -
7/10/2014 Initial Claims Previous Week 312K
7/10/2014 Continuing Claims Previous Week 2567K
7/10/2014 Wholesale Inventories May 2014 0.60%

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

 

This week’s economic news releases do not even start until the Federal Reserve’s meeting minutes from the June meeting are released on Wednesday. The minutes are not expected to hold much new information, other than perhaps providing a little color as to the discussion around when to increase interest rates. Even this is likely to be very vague with a few outspoken members of the Fed on both sides of the debate. With so many Fed member speeches having occurred since the meeting, including Chair Yellen’s press conference, it is very unlikely the market will react to whatever is in the meeting minutes. On Thursday the standard weekly jobless claims data is set to be released with expectations of little change over two weeks prior. Wrapping up the week on Thursday is the release of the wholesale inventories data for the month of May. While this release is typically largely ignored by the markets, the markets could watch this one a little closer than normal, given the negative impact on GDP in the first quarter which inventories made.

For a PDF version of the below commentary please click here Weekly Letter 6-30-2014

Commentary at a glance:

-Mixed week for US indexes as economic data was digested by the markets.

-GDP was how low?

-Iraq seems to be having less and less of an impact on the global financial markets.

-Russia continues to lose ties with western European countries.

-Economic news releases last week, on the whole, came in below expectations.

 

Market Wrap-Up: With what could be called a bump in the road last week with the GDP release, it was somewhat surprising that we did not see all of the three major US indexes turn in losses for the week. The NASDAQ managed to make it two weeks in a row of positive gains, while the S&P 500 and the Dow moved lower. Volume was strong on the NASDAQ and S&P 500, but weak on the Dow. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 6-30-14

This week I have redrawn the trading channels and adjusted the time frame of the charts above as we are very close to bringing this quarter to a close. As you can see above, all three of the major indexes are in an upward trending trading channel with the Dow (upper right pane above) currently having the widest channel. The S&P 500 (upper left pane above) is most at risk of breaking down below the trading channel and the NASDAQ (lower left pane above) continues to look like it wants to move higher. Last week is a good representation of the type of market we currently find ourselves investing in; the news was not positive, yet the markets by and large did not react negatively. The VIX actually moved lower (a sign that risk dissipated) on Wednesday, the day the poor GDP figure was released! For now it seems the markets will continue to bang around looking for direction as we move through the summer doldrums.

 

National News: National news last week was focused mainly on one thing and one thing only—the negative 2.9 percent change in GDP the US experienced during the first quarter of 2014. Below is a chart showing the change in GDP on a quarterly basis since the first quarter of 2009 with the data being pulled the Bureau of Economic Analysis (www.bea.gov):

GDP change 6-30-14

As you can see above, the -2.9 percent reading presented by the government on Wednesday last week is a bit nerve racking for the markets. Yes, the markets shrugged it off as the weather was to blame for the most part, but the swing is remarkable. The US economy went from growing at 2.6 percent down to contracting at 2.9 percent in the span of a quarter. The only other times we have seen such reversals in GDP were fourth quarter 2008 (when the economy was spiraling downward) and third quarter 2000 (when the dotcom bubble was popping). Other than these two times, you have to look all of the way back to 1981 to find a larger negative quarterly swing in GDP. In looking at the release, it looks like one of the big driving forces for the decline was the change in exports of goods and services, which declined by 8.9 percent during the first quarter after having increased by 9.5 percent during the fourth quarter of 2013. Private inventories were also partially to blame for the decrease in GDP as they increased by half of what they did during the fourth quarter of 2013. Personal consumption also saw lower growth across the board during the first quarter of 2014 when compared to the fourth quarter of 2013. All of these data points boiled down to a dismal first quarter of GDP in the US. So now the real question is; was all of the bad news due to the weather? While most everyone is saying the weather was the root cause of the issues with the first quarter, it seems highly unlikely that it was the only cause for weakness. The data that has most recently been coming out about the second quarter of 2014 shows some improvement for sure, but not enough improvement to justify seeing GDP rebound up to 3 or 4 percent during the quarter, by my estimation. It seems to me that spending has not gone up enough, and the pent up demand idea seems a little farfetched. US consumers did not eat out twice as much during the second quarter of the year to make up for lost meals during the first, nor did double up on their visits to various services areas, such as hair and nails. We would need to see the strongest recovery in quarterly GDP numbers since the fourth quarter of 2011 to get us back to even. To get to a positive 2 percent GDP growth, we would need to see the strongest quarterly recovery in GDP since the economy bottomed during the second quarter of 2009. Aside from the GDP numbers, the National news last week was focused on a number of Supreme Court decisions.

 

The US Supreme Court is set to end its current 2013-2014 session today, June 30th, and in doing so it released several interesting and potentially impactful decisions. One of the decisions last week pertained to cell phone searches by police and the new requirement for a warrant to do so. Another decision dealt with recess appointments and was seen as a blow to the current administration because the law now curbs the President’s ability to appoint people to senior government positions while the US Senate is in recess, bypassing the Senate vote. Other decisions that have come out so far from the court include: a ruling that says private companies will not have to comply with Obamacare if there are conflicts with their religious beliefs, that having people pay for streaming video of broadcast TV on the internet is illegal and that public sector unions can no longer force membership in the union. While none of these rulings have direct impact on many publically listed companies, there are a number of companies that could be making ancillary changes due to the rulings. The next Supreme Court session is scheduled to begin on September 29th.

