For a PDF version of the below commentary please click here Weekly Letter 3-23-2015

 

Commentary at a glance:

-US markets rallied on the heels of the Fed statement.

-June, September or 2016: who cares when rates start to increase?

-Greece is once again making headlines as the country needs cash—fast!

-We continued to adjust our models for the given market environment.

-Economic data released last week came in much weaker than the markets had expected.

 

Market Wrap-Up: It looks like yet another “downturn” in the markets has been corrected as the markets last week followed through on a rally that started two weeks ago. The rally came on the heels of the Federal Reserve announcement in which Chair Yellen lost her patience with the word “patience” as to when interest rates will be increased. The charts below are of the three major US indexes in green with their respective wide trading ranges drawn by the red lines. The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 3-23-15

 

With the turnaround under way, the NASDAQ pushed higher at a faster rate than the other two major US indexes. It easily remains the most technically strong of the three major indexes, with the biggest driver of the index seemingly being its all time high level, which is now easily within reach. It has been a little over 15 years since the NASDAQ hit its all time high level (back in early 2000), and it now looks like it will make it to a new high early this week, barring something really changing the direction of the NASDAQ. While the NASDAQ is looking strong, the S&P 500 and Dow are significantly weaker, from a technical standpoint. The S&P 500 is a little stronger than the Dow, but it is a pretty tight race between second and third place. The next major points of resistance for the S&P 500 and the Dow will be the high points from the very first few trading days of March. If the indexes push through these levels, they could be setting up for a longer term run higher despite some of the uncertainties that seem to remain lurking in the shadows of the financial markets. One aspect of last week’s move that was encouraging is that volume picked up a bit, compared to the move down, which occurred over the previous 2 weeks. This seems to indicate that there was more participation in the markets on the way up than down; this sentiment is also echoed by the movement on the VIX. The VIX moved lower and is currently sitting near the lowest point we have seen so far during 2015. This level, however, is a little more than 20 percent above the low points we reached during 2014. Why all of the positive movement in the markets last week? It all had to do with just one thing: the policy statement from the Federal Reserve that was released on Wednesday afternoon.

 

National News: Heading into last week there was rampant speculation about a single word that could be absent from the FOMC statement released on Wednesday; that word was “patience.” Would Chair Yellen leave it in the statement, signaling that we were a few months or more away from the initial rise in interest rates, or would she remove it, signaling that rates would likely rise at the June meeting? True to her form and the form of past Federal Reserve chairs, Chair Yellen did remove the word “patience,” while at the same time adding the word “impatient” to the statement. Previously she has said that removing the word does not mean that a rate hike was imminent, but the market seemed to run with its removal as indicating that rates would go up in June. In order to dampen the effect of this, she added that while “patience” had been removed, the Fed was not getting impatient and would still be data dependant on when to raise rates. What data is the Fed looking at and how will the data be interpreted? These are the million dollar questions. The Fed has outlined the indicators being considered several times, but knowing what key levels and trends the Fed is looking for is the realm of speculation. The strength of the US dollar was mentioned in Chair Yellen’s statement and her mention of it caused a massive sell off in the US dollar, triggering one of the largest intraday moves we have seen on the dollar in a number of years.

 

The labor market is one of the dual mandates of the Fed and is weighing heavily on the decision concerning when to increase rates. The official unemployment rate in the US has been steadily coming down and has actually moved under the initial target level set by Chairman Bernanke at the end of his term. But the official unemployment rate only tells part of the story. The U6 unemployment rate is worse, with the latest figure being 11.0 percent. The labor force participation rate has also been coming down and, potentially the most important, wage inflation is still not picking up. Typically, wages increase and, with the increase, more and more people look for and find jobs. However, this time around wages have not gone up. In fact, wages have pushed lower, making it very hard to decipher which signals are true and which may not be correct about the labor market. The second aspect to the Fed’s dual mandate is price stability and this too is causing the Fed a little pause. Prices in the US have been rising, but they have been rising at a very slow pace. Typically, the Fed would like to see inflation running at about 2 percent annually. The US economy, however, has been running an inflation rate under 2 percent since 2012 and the first print according to the Bureau of Labor and Statistics was that prices actually declined by one tenth of a percent during January of this year (this is the latest data point). Much of the decline in price inflation has been due to the drop in energy costs as it seems almost everything else is increasing in cost. The conundrum the Fed faces is that if the Fed wants to increase prices it would typically cut rates, but we are at the lower bound of interest rates already. If prices were running away to the up side (i.e. inflation was running away), the Fed would raise rates to help combat this; but this is just not the case right now. In the end, with the Fed being data dependent, it looks like September is the most likely meeting at which the Fed will start to raise interest rates and the rates will likely move by 0.25 percent. The bottom line is that rates will rise; they have to so the Fed has the ability to act rationally should economic hardship once again come upon the US economy. With its back against the wall with the rate being down at zero, the Fed would have to immediately jump to unusual measures to help the economy if things were to turn bad for the economy. Getting rates moving upward to something at or above 1 percent is very positive, providing the Fed with the space and ability to act should it need to in the future.