 

International News: International news last week continued to focus on the Middle East and Russia. Iraq continued to be the focal point of international headlines last week as ISIL continued to make headway in many regions of the country in their push toward Baghdad. The US has sent 300 “military advisers” to Iraq in the past week, but they are there in non-combat roles, mainly helping with logistics and tactics for the Iraqi government to follow. The US is now flying armed drones over Baghdad, in an effort to be ready and able to protect our citizens and interests within the city. While it looks like the Iraqi army is growing in size, it may be too little too late as ISIL recently announced the creation of a Caliphate (new Islamic state). While there are no countries in the world recognizing this new state, it is one of the steps in the goal of ISIL in Iraq. If the current government allows, we could see parliamentary elections later this week, but it is questionable. Another interesting development in Iraq was the delivery of five second-hand Russia fighter jets to the Iraqi government, which they purchased for $500 million. This comes despite the US promise of 34 F-16 planes for the Iraqi government, which have been “held up” by various delivery delays. Russia seems to be playing either good cop or bad cop in most of the current global political situations, which is exactly what it wants.

 

Russia has returned to the Ukrainian border many of the troops that were pulled out just a few short weeks ago as a cease fire between Russian leaning rebels and the Ukrainian government seems to be crumbling. A trade deal may also have added fuel to the fire between Ukraine and Russia last week as the Association Agreement between Ukraine and the EU was finally signed. This trade deal was the same deal former Ukrainian President Yanukovych refused to sign 8 months ago, which led to the outbreak of unrest and his ultimate downfall. Other signatories of the agreement include Georgia and Moldova, both of which are actively trying to strengthen ties with the EU in order to be saved from the grip of Russia. While the deals will likely increase trade between the countries, there remains the issue of dependence from Russia’s energy supply, as most of the western European countries have few options other than paying Russia for its energy.

 

Market Statistics: Last week was a positive week for only one of the major indexes in the US, as both the Dow and the S&P 500 moved lower:

 

Index Change Volume
NASDAQ 0.68% +
S&P 500 -0.10% +
Dow -0.56% -

 

Volume last week was above average on both the NASDAQ and the S&P 500 and below average on the Dow. Only the NASDAQ managed to eke out a gain for the week.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Home Construction 2.07% Aerospace and Defense -2.57%
Utilities 1.01% Oil and Gas Exploration -2.37%
Consumer Services 0.54% Consumer Staples -2.33%
Software 0.44% Industrials -2.28%
Biotechnology 0.43% Energy -2.10%

Many of the sector moves last week seemed to have been driven by individual stock performance by a few key companies within each sector. For instance, the move in the Biotechnology sector was driven by the performance of Vertex Pharmaceuticals, the tenth largest Biotechnology company, which saw a gain of more than 44 percent last week on an FDA approval of a stage three drug.

Fixed-income investments were mixed last week as the global financial markets digested the dismal numbers from the US government on first quarter GDP:

Fixed Income Change
Long (20+ years) 1.29%
Middle (7-10 years) 0.70%
Short (less than 1 year) 0.02%
TIPS 0.64%

In currencies, the US dollar was down 0.47 percent against a basket of international currencies. The Canadian dollar was the strongest currency of the week, gaining 0.87 percent against the US dollar, with a lot of volume trading on the currency; this is the second week in a row that the Canadian Dollar has beaten the US dollar by more than three quarters of a percent.

Commodities were mixed last week as metals performed well and oil moved only slightly, given the situation unfolding in Iraq:

Metals Change Commodities Change
Gold 0.13% Oil -0.84%
Silver 0.70% Livestock 2.00%
Copper 1.95% Grains -0.93%
Agriculture 0.11%

The overall Goldman Sachs Commodity Index decreased by 0.55 percent, while the Dow Jones Commodity Index was down 0.48 percent for the week. Oil traded in a very tight trading range last week as the international community seems to be waiting for more solid information coming out of Iraq. Of particular interest is: which countries are helping out the Iraqi government (such as Russia supplying the Iraqi government with several fighter jets) and which are capable of carrying out bombing runs against insurgent positions? This capability was very limited for the Iraqi government prior to the jets and we will have to wait and see if this turns the tides.

Last week saw a mixture of positive and negative performance when looking at the global financial markets, with the split being between the developed and emerging markets. The best performance of the global indexes was in Russia with the Russian Capped index gaining 1.23 percent. The worst performance last week was found in Brazil with the Sao Paulo based Se BOVESPA Index giving up 2.71 percent.

With the mixed direction of the major indexes and the two larger indexes moving lower it was not surprising that the VIX moved higher by 3.78 percent over the course of the previous week. The majority of the upward move was done on Tuesday of last week with the other four trading days combined adding up to a decline. We remain at very low levels on the VIX, but as was pointed out to me at a conference last week, low levels of the VIX for extended periods of time are not unusual and can easily last for longer than a year.

For the trading week ending on 6/27/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week Year to Date
Aggressive Model -0.23 % 2.31 %
Aggressive Benchmark -0.28 % 4.29 %
Growth Model -0.29 % 3.38 %
Growth Benchmark -0.21 % 3.39 %
Moderate Model -0.21 % 4.26 %
Moderate Benchmark -0.16 % 2.46 %
Income Model -0.33 % 5.08 %
Income Benchmark -0.08 % 1.30 %

*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 no changes to our models over the course of the previous week, as the current very low volume environment has failed to produce any credible buying opportunities. As we move more and more into summer it seems the markets will continue to wander around looking for direction.

 

Economic News:  Last week was a typical summer week as far as the number of economic news releases; with the focus of the week being the final estimate of first quarter 2014 GDP. In aggregate, the economic news releases released last week came in below market expectations as the downward revision in GDP stole the spotlight of the week:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/23/2014 Existing Home Sales May 2014 4.89M 4.80M
Neutral 6/24/2014 Case-Shiller 20-city Index April 2014 10.80% 11.60%
Positive 6/24/2014 New Home Sales May 2014 504K 440K
Slightly Positive 6/24/2014 Consumer Confidence June 2014 85.2 84
Negative 6/25/2014 Durable Orders May 2014 -1.00% 0.40%
Neutral 6/25/2014 Durable Goods -ex transportation May 2014 -0.10% 0.40%
Negative 6/25/2014 GDP - Third Estimate Q1 2014 -2.90% -1.80%
Neutral 6/26/2014 Initial Claims Previous Week 312K 310K
Neutral 6/26/2014 Continuing Claims Previous Week 2571K 2588K
Neutral 6/26/2014 Personal Income May 2014 0.40% 0.40%
Slightly Negative 6/26/2014 Personal Spending May 2014 0.20% 0.40%
Neutral 6/27/2014 University of Michigan Consumer Sentiment June 2014 82.5 81.7

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

 

Last week started with an existing home sales figure that failed to impress the market, despite the figure being close to 5 million units, up from 4.6 million units in April. While the home builders seemed to move higher on the announcement, the overall markets did not budge. On Tuesday new home sales significantly beat market expectations, further adding to the rise of the US home building sector. On Wednesday the doozy of the week was released when the government’s third estimate of GDP for the first quarter of 2014 showed a decline of 2.9 percent. While nearly all economists anticipated that the GDP revision would be negative, most thought it would be near -1.8 percent and very few, if any, thought it would be under -2 percent. So the reading of -2.9 was a bit of a shock. As mentioned above, there were a number of reasons for the downward revision, but the markets shrugged off the news as “old news” and continued to push higher. Potentially more concerning and largely missed by the markets was the durable goods orders for the month of May, which were released the same time as the GDP print. Durable goods orders were shown to have declined by one percent during May, while Durable Goods orders excluding transportation fell by one tenth of a percent. While these figures can be very volatile month to month, we need all of the growth we can get in spending to turn around the negative GDP number from the first quarter to eke out a small gain in GDP for the first half of 2014. After the major miss on GDP, all other news last week seemed to be very minute in scale. Personal income and spending were both released on Thursday, with spending once again putting up a little caution flag as it rose by only half of expectations. Wrapping up the week was the release of the University of Michigan’s Consumer Sentiment Index for the month of June, which increased slightly for the final estimate of the month over the previous estimations.

 

This week is a shortened trading week due to the 4th of July holiday, so there is the standard amount of releases packed into just 4 days. This week the focus of the economic news releases will be on jobs. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
6/30/2014 Chicago PMI June 2014 61
7/1/2014 ISM Index June 2014 55.8
7/2/2014 ADP Employment Change June 2014 200K
7/2/2014 Factory Orders May 2014 -0.40%
7/3/2014 Nonfarm Payrolls June 2014 210K
7/3/2014 Nonfarm Private Payrolls June 2014 213K
7/3/2014 Unemployment Rate June 2014 6.30%
7/3/2014 Initial Claims Previous Week 315K
7/3/2014 Continuing Claims Previous Week 2580K
7/3/2014 ISM Services June 2014 56.5

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

 

This week starts off on Monday with the Chicago PMI. Expectations are for a 61 reading, but we need something a bit higher if the second quarter GDP numbers will dig out from the hole left by the first quarter. On Tuesday the ISM index for the month of June will be released. Much like the Chicago PMI on Monday, this release will need to be above the 55.8 expected reading if we are to see the second quarter GDP number print above 1 percent. On Wednesday the first of the employment related figures is released, that being the ADP employment change figure for the month of June, which is expected to show that 200,000 jobs were created during the month. This 200,000 level is a key level in that we have about 200,000 people entering the workforce in any given month. If we have job growth under 200,000 per month, all else equal, unemployment would go up. We really need something more on the order of 250,000 jobs created per month to make a meaningful dent in the overall unemployment rate. On Thursday all eyes will be on the overall unemployment rate in the US, which is being released by the government one day ahead of normal. Expectations are for no change from the 6.3 percent seen during May, but with how odd some of the numbers have been recently, we could see a wide deviation from this expectation. The market, however, will likely not react to this release as many of the traders who have the ability to move the market will not be in the office on Thursday ahead of the holiday. As always, the nonfarm public and private payroll figures will be more important to investors than the overall unemployment rate as they really tell more of the underlying story about where and what kind of jobs were created during the month. In the release of the unemployment rate the participation rate as well as the U-6 unemployment rate will also be closely watched by the market for any additional clues about the strength of the US economy. The week wraps up on Thursday with the release of the ISM Services Index for the month of June, which is expected to show that services grew at a faster pace than manufacturing during the month. This would be a positive development as a large percentage of the US economy is based on the services sector. Two speeches that will be watched by the market over the coming week include one by Secretary of the Treasury Jack Lew on Tuesday and one by Fed Chair Janet Yellen on Wednesday afternoon. While neither of these speeches is expected to hold any new information, the market likes to watch pretty closely to see if there is anything to read between the lines.

For a PDF version of the below commentary please click here Weekly Letter 6-23-2014

Commentary at a glance:

-All three of the major US indexes moved higher during the course of the previous week.

-NASDAQ has finally broken above its level seen back in March of 2014!

-Iraq seems to be falling further and further from peace.

-Fed Chair Janet Yellen has spoken—and said relatively nothing new.

-Economic news releases last week, on the whole, came in above expectations.