 

Earnings season officially wrapped up for the fourth quarter of 2014 last week. Below is the final table for the fourth quarter of 2014 of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Adobe Systems 0% General Mills 4% Oracle 2%
Darden Restaurants 18% GUESS 9% Shoe Carnival 67%
DSW 30% KB Home 250% Tiffany & Co 1%
FedEx 7% Nike 6% Williams-Sonoma 1%

 

Retailers were under the spotlight last week as their earnings were trickling in. Shoes had a great quarter, evidenced by both DSW and Shoe Carnival easily beating market expectations. KB Home, one of the largest home builders in the US, released great earnings last week, although the future is less certain thanks to the prospects of higher interest rates at the end of the year. Darden also made a few headlines as the restaurant chain operator seems to have finally started to turn around Olive Garden across the US.

 

International News: Will Greece receive the money? Will Greece be able to pay its bills today, tomorrow, next week, next month? These are all questions investors and economists alike have been asking about Greece over the past few years. These questions persisted through four different governments in Greece, each one vowing to change what the previous government did before them and each one failing miserably. Last week Greece found about 2 billion Euros at the end of the week to make loan payments rather than default. This week the heads of Greece are in various places in Europe pleading their cases for more bailout funds. Europe is beginning to tire of these shenanigans as the proposals Greece has put forward under the current government have been full of holes and appear to have been written up by amateur economists. How are the financial markets taking all of this? The financial markets have largely been ignoring what Greece has been up to. One can only cry wolf so many times before the cry falls on deaf ears. So with the odds of Greece leaving the Euro and Euro zone increasing (in some cases having recently moved over 50 percent), according to a lot of financial people, the markets seem to be taking a whole different approach to thinking about such an action. Pertaining to the strength of the Euro, if the weakest member of the Euro were to leave, that would inherently increase the value of the Euro. The thought and fear of contagion seems to be lessening as the rest of Europe could easily help the other weak members, Italy and Spain, if Greece no longer had to be supported by Europe. It will be touch and go between Greece and the rest of Europe over the next few weeks and it seems the markets will start to take more notice as Greece’s cash stock pile dwindles. While Europe is still working through the situation in Greece, other developments were being made in Asia.

 

Asia has largely stayed out of the news recently as Russia, Ukraine and Europe seemed to garner the most headlines. However, last week Asia made a few headlines with the Asian Infrastructure Investment Bank (AIIB) getting some major international support. The AIIB is a large multinational bank that will likely rival the World Bank and the IMF in the future and is run by and largely funded by China. The US has long been against the AIIB gaining support, but last week France, Germany and Italy all signed up to be a part of the bank, following the UK joining two weeks ago. Many people view the move by the Europeans to back the bank as a major snub to the US, but it makes sense for Europe to try to align with Asia as that is the region of the world that will likely experience the most growth over the coming decades as their economies far surpass the size and impact of the US. Why is the US not supporting the AIIB? It would remove some of the power of the World Bank, which is nearly fully funded by the US and almost always takes actions that help the US agenda. As China and Asia come to economic power, there will likely be more little spats between Asia and the US. The collateral damages in partnerships and agreements between countries could really start to mount, leading us into a very uncertain time for the global economy.

 

Market Statistics:

Index Change Volume
NASDAQ 3.17% Above Average
S&P 500 2.66% Way Above Average
Dow 2.13% Way Above Average

 

With the Fed replacing the word “patience” with the words “not being impatient,” the US financial markets took this as a positive sign that rates are more likely to start moving up in September, rather than June. With prevailing thoughts of rates staying low a little longer, the “risk on trade” was under way with investors rushing toward technology related names and pushing the NASDAQ to being the best performing index of the week. Volume was high last week, but that could have had more to do with the quadruple witching falling on last Friday than anything else.

 

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 6.14% Basic Materials -0.45%
Residential Real Estate 6.10% Broker Dealers 0.93%
Infrastructure 4.81% Financial Services 1.11%
Utilities 4.66% Insurance 1.86%
Healthcare 4.57% Technology 2.09%

Biotechnology was the top performing sector of the markets last week, a spot it has grown accustomed to over the past few months. Other areas of the market that saw strength were all related to the Fed statement on interest rates most likely not increasing until September and included sectors such as Utilities and Real Estate. Infrastructure was an interesting sector last week as it was one of the top performing sectors; this is a rare occurrence. Most likely, Infrastructure was up because of the news about the Asian Infrastructure Bank being set up by China. On the flip side, Materials continues to struggle as it was the sole sector that moved lower during the course of the week as global demand remains uncertain.