 

Market Wrap-Up: With positive manufacturing news, all three of the major US indexes pushed higher last week with the NASDAQ finally catching up to where it was back in early March. The move last week was done on high volume as investors seemed to take comfort in Federal Reserve Chair Janet Yellen’s comments on Wednesday.  Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 6-23-14

The S&P 500 (upper left pane above) remains the strongest of the three major indexes on a year to date basis, but the NASDAQ (lower left pane) is quickly making up lost ground. We saw new all time highs on both the S&P 500 and the Dow last week with both indexes closing out the week at new highs. The big story of the week last week was the fact that on Wednesday the NASDAQ, riding on the heels of the Fed statement, finally broke back above the high level seen back in early March of this year. For a little perspective on how long this breakout has been coming, it took the S&P and the Dow 25 and 27 days, respectively, to break out and from new highs after the meaningful declines seen earlier this year. The NASDAQ took a full 73 days to perform the same feat. Where might the markets go from here? While the NASDAQ has quickly closed the gap, it looks like it may have moved a little too far too fast and a small pull back at this point would not be the least bit surprising. The Dow and the S&P 500, on the other hand, have been building support and momentum over the past few weeks and doing so in a steady manor, so they could conceivably continue to move higher. One big wild card to all of this is the fact that Iraq looks like it could be getting itself into a long and drawn-out conflict, which could impact global oil prices and, in turn, consumer spending around the world. One measure of risk that does not seem to care much about the situation in Iraq is the VIX, which just last week plunged down to a multiyear low following Chair Yellen’s comments and several news stories about how the Iraqi army is regaining ground on the Islamic State in Iraq and Levant (ISIL).

 

International News: International news last week focused on the situation in Iraq as ISIL continued to make headway in many regions of the country in their push south towards Baghdad. While there are some reports out about the Iraqi army making tactical offensive strikes against the group, it still seems like the blitzkrieg the ISIL is operating is working. Last week we saw some of the more notable religious leaders take up the cause, urging many Iraqis to take up arms against the intruders with the main voice being that of Shiite cleric Muqtada al-Sadr, a man who was very outspoken against the US back in 2008. Even the Grand Ayatollah Ali al-Sistani threw his opinion into the fold in a rare political statement during which he called on current Prime Minister Maliki to reach out to the religious minorities to see if he can forge a diplomatic end of the escalating conflict. This call came on the heels of US President Obama calling for a diplomatic end to the fighting and making a pretty clear case that the current mess is the problem of the current Iraqi government and no one else. President Obama, however, did announce that he is sending 300 “military advisers” into Iraq as well as a few Special Forces teams that are tasked with protecting the US interests within the country. The US also now has both unmanned and manned aircraft in the air over Iraq 24 hours a day, gathering information about who and what the US should strike if we do get involved militarily in the current conflict. Most at risk in this environment is the global oil supply and prices. While a short term fluctuation in the oil production coming out of Iraq could be easily handled with the world’s oil stock piles, a long term conflict within Iraq, and in particular southern Iraq, could push the price of oil up meaningfully.

 

National News: National news last week was a buzz about the Federal Reserve rate statement and Fed Chair Yellen’s press conference, both of which occurred on Wednesday. The Fed statement on interest rates held almost nothing new as there were very few changes between the March statement and the current one. For a visual look at what actually changed in the statement, please see this link at the Wall Street Journal http://blogs.wsj.com/economics/2014/06/18/parsing-the-fed-how-the-statement-changed-39/  In a nut shell, the Fed kept the Tapering program on schedule (taking the bond buying down from $45 billion per month down to $35 billion per month), lowered their growth projections for the US and lowered their target Longer Run interest rate. The $10 billion cut in the tapering program was well telegraphed to the markets and came as no surprise to anyone watching the Fed. At the current run rate, the tapering program will likely draw to a close some time during the fourth quarter of 2014, at which time the markets will be watching for signs of when interest rates may start to rise. Based on the latest Fed statement the Fed funds rate is now expected to be 1.2 percent during 2015 and 2.5 percent by the end of 2016, as opposed to the March projections of 1.125 percent and 2.4 percent, respectively. But this was not what caught the attention of Wall Street. The attention grabbing was done by the downgrade of the US economic growth expectations for 2014. In the March projections GDP for 2014 was expected to grow between 2.8 and 3.0 percent, but in the latest projections these numbers have been revised down to between 2.1 and 2.3 percent growth. Much of the decline is being blamed on the greater than expected negative impact of weather on the US economy during the first quarter of the year. But there is more going on with the GDP figure than bad weather as there was one other very small change to the projections that seems to have been overlooked by the majority of Fed watchers. The longer run GDP figure for the US saw the lower end of its range lowered from 2.2 down to 2.1 percent, while the upper bound stayed the same at 2.3 percent. While a 0.1 percent decline in GDP may seem trivial, with the GDP figure above $16 trillion, that decline in growth of GDP is worth as much as $160 billion dollars per year, which is far from pocket change. The drop off is more than the total GDP of countries such as Romania, Vietnam and Hungary, according to the latest figures published by the World Bank. On a slightly more positive note, the unemployment rate projections were lowered for 2014 through 2015 as the US seems to slowly be getting back on track to full and normal employment. In the end, it would have been nice to get a little bit more clarity as to what Chair Yellen is thinking, but she did not give any more or any less than was expected; she has come a long way in a short amount of time in terms of her ability to utilize Fed speak.

 

Market Statistics: Last week was a positive week for the major indexes in the US, as all three indexes moved higher on strong volume:

Index Change Volume
S&P 500 1.38% ++
NASDAQ 1.33% +
Dow 1.02% +

 

For a summer week it is somewhat unusual to see such high volume and a price move greater than 1 percent on all three of the major US indexes.

 

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
Medical Devices 4.01% Telecommunications 0.04%
Biotechnology 3.25% Aero Space and Defense 0.36%
Pharmaceuticals 3.13% Technology 0.43%
Utilities 2.96% Financials 0.50%
Oil and Gas Exploration 2.89% Semiconductors 0.62%

One interesting sector last week was the Utilities sector, which saw the fourth best performance of the week despite it being one of the most defensive sectors of the financial markets. Some of this move was likely due to the continuing rise in the cost of energy as uncertainty over the situation in Iraq remains very high.

Fixed-income investments were mixed last week as the global financial markets continue to try to make sense of central bankers’ speeches around the world:

Fixed Income Change
Long (20+ years) -0.31%
Middle (7-10 years) -0.03%
Short (less than 1 year) -0.01%
TIPS 0.68%

In currencies, the US dollar was down 0.46 percent against a basket of international currencies. The Canadian dollar was the strongest currency of the week, gaining 0.90 percent against the US dollar with a lot of volume trading on the currency.

Commodities were mixed last week as metals performed well and oil moved a little:

Metals Change Commodities Change
Gold 2.88% Oil 0.12%
Silver 5.87% Livestock -0.90%
Copper 3.63% Grains 0.66%
Agriculture 0.29%

The overall Goldman Sachs Commodity Index increased by 1.30 percent, while the Dow Jones Commodity Index was up 1.32 percent for the week. Oil had a bit of a wild ride last week coming off the very large increase two weeks ago on the fighting in Iraq; it seemed to settle down a bit last week. Most of the downward move in oil was due to the US saying that it may take actions in Iraq to support the government, but this seems to be falling by the wayside as several religious leaders are now calling for a new government to replace the existing one in Iraq.

Last week saw a mixture of positive and negative performance when looking at the global financial markets, with the split being between the developed and emerging markets. The best performance of the global indexes was in the Netherlands with the Amsterdam index gaining 0.89 percent. The worst performance last week was found in China with the Shanghai based Se Composite Index giving up 2.13 percent.

Just when I thought the VIX was moving in the correct direction toward a higher and more reasonable level, the VIX reversed course and fell like a rock. Last week the VIX moved lower by 10.92 percent; much of the decline may be attributed to a decline of more than 12 percent on Wednesday last week following the press conference and interest rate announcement by Fed Chair Janet Yellen. With such a weekly decline we are now back at levels of the VIX not seen since February of 2007.  When looking at the current level of 10.85, the S&P 500 is expected to move by about 3.1 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 6/20/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week Year to Date
Aggressive Model 1.54 % 2.55 %
Aggressive Benchmark 0.89 % 4.59 %
Growth Model 1.34 % 3.69 %
Growth Benchmark 0.69 % 3.61 %
Moderate Model 1.12 % 4.49 %
Moderate Benchmark 0.50 % 2.62 %
Income Model 1.08 % 5.42 %
Income Benchmark 0.24 % 1.37 %

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

 

We made no changes to our models over the course of the previous week as many of our positions seem to be moving back into favor with the markets rotating around as they struggle for direction in this low volume environment. We continue to watch sectors of the market such as biotechnology and healthcare for an entry point, but they are currently trading in too wide of a trading range with volatility seemingly increasing within the sectors specifically.

 

Economic News:  Last week was a typical summer week as far as the number of economic news releases, with the focus of the week being US manufacturing. In aggregate the economic news releases released last week came in better than the market was expecting as several key manufacturing and business activity indexes beat expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Positive 6/16/2014 Empire Manufacturing June 2014 19.3 12.8
Slightly Positive 6/16/2014 NAHB Housing Market Index June 2014 49.00 46.00
Neutral 6/17/2014 Housing Starts May 2014 1001K 1028K
Slightly Negative 6/17/2014 Building Permits May 2014 991K 1050K
Neutral 6/17/2014 CPI May 2014 0.40% 0.20%
Neutral 6/17/2014 Core CPI May 2014 0.30% 0.20%
Neutral 6/19/2014 Initial Claims Previous Week 312K 313K
Neutral 6/19/2014 Continuing Claims Previous Week 2561K 2638K
Positive 6/19/2014 Philadelphia Fed June 2014 17.8 13.4

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

 

On Monday the 16th the Empire Manufacturing handedly beat market expectations, coming in at 19.3 versus expectations of only 12.8. The June reading of 19.3 was also an improvement from the May reading of 19.0. This is a positive development for the overall health of the US economy as the great New York area is a key geographic location for US manufacturing and many times is a leading indicator of future economic activity for the rest of the country. Adding to the positive news on Monday was the release of the NAHB Housing Market index for the month of June, which also beat expectations, but by a lesser amount than the manufacturing index. On Tuesday more housing related information was released with the Housing starts and building permit figures for the month of May. Housing starts came in very close to markets expectations while building permits left some to be desired. Also released on Tuesday was the Consumer Price Index (CPI) for the month of May, which indicated that prices rose at four tenths of one percent. While this was above expectations, it was not so fast as to warrant the Fed stepping in to stop inflation. The CPI will be very interesting to watch in June as we could see the result of rising gas and energy prices push the figure higher than 0.4 percent. On Thursday the standard weekly unemployment figures came in reasonably close to market expectations and were a non-market-moving event. Wrapping up the week on Thursday was the Philadelphia Fed’s Manufacturing Index, which, much like the Empire index earlier in the week, beat expectations and the May level of 15.4. With two strong manufacturing numbers in one week it was not surprising to see the financial indexes in the US advance as manufacturing is such a key component of growth within the US economy.