Fixed income has been on a very wild ride since the end of January as investors attempt to guess when the Fed will start to increase interest rates. After last week’s announcement it looks like September is the odds on favorite for the first increase:

Fixed Income Change
Long (20+ years) 3.78%
Middle (7-10 years) 1.64%
Short (less than 1 year) -0.01%
TIPS 2.02%

With the implication that rates are unlikely to start to increase in June, the US fixed income market saw a continuation of the upward move that started two weeks ago. The US dollar reversed course last week and pushed lower after touching multiple year highs against a few currencies two weeks ago. There is a lot of speculation about why the dollar moved lower last week, but one of the strongest thoughts is that with options expiring on Friday last week, some people had to “sell” to close their position to book such large gains. Whatever the reason, the US dollar did not have a good week last week, falling 2.53 percent against a basket of international currencies. The strongest of the major global currencies last week was the Swiss Franc as it gained 3.05 percent against the US dollar. The weakest of the major global currencies last week was the Japanese Yen as it gained only 1.15 percent against the value of the US dollar as weakness looks like it will continue for the island country. Last week was the first pull back we have seen on the US dollar in a long time, so we will have to watch closely to see if this is the start of a trend or if it was just an isolated event.

It was finally time for commodities to move higher after being significantly beaten down over the course of the past few months. It has been very rare for us to see all of the commodities listed below gain during any single week:

Metals Change Commodities Change
Gold 2.43% Oil 3.86%
Silver 7.38% Livestock 1.80%
Copper 3.25% Grains 2.08%
Agriculture 2.17%

The overall Goldman Sachs Commodity Index turned in a gain of 0.98 percent last week as it bounced off the lowest point we have seen so far during 2015. Oil continued its very unusual and wild ride last week after falling nearly 10 percent two weeks ago. It was the bull’s turn last week, pushing the black gold higher by almost four percent.  All of the publically traded metals gained in value last week with Silver being the top performer, gaining more than seven percent, while the more industrially used Copper advanced 3.25 percent and Gold brought up the rear, gaining only 2.43 percent. The soft commodities also had a good week last week gaining across the board, with Agriculture in general gaining more than two percent. Much of the moves in the commodities last week probably had more to do with the decline in the US dollar than anything else, but it is still nice to see some of them increase from the abnormally low levels they have been trading near for the past month.

On the international front last week China saw the best performance of the week with the Shanghai based Se Composite Index gaining 7.25 percent. India turned in the worst performance of the week last week, being the only major global index to post a decline. The Bombay based Se SENSEX index declined by 0.85 percent over the course of the week. Overall, the Indian stock market has been performing very well since Narendra Modi took over as Prime Minster for the country back in May of 2014.

After being up for the previous two weeks in a row it only seems right that the VIX gave back all of its increase in just one short week last week. Last week the VIX closed almost exactly at the lowest level we have seen so far this year, tumbling down by almost 20 percent. During the month of March we have now seen the VIX fall from nearly 17 all of the way down to 13; this means the markets do not seem worried about the unknowns of the markets: the situation in Europe, the potential move in rates by the Fed or anything else that most economists point to as uncertainty on the horizon. The VIX is telling investors that everything will be fine and that it will be relatively smooth sailing from here. I am not sure I fully believe the VIX at this low of a level given what is going on, but the VIX is what it is. At the current level of 13.02 the VIX is implying a move of 3.76 percent over the course of the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 3/20/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 2.57 % 3.05 %
Aggressive Benchmark 2.86 % 3.20 %
Growth Model 1.93 % 1.88 %
Growth Benchmark 2.22  % 2.52 %
Moderate Model 1.31 % 0.87 %
Moderate Benchmark 1.59 % 1.82 %
Income Model 1.14 % 0.71 %
Income Benchmark 0.79 % 0.95 %

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

 

We made a few changes to our models over the course of the previous week. The major changes were that we put some of the cash we had been holding to work. We purchased an additional step into our healthcare position, in addition to adding a first step into the pharmaceuticals sector. We also added to our position in the US dollar as we continue to think this position will pay very well as the uncertainty surrounding Europe will likely only grow and the US remains well ahead of the majority of the world in its monetary actions; we are about to increase rates whereas nearly everyone else is still in easing mode. While we still have some cash on the sidelines, we are participating in a large percentage of the market upside over the course of the previous week and continue to look for investment opportunities.

 

Economic News:  Last week was a slow week for economic news releases, but for the second week in a row nearly everything that came out was negative. There were two releases that significantly missed expectations, highlighted below in red, and none that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Negative 3/16/2015 Empire Manufacturing March 2014 6.9 8.8
Slightly Negative 3/16/2015 NAHB Housing Market Index March 2014 53 56
Neutral 3/17/2015 Building Permits February 2014 1092K 1070K
Slightly Negative 3/17/2015 Housing Starts February 2014 897K 1041K
Neutral 3/19/2015 Initial Claims Previous Week 291K 293K
Neutral 3/19/2015 Continuing Claims Previous Week 2417K 2415K
Negative 3/19/2015 Philadelphia Fed March 2014 5 6.9

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

 

Last week started out on Monday with the release of a poor reading from the Empire Manufacturing Index, which slowed down during the month of March. While manufacturing still expanded during the month it did so at a slower rate than was expected. This was the third month in a row of steady declines in the index, starting what looks to be a troubling trend. Also released on Monday was the NAHB Housing Market Index, which came in at 53, while the market had been expecting 56. The index rates the relative level of current single home sales with a 50 reading being the middle of the road. Anything above 50 is a positive outlook, while anything below 50 is a negative outlook. So while a reading of 53 is positive, it is less positive than it was during February. On Tuesday building permits came in better than expected, while housing starts missed expectations due to poor weather in the north east. On Thursday both standard weekly unemployment related figures came in very close to market expectations and were therefore non market moving events. The week wrapped up on Thursday with a negative reading on the Philadelphia Fed Index as the print came in at 5.0, while the market had been expecting 6.9. Much like the Empire index earlier during the week, manufacturing was growing in the greater Philly area, but doing so at a slower rate than during February. Unlike the Empire index, the Philly index has now been slowing down for five months in a row. With a slowdown in manufacturing being seen in several different regions, the US economy appears to be not quite as strong as many economists would have liked given the economic recovery we have seen over the past few years. This also leaves the Fed in an even more precarious position as raising rates may hurt the economy if we are not growing above the stall speed for the economy.

 

This week is an average week for economic news releases with the releases spread out over the full trading week. The releases highlighted below have the potential to move the overall markets on the day they are released:

 

Date Release Release Range Market Expectation
3/23/2015 Existing Home Sales February 2015 4.90M
3/24/2015 CPI February 2015 0.20%
3/24/2015 Core CPI February 2015 0.10%
3/24/2015 New Home Sales February 2015 470K
3/25/2015 Durable Orders February 2015 0.50%
3/25/2015 Durable Goods -ex transportation February 2015 0.30%
3/26/2015 Initial Claims Previous Week 293K
3/26/2015 Continuing Claims Previous Week 2425K
3/27/2015 GDP – Third Estimate Q4 2014 2.40%
3/27/2015 University of Michigan Consumer Sentiment March 2015 92.0

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

 

This week starts off on Monday with the release of the existing homes sales figure for the month of February; expectations for this release are pretty high with the expected number being close to 5 million units. One has to wonder if the same bad weather that hurt some of the housing numbers last week will have an adverse effect on existing home sales as well. On Tuesday the Consumer Price Index (CPI) is set to be released and this will be an unusually important release as the Fed will likely be watching very closely and the figure may play into when the Fed starts to increase interest rates. The higher this number is the sooner the Fed will likely raise interest rates if everything else was equal. Also released on Tuesday is the new Home Sales figure for the month of February. This release, like the existing home sales figure, is at risk of being lower than expected due to weather. On Wednesday one of the very important releases of the week is set to be released with the durable goods orders for the month of February being reported. Expectations are for overall orders growth of 0.5 percent, while orders excluding transportation are expected to increase by 0.3 percent. Both of these numbers seem a little high given the negative tint we have been seeing recently in order economic news releases. If these two numbers come in negative it would be a bad sign for the US economy, but this in turn may lead to the markets moving higher as it would likely make the markets think the Fed will raise rates later during the year. On Thursday the standard weekly employment related figures are set to be released with expectations of both figures being slightly higher than they were last week. On Friday the key release of the week is set to be released, that being the third and final estimate of fourth quarter GDP in the US as measured by the US government. After a large downward revision for the second estimate of this figure, the market is expecting this release to claw back some of what was given up with the last revision, with overall GDP for the fourth quarter to be increased from 2.2 percent up to 2.4 percent. If this figure misses it will likely lead to increased market volatility, but there is no certainty in the direction the market would move. Much like the durable goods orders and the CPI numbers, bad news seems to be taken as positive by these markets, while good news may have the opposite impact. Wrapping up the week this week is the University of Michigan’s Consumer Sentiment Index, which is expected to show little change over the mid-month reading just two weeks ago. If we see a large drop off in this figure it would be negative, but that is highly unlikely. Overall, the scheduled economic news releases are likely to be overshadowed this week by what happens in Greece with the international lenders as the country struggles to find the money to pay its bills.