 

With the end of a month and a quarter quickly approaching, this week has several key economic news releases that could impact the overall movement of the markets. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
6/23/2014 Existing Home Sales May 2014 4.80M
6/24/2014 Case-Shiller 20-city Index April 2014 11.60%
6/24/2014 New Home Sales May 2014 440K
6/24/2014 Consumer Confidence June 2014 84
6/25/2014 Durable Orders May 2014 0.40%
6/25/2014 Durable Goods – transportation May 2014 0.40%
6/25/2014 GDP - Third Estimate Q1 2014 -1.80%
6/26/2014 Initial Claims Previous Week 310K
6/26/2014 Continuing Claims Previous Week 2588K
6/26/2014 Personal Income May 2014 0.40%
6/26/2014 Personal Spending May 2014 0.40%
6/27/2014 University of Michigan Consumer Sentiment Index June 2014 81.7

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

 

This week starts off on Monday with the release of existing home sales for the month of May, which is expected to be just shy of 5 million homes. Combine this release with the Case-Shiller index and new home sales, both released on Tuesday, and we should have a pretty good idea of the health of the US housing market. If all goes as planned we should see the US housing market slowly advancing as we move fully into the peak buying season in much of the country. One of the potentially most impactful releases of the week comes out on Tuesday, that being the Consumer Confidence Index for the month of June, which is expected to have increased by one point to 84. This seems pretty likely as the index loosely follows the University of Michigan’s Consumer Sentiment Index and all indications for that index are pointing to a slight increase during June. On Wednesday the Durable goods orders figure for the month of May is set to be released and expectations are for orders to have picked up at a four tenths of a percent pace. A reading this close to zero could go either way, with hopes that it will stay above zero, indicating that orders are increasing. Later during the day on Wednesday the potentially most impactful release of the week is released, that being the third estimate of GDP in the US during the first quarter of 2014. This release has been problematic the last two months with each estimate significantly missing expectations to the downside. It seems the market has caught on to this game as the average estimate now is for the revision to come in at -1.8 percent all of the way down from the -1 percent last month. This seems to be a scenario where a bar has been set so low that it would be very surprising if the reading was worse than -1.8 and not very surprising to see something better than -1.8 percent. On Thursday the standard weekly unemployment figures are set to be released with expectations of little change in either figure over the previous two weeks. Later during the day on Thursday personal income and spending are set to be released with both expected to be 0.4 percent. It would take a drastic deviation from expectations on these two releases for the market to take much notice, but stranger things have happened. On Friday the University of Michigan’s Consumer Sentiment Index (final estimate) for the month of June is set to be released and is expected to show a slight improvement over the second estimate, but still stay very close to 81.2. In addition to the scheduled releases we also have a few Federal Reserve Officials making speeches this week and Treasury secretary Jack Lew making a speech on Tuesday, which will be very closely watched by Wall Street.

For a PDF version of the below commentary please click here Weekly Letter 6-16-2014

Commentary at a glance:

-All three of the major US indexes moved lower during the course of the previous week.

-Instability in Iraq is starting to be felt in the markets.

-World Bank lowers 2014 global growth estimates.

-The Republican establishment took a major hit in the primaries.

-Economic news releases last week, on the whole, came in below expectations.

 

Market Wrap-Up: Last week started out with both the S&P 500 and the Dow making new all time highs on Monday. For the NASDAQ, last week was looking to be the week that finally saw the index break above its beginning of March high, but that was before some key data was released and the oil market jumped higher, both of which ultimately led to last week being a down week. Below are my standard charts with the key indexes represented by the green lines and the most recent trading channels or resistance levels on the three major indexes represented by the red lines:

4 charts 6-16-14

As you can see in the above charts, the markets rolled over a little last week, after a very strong move higher that started back in the middle of May. The S&P 500 (upper left pane) remains the strongest of the three major indexes as it is well above its most recent trading range, while the Dow (upper right pane) now finds itself in the middle of its most recent trading range. The NASDAQ (lower left pane) remains the laggard of the group as it failed to break out to a new high over the level seen at the end of February. With volume being so low it seems like last week’s rollover was more a function of investors taking some profits and adjusting their portfolios than the start of a more meaningful downward move in the markets. We did, however, see the VIX (lower right pane) move meaningfully higher, but this move seemed to be more about the situation unfolding in Iraq than fears about the future movements of the markets. At this point the market is likely to chop around, looking for direction until we get into earnings season for the second quarter, which is just a few short weeks away.

 

International News: International news last week was focused on two main items: the first being the continued and increasing unrest in Iraq and the second being the report released by the World Bank, in which they lowered the overall expected growth rate globally during 2014, in addition to numerous individual country downgrades. The situation in Iraq has been deteriorating for the past several months as a Sunni group known as the Islamic State in Iraq (ISIL), coming mainly out of northwestern Syria and northern Iraq, have advanced through the northern part of Iraq and is rapidly moving toward Baghdad and southern Iraq. So far ISIL has taken control of Mosul, Kirkuk, Tikrit (Saddam Hussein’s home town) and Tal Afar and are now less than 100 miles from Baghdad, which is the strong hold of the current Iraqi government. This situation puts the US in a very precarious position because within the last 12 months we have fully pulled out of Iraq at the request (and almost the boot) of the Iraqi Prime Minister Nouri Al-Maliki. The situation also continues a centuries old religious war between the Shia and the Sunni, a religious war the US does not want to get caught in the middle of trying to settle. Of more interest in this situation could be the unlikely friends that may come together to fight for Iraq. It is well known that Iran is not be a friend of the US, but it turns out Iran dislikes the Sunnis even more than the US. Iran has recently indicated that it will work with the US to try to stop the advance of ISIL in Iraq. How the two countries will work together remains to be seen, but it should be interesting to watch. Syria is also likely to get involved as it is the country with the largest Sunni population in the region, although the Syrian government is Shia. While the US may work with the government in Tehran, it is highly unlikely to get involved with Syrian President Assad as he is still in the middle of a civil war within his own country. With so many unknowns and players in Iraq, what is actually being done? So far, very little outside intervention is taking place in Iraq. President Obama gave a speech on Friday, calling on the Iraqi government to take action and saying the situation is their problem, not ours. But it seems very unlikely the Iraqi’s will be able to defend themselves against ISIL when the vast majority of the government forces laid down their arms and ran away when confronted by ISIL. Prime Minister Maliki has called on the US to launch air strikes against ISIL targets, but so far we have not obliged. The US has, however, positioned several naval ships in the gulf as a precursor to what may come if we do become involved. In an ironic twist, the US actually sent the air craft carrier George HW Bush to the Persian Gulf. What does all of this mean to the financial markets? Oil prices increasing.

 

Oil prices have been on a bit of a wild ride during the last week as WTI crude increased to a 9-month high and Brent crude moved over $112 per barrel. The entire oil move is on fears that Iraq’s southern oil fields could be disrupted by the fighting. Iraq is the second largest oil producer in OPEC, pumping 3.3 million barrels a day in May, according to the latest OPEC report. So far the insurgents only have control of one northern oil field that produces about 330,000 barrels of oil per day. While it is very unlikely the US and others would let the situation get so far out of hand that the Iraqi government would actually lose control of the southern oil fields, the markets seem to be pricing in the very slim chance that there could be major disruptions. While prices at the pump have started to increase and a $112 level is not a major concern, once the price of oil gets above $116 or $120, the global economy will start to feel the pinch. Airlines saw the most direct impact of the oil move last week with several of the major airlines such as Delta and American Airlines falling more than 7 percent during the course of the week. A rise in the overall cost of energy could put even further downward pressure on a global economy that is already showing signs of weakness.

 

Last week the World Bank released their latest report on expectations for the global economy, in which they lowered the developed world’s growth for 2014 from 5.3 percent back in January down to 4.8 percent. Overall growth for 2014 is expected to be 2.8 percent. A few of the more notable countries in the report include China (expected to grow at 7.4 percent), South America (overall growth will be 1.9 percent), Europe (2.4 percent), Russia (0.5 percent) and the Middle East (1.9 percent). Report author Andrew Burns identified energy bottlenecks and lower consumer spending as the main reasons for the downgrades; at least he didn’t blame the downgrades on the poor weather in the US during the first quarter!

 

National News: National news last week was all about a single primary Republican race that took place on Tuesday evening between House Majority Leader Eric Cantor and relatively unknown challenger Dave Brat, who is an economics professor at Randolph-Macon College in Virginia. Cantor thought he had a lock on the race and many people are saying he did not take the challenge seriously due to pollsters saying he was clearly going to win. But after all of the votes were counted, Cantor had 44 percent of the vote and Brat took 55 percent, making the outcome one of the largest upsets in a long time for House Republicans. Cantor was not alone in thinking Brat was not a viable opponent. The Tea Party thought he was such a long shot that even they did not back him. He spent about $213,000, much of it his own money, to fund his campaign while Cantor spent close to $6 million. In the end, money didn’t talk and Cantor is out. This presents a bit of a problem going forward for many Republicans thinking they are secure in their seat, as the Tea Party will now be trying harder than ever to unseat them. The most immediate impact of the election is being seen in the race for who is to become Speaker of the House after John Boehner. It was always thought that Eric Cantor would be the one to take over after Boehner departed. As for Eric Cantor, his time in the House is now complete, but it is unlikely that he will leave politics all together as he could easily run for Governor, the Senate or maybe even a higher office.

 

Market Statistics: Last week was a negative week for the major indexes in the US, as all three indexes moved lower on weak volume. The NASDAQ turned in the best performance, giving up 0.25 percent, while the S&P 500 came in second, losing 0.68 percent. The Dow turned in the lowest performance of the week, moving down 0.88 percent. Volume overall last week was above the past few weeks, but still very low compared to the average weekly volume we have seen over the past year. The best performing sector of the markets last week was the Oil and Gas Exploration sector, which gained 2.49 percent. The worst-performing equity sector last week was the Home Construction sector, with a decline of 2.81 percent over the course of the week as potential home buyers seem to be moving now rather than waiting for new homes to be built out of fear of rising mortgage rates.

Fixed-income investments were mixed last week as the global financial markets try to figure out what central banks will do in the near future. The long-end of the yield curve increased by 0.50 percent as the middle of the curve moved higher by 0.01 percent for the week. Short-term treasuries were flat for the week and TIPS (US government bonds linked to inflation) increased by 0.05 percent. In currencies, the US dollar was up 0.33 percent against a basket of international currencies. The British Pound was the strongest currency of the week, gaining almost a full percent against the US dollar with a lot of volume trading on the currency.

Commodities were mixed last week as oil moved higher on fears of further Iraq violence. The overall Goldman Sachs Commodity Index increased by 2.36 percent, while the Dow Jones Commodity Index was up 0.79 percent for the week. Oil moved higher by 4 percent during a week that saw a lot of trading. Metals were mixed last week as gold increased by 1.95 percent and silver moved higher by 3.50 percent. The more industrially used copper went down by 1.31 percent. Agriculture advanced last week 0.29 percent, while grains slid for a fifth week in a row, giving up 2.91 percent. Livestock jumped up 2.47 percent. With the decline last week, grains have now fallen more than 11 percent during the past 5 weeks in what has turned out to be a very sharp downturn.