 

Fun fact of the week—How many times has the Fed increased interest rates?

 

With all of this talk about an interest rate hike I decided to pull the data and look at how many times the Federal Reserve has increased interest rates.

 

Since 1971 there have been 134 individual interest rate increases in the Fed Funds rate with the largest single day move being a 2.5 percent increase in late October of 1979, pushing rates up to 15 ½ percent.

 

Data Source: Federal Reserve Bank of New York http://www.Newyorkfed.org

 

For a PDF version of the below commentary please click here Weekly Letter 3-16-2015

Commentary at a glance:

-US markets continued lower on Fed speculation.

-The US dollar continues to strengthen.

-Russian President Putin missing for 10 days?

-We adjusted several positions in our models to take advantage of the current market environment.

-Economic data released last week came in much weaker than the markets expected.

 

Market Wrap-Up: With the markets having sustained a bit of a down trend over the past few weeks I have redrawn the key levels on two of the three charts. I had to move away from the trading channels on both the S&P 500 and the Dow since they both broke these levels, and by such a large amount. The charts below are of the three major US indexes in green with their respective key levels drawn by the red lines. The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 3-16-15

On the S&P 500 chart (upper left pane above) I have drawn two key support levels; both of these are based on previous support levels. The first support level is relatively close to current levels, only about 0.65 percent below the closing price on Friday. The second red line that is much lower than the current level is an area the market has tested before back in January—the psychological 2,000 level on the index. This level is about 2.6 percent below the current level of the index. I redrew the red lines on the Dow (upper right pane) above as well and, much like the S&P 500, the levels are just below current levels, about 2 percent below current levels, and then a red line at the bottom of the chart is the 17,000 level, a third significant level of support should the markets really start to move lower. While I was outlining the downside for both the S&P 500 and the Dow I noticed the NASDAQ (lower left pane above) has once again moved into a trading channel that is actually the inverse of the old trading channel from before. If you look at the chart, the two red lines crossed over each other back in early March, thus the support and resistance levels of the past trading channel flipped. The upper red line currently is now a resistance level, while the lower red line is a support level. In less than a month we have already seen both levels be tested as the index is now moving in the middle of the new trading range. From a technical standpoint, the NASDAQ remains the strongest of the three major indexes, while the S&P 500 and the Dow are equally weak. The weakness of the indexes, however, did not translate into a big jump in the VIX last week or really over the recent downward trend as it seems the larger institutional investors are not actively adjusting their portfolios. These larger institutions are the managers who typically use options in large numbers and options are what drive the level of the VIX, so it seems the recent moves in the markets have been smaller investors adjusting positions rather than institutional investors. At this point it looks like the markets will be perfectly content just banging around on the news of the day as investors try to time the first Fed rate hike and attempt to be just barely in front of the announcement.

 

National News: Last week the national news focused on two main topics: the standby “when will the fed raise interest rates?” and the strength of the US dollar. With the latest economic news releases seeming to show that there is a little more weakness in the data than the Fed probably would like, in things such as retail sales and consumer sentiment, these fears are being offset by the falling prices being seen at both the consumer and producer levels as well as the currently healthy jobs market in the US. With such large factors in the health of the US economy seemingly opposed to each other it makes the Fed’s dual mandate very hard to implement as the “price stability” piece would say raise rates, while the “full employment” piece seems to be saying that it may be a little early. The Fed will likely increase rates this year and, in doing so, will start what is likely to be a long term trend toward interest rate normalization. The bets as to when the first of the rate hikes will occur are still very split with the  odds of June and odds of September being roughly split. We are starting to see adjustments in the market to a rising rate environment and have actively started to adjust our positioning for the event; last week we sold one of our utility holdings that seemed to be the most at risk to rising interest rates. While speculation was going on about the Fed, speculation was also running rampant about the US dollar.