Last week saw a mixture of positive and negative performances when looking at the global financial markets, with the split being about even between moving up and moving down. The best performance of the global indexes was in Brazil with the Sao Paulo based Se BOVESPA index gaining 3.16 percent. The worst performance last week was found in the UK with the FTSE 100 giving up 1.17 percent.

We finally saw the VIX move upward last week after touching a multiyear low two weeks ago. The weekly gain on the VIX last week was 13.5 percent, which was the largest gain since the beginning of April. Much of the move on the VIX is being blamed on the situation in Iraq, but I have a feeling that there was too much complacency being priced into the markets and the situation in Iraq was just the small catalyst the markets needed to adjust its thinking. At the current level of 12.18, the S&P 500 is expected to move by about 3.5 percent over the course of the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 6/12/2014, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week Year to Date
Aggressive Model -1.08 % 0.98 %
Aggressive Benchmark -0.29 % 3.67 %
Growth Model -0.88 % 2.31 %
Growth Benchmark -0.23 % 2.90 %
Moderate Model -0.75 % 3.33 %
Moderate Benchmark -0.16 % 2.11 %
Income Model -0.59 % 4.30 %
Income Benchmark -0.08 % 1.12 %

*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 change to our models over the course of the previous week. Last week we were watching our two new positions, transportation and global infrastructure, very closely to make sure we did not miss any sell signals, but none were tripped. With summer trading now taking hold of the markets, we will likely continue to see a choppy market as investors struggle to figure out the direction of the overall market. We will continue to watch for areas of the market that look cheaply priced and take advantage of such areas when they arise.

 

Economic News: Last week was a typical summer week with both employment and consumer related economic news releases. In aggregate the economic news releases that were released last week came in slightly worse than the market was expecting, with Retail sales providing the largest downward surprise:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/12/2014 Initial Claims Previous Week 317K 315K
Neutral 6/12/2014 Continuing Claims Previous Week 2614K 2638K
Negative 6/12/2014 Retail Sales May 2014 0.30% 0.70%
Neutral 6/12/2014 Retail Sales ex-auto May 2014 0.10% 0.40%
Neutral 6/12/2014 Business Inventories April 2014 0.60% 0.40%
Slightly Negative 6/13/2014 PPI May 2014 -0.20% 0.20%
Slightly Negative 6/13/2014 Core PPI May 2014 -0.10% 0.10%
Slightly Negative 6/13/2014 University of Michigan Consumer Sentiment Index June 2014 81.2 82.9

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

 

Last week started out on Thursday with the release of the standard weekly unemployment figures with both initial and continuing jobless claims coming in very close to market expectations. The negative news of the week, however, was released at the same time, that being the retail sales figure for the month of May, which was shown to have increased only 0.3 percent during the month. Retail sales growing at only 0.3 percent is very slow, especially if we are going to see the US grow by anything close to three percent for full year 2014. Even when auto sales were removed from the retail sales figures, sales were still very weak. It is this weakness that has some investors concerned that the high hopes for GDP growth in the second quarter may be a bit too lofty. On Friday we saw an interesting release out of the Producer Price Index (PPI) that showed that prices at the producer level declined by two tenths of a percent during May, this compared to expectations of a two tenths increase in prices. While two tenths of a percent decline may seem like a small number, the fact that it was negative should be a bit of a wakeup call to some economists that think the low level of interest rates being held by the Fed will lead to outright inflation in the US economy. However, it is likely that prices at the producer level will have increased noticeably during June if the price of energy, and oil specifically, keeps moving the way it has over the past week. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of June (first estimate); it came in a bit lower than the market was expecting. This lower reading on the sentiment index is much more in line with what we have been seeing on consumer spending and should give some pause to investors thinking the US consumer is strong and going to carry the US recovery forward at all cost.

 

This week is a typical summer week for economic news releases as there are a few releases that could impact the markets. The focus this week seems to be on manufacturing. The economic news releases that are potentially the most impactful are highlighted in green:

 

Date Release Release Range Market Expectation
6/16/2014 Empire Manufacturing June 2014 12.8
6/17/2014 Housing Starts May 2014 1028K
6/17/2014 Building Permits May 2014 1050K
6/17/2014 CPI May 2014 0.20%
6/17/2014 Core CPI May 2014 0.20%
6/19/2014 Initial Claims Previous Week 313K
6/19/2014 Continuing Claims Previous Week 2638K
6/19/2014 Philadelphia Fed June 2014 13.4

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

 

This week starts off on Monday with the release of the Empire Manufacturing Index for the month of June, which is expected to have fallen from 19 in May down to 12.8. While this decline may seem like a lot we are still working our way through the first few months of the year that were messed up due to weather, so anything is possible on this number. On Tuesday some housing related figures are set to be released with housing starts and building permits, both for the month of May, being released with expectations that both figures will be over 1 million units, but slightly lower than the April figures. These two releases would really have to miss to be noticed by the markets and that seems unlikely given the real estate market we have been seeing the past few months in a variety of cities around the country. Later during the day on Tuesday the Consumer Price Index for the month of May is set to be released and if it goes anything like the Producer Price Index last week, we could see a bit of a downward surprise on this release, but much like the producer price index we will likely see a jump higher in June due to the rising costs of energy. On Thursday the standard weekly unemployment related figures are set to be released with expectations that both figures will remain close to where they were last week. Wrapping up the week on Thursday is the release of the Philadelphia Fed’s business conditions index, which is expected to be slightly lower than it was in May, but not by enough to cause any alarm. In addition to the releases mentioned above, Fed Chair Janet Yellen will be releasing the latest rate decision on Wednesday as well as holding her monthly press conference, so the markets will likely be watching this very closely for any signals that interest rates may be on the rise sooner than expected.

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