 

The US dollar has been doing very little other than moving higher over the past few months as international investors seem to be fleeing their local currencies in favor of holding dollars. The chart below depicts the movements of the US dollar against a basket of international currencies going all of the way back to 2007:

Dollar bull 3-16-15

As you can clearly see, the Dollar has been moving in a near vertical fashion so far during 2015 and has been on a very steep trajectory since the middle of 2014. So the big question becomes: can this movement continue? I think the dollar still has some room to move higher for several reasons; the first being the US economy. Yes, it may not be as strong as many investors would like it to be, but it is a lot better than most of the rest of the world. Europe is just now starting to take drastic means to try to save its economy. These measures will take years to implement and may not work. Japan is still trying to fix its economy and has been doing so for the better part of the last 30 years. China, while still the largest buyer of US debt, has enough of its own internal problems to fix that it cannot focus much of its attention on the value of the Yuan. Other commodity rich countries like Australia, Canada and Brazil have all see their currencies fall as commodity prices have plummeted and this looks to be a longer term trend, not a short term blip at this point. Finally, the Swiss Franc fell from its status as a “safe haven” currency just a few short months ago when the Swiss removed the peg, to the detriment of many traders and hedge funds that were counting on that peg staying in place and leveraging the trades accordingly. So where else can people or corporations realistically put earnings so they do not see their buying power eroded over time? The US dollar really is a sort of best house in Detroit scenario, as there are few other viable options.

 

Earnings season is almost officially finished for the fourth quarter of 2014, but that does not stop the stragglers from continuing to trickle in. Being so close to the end of earnings season for the fourth quarter of 2014, the table of companies that released earnings has continually shrunk week to week. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Barnes & Noble -22% Krispy Kreme 0% Ulta Salon 7%
Buckle 1% Men’s Wearhouse 57% Urban Outfitters 5%
Dollar General 0% Revlon 0% Vail Resorts 35%
El Pollo Loco 0% Rosetta Stone -6% Williams-Sonoma pushed
Express 7% Shake Shack 67% Zoe’s Kitchen 0%
Kirkland’s 0% Stein Mart 0% Zumiez 0%

 

An interesting aspect to the companies and figures listed above is that there are a large number of them that show zero, meaning they hit market expectations exactly with their announcements. These companies are reporting very late so there are numerous comparable stores and companies that have already released their earnings, so perhaps the analysts really have fine tuned their expectations, but this still seems like an odd phenomenon. One local company had a good fourth quarter earnings season and that was Vail Resorts, but it looks like the first quarter of 2015 may be a little more difficult for them given the lack of snow for much of the quarter. Shake Shack made headlines last week as the company beat market expectations on earnings, but issued not so good of an outlook, which led to its stock being hit during afterhours trading.

 

There have now been 498 companies out of the S&P 500 that have released their earnings and the earnings expectations beat and miss numbers have not changed since last week. 75 percent of companies beat earnings per share expectations during the fourth quarter of 2014, while 25 percent missed. When looking at revenues, 58 percent of companies beat expectations while 42 percent missed expectations. These numbers are setting up for a very interesting first quarter earnings season, as companies had to deal with not only poor weather across much of the east coast, but also a general slowdown in spending and manufacturing that we have been seeing over the past few months in the economic news releases.

 

This week we are down to only 12 companies releasing earnings that the majority of people would recognize. Below is a table of the better known companies that will release their earnings this week, with the releases that have the most potential to impact the markets highlighted in green:

 

Adobe Systems General Mills Oracle
Darden Restaurants GUESS Shoe Carnival
DSW KB Home Tiffany & Co
FedEx Nike Williams-Sonoma

 

Retail remains one of the most represented areas of the markets that is still releasing earnings and this week is no exception with the markets likely to watch the earnings of Nike, General Mills, and Tiffany & Co very closely. The market is watching these last few retailers’ earnings very closely because we have seen an overall decline in consumer spending over the past few months and the market is looking for this to translate into retailers’ bottom lines. So far, the decline in spending has not hit since the earnings being released ended in December of 2014, but anything in the forward guidance that would signal weakness will be closely scrutinized at this point by the market. FedEx is also releasing earnings this week and is a company that is always closely watched. Given the large amount of packages it touches, FedEx is able to get a good feel for the overall health of the US economy, or at least of small businesses, based the amount of packages that were shipped during the quarter.

 

International News: International news last week was pretty uneventful, other than some large speculations about the well being of Russian President Putin. Toward the middle of last week it was announced that the Kremlin had canceled a trip for the President as well as a number of meetings. The Kremlin then published old photos of the President working, saying he was currently working. All of this fueled speculation that he was either ill, had died, been captured by army generals or even flown to Switzerland to see the birth of a love child. The markets love to run with stories like this when there is nothing else to talk about, and this time was no exception. Russian yields on bonds increased and the equity markets in Russia had one of the worst weeks in a long time as thoughts of what would happen if the rumors were true made investors question their holdings. President Putin was shown in public early Monday morning and he seemed to be in good spirits, even joking about many of the rumors that were circulating. But this little episode does leave investors wondering what happens to Russia after Putin? With Russia being such a large player in the political sphere globally and such a large player in the energy markets around the world it is a major wildcard that at some point could be more than just rumors. From what I can find and what is publically available it is unknown as to how Russia will handle the eventual succession of power, but one thing is for sure, the global financial markets will have to react to any shift.

 

Market Statistics:

Index Change Volume
Dow -0.60% Above Average
S&P 500 -0.86% Above Average
NASDAQ -1.13% Average

 

All three of the major US indexes moved lower last week in a very volatile trading week as the market seemed to lack any real direction, bouncing around on various news and rumors throughout the week. The NASDAQ saw the weakest performance last week after being the top performing index for the past several weeks. The decline, however, was done on just average volume. As mentioned above, the Dow and the S&P continue to trade lower as they move further and further away from the positive technical levels we saw just a few short weeks ago and remain in a sort of “no man’s land” with very little support between the current and substantially lower levels.

 

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 2.56% Natural Resources -3.12%
Pharmaceuticals 1.90% Energy -2.74%
Healthcare Providers 1.72% Oil & Gas Exploration -2.40%
Broker Dealers 1.50% Technology -2.28%
Biotechnology 0.87% Materials -2.00%

There is nothing that is really surprising on the top and bottom sector lists this week. With such a drastic decline in the price of oil it was not surprising to see that materials as well as various aspects of the energy industry comprised the bulk of the top 5 declining sectors. On the positive side, the same few names seem to keep coming up week after week, those being Healthcare, Pharmaceuticals and Biotechnology. In looking back at the sector performance of the past few weeks I see that Biotechnology, Pharmaceuticals and Healthcare have been among each of the past four weeks’ top 5 sectors. On the other side, Energy has been in the bottom 5 performing sectors of the markets for each of the past four weeks.

Fixed income has been on a very wild ride since the end of January as investors attempt to guess when the Fed will start to increase interest rates and what the markets will do, both for equity and fixed income investments, when rates to begin to increase:

Fixed Income Change
Long (20+ years) 2.61%
Middle (7-10 years) 1.01%
Short (less than 1 year) 0.00%
TIPS -0.41%

Last week it was the bull’s turn on the fixed income market as some of the economic data released, particularly the retail sales figures, were bad enough to make some economists think the Fed may hold off increasing rates in June in favor of waiting until September. The US dollar keeps getting stronger as the rest of the world seems to be either stepping into or wading through the quantitative easing unknown. The US dollar gained 2.67 percent against a basket of international currencies last week. The strongest of the major global currencies last week was the Japanese Yen as it lost 0.47 percent against the US dollar. The weakest of the major global currencies last week was the Euro as it fell by 3.20 percent against the value of the US dollar as the ECB continues its bond buying adventures. For the time being it looks like the rising US dollar is here to stay as the alternative currencies that investors could own look far less attractive.

Commodities and metals all sold off last week as there seemed to be a lot of fears of further downside moves in the markets:

Metals Change Commodities Change
Gold -0.88% Oil -9.92%
Silver -1.91% Livestock -2.90%
Copper -1.14% Grains -0.06%
Agriculture -2.30%

The overall Goldman Sachs Commodity Index turned in a loss of 5.48 percent last week. After moving virtually sideways for the better part of 5 weeks, Oil dropped by almost 10 percent last week and is down at almost the lowest level we have seen since the bottom of the great recession back in early 2009.  The decline on metals last week looked tame relative to oil, but across the board the metals also declined, with Silver being hit the hardest, giving up 1.91 percent, while Gold slid by 0.88 percent. So far Gold has held its key support level of $1,150 per ounce, but at the current rate of decline it looks like it will be a short matter of time before it breaks that level and forges ahead much lower. Even the soft commodities were hit last week with livestock falling almost 3 percent, while agriculture declined by 2.3 percent and grains gave up just a little.  If you were invested in commodities last week it seems there was nowhere to hide as everything moved lower.

On the international front last week, China saw the best performance of the week with the Shanghai based Se Composite Index gaining 4.06 percent. Russia could not manage to stay off the bottom of the list last week after rumors circulated about the health of President Putin, rumors the Kremlin has adamantly denied, even going so far as to publish old pictures of him working at his desk to prove that he is doing well. Overall, the MSCI Russian Capped Index declined by 8.15 percent, so it seems like the rhetoric from the Kremlin may not have been working as well as it would have liked.

The VIX last week increased by only 5.26 percent during a week that saw some much wider swings during the middle of the week. With such volatility being seen in the overall markets, as denoted by the number of days last week that the Dow moved by more than 100 points (four out of the five trading days),  it was a little surprising to not see the VIX move more than it did. At the current level of 16.00 the VIX is implying a move of 4.61 percent over the course of the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 3/13/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.16 % 0.46 %
Aggressive Benchmark -1.32 % 0.33 %
Growth Model 0.05 % -0.06 %
Growth Benchmark -1.03  % 0.29 %
Moderate Model -0.03 % -0.44 %
Moderate Benchmark -0.73 % 0.23 %
Income Model -0.01 % -0.42 %
Income Benchmark -0.37 % 0.15 %

*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 several changes to our models over the course of the previous week. The first was our initial repositioning for the eventual Fed interest rate hike. One of our most exposed areas of the markets to interest rate hikes was utilities as many people invest in these because of the dividends they pay, while savings accounts at banks pay next to nothing. We had three large holdings in utility companies that would be at risk as interest rates start to climb; they were Southern Company, Consolidated Edison and Wisconsin Energy. Last week we sold Southern Company across all models; this was done because it has the highest risk among the three utilities companies and was also providing the least amount of return. The second utility we will likely be selling in the coming weeks or month will be Wisconsin Energy, leaving us with just one: Consolidated Edison. Our individual utility holdings have all been held for longer than a year and in most cases since December of 2011. Another major change last week was selling part of our position in Powershares Low Volatility ETT (ticker SPLV). This position was used to participate more fully in the upside moves of the markets during uncertain times. At this point we were seeing increasing volatility within the fund and feel that cash or other investments may be a more prudent spot to invest. We also sold our partial position in Small Cap Growth (ticker RYWAX) over the course of the week. We made only one purchase last week and that was to increase our exposure to the US dollar, a position we started building late last year. We purchased the Rydex Strengthening Dollar fund (ticker RYSBX) in our more aggressive models, while utilizing the Profunds rising dollar fund (ticker RDPIX) in our lower volatility models. At this point we have raised cash across the models and are actively looking for investment opportunities for the market environment we are currently experiencing.

 

Economic News:  Last week was a slow week for economic news releases, but nearly everything that came out was negative. There were five releases that significantly missed expectations, highlighted below in red, and none that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 3/12/2015 Initial Claims Previous Week 289K 306K
Neutral 3/12/2015 Continuing Claims Previous Week 2418K 2421K
Negative 3/12/2015 Retail Sales February 2015 -0.60% 0.40%
Negative 3/12/2015 Retail Sales ex-auto February 2015 -0.10% 0.60%
Negative 3/13/2015 PPI February 2015 -0.50% 0.30%
Negative 3/13/2015 Core PPI February 2015 -0.50% 0.10%
Negative 3/13/2015 University of Michigan Consumer Sentiment Index March 2015 91.2 95.8

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

 

Last week the economic news releases were stacked on the last two trading days of the week, but that did not stop them from having their impact on the overall movement of the markets. On Thursday the standard weekly unemployment related figures were released with both figures coming in very close to market expectations and therefore not having much, if any, impact on the markets. Retail sales released later during the day, however, did have a noticeable impact as both overall sales and sales excluding auto sales fell during the month of February. Retail sales fell by six tenths of a percent while expectations had been for growth of four tenths of a percent. Falling retail sales are a major negative sign for the US economy and this is not the first negative print we have seen. Overall, retail sales have now declined during each of the last three months, as has the retail sales excluding gasoline and auto sales. The news did not improve on Friday when the Producer Price Index (PPI) showed that overall prices at the producer level declined by 0.5 percent, while core prices also declined by 0.5 percent. Overall, producer prices have now declined 4 consecutive months in a row. These falling prices combined with falling retail sales presents an interesting problem for the Fed as it debates when to start raising interest rates. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of March, which showed an unexpected decline of more than four percent. This decline in confidence somewhat mimics what we have been seeing recently in consumer spending and could be the start of a much bigger problem for the overall health of the US economy.

 

This week is a very slow week for economic news releases with all of the releases occurring on the last two trading days of the week. The releases highlighted below have the potential to move the overall markets on the day they are released:

 

Date Release Release Range Market Expectation
3/16/2015 Empire Manufacturing March 2014 8.8
3/16/2015 NAHB Housing Market Index March 2014 56
3/17/2015 Building Permits February 2014 1070K
3/17/2015 Housing Starts February 2014 1041K
3/19/2015 Initial Claims Previous Week 293K
3/19/2015 Continuing Claims Previous Week 2415K
3/19/2015 Philadelphia Fed March 2014 6.9

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

 

This week starts on Monday with the release of the Empire Manufacturing index for the month of March. The markets are expecting a slight increase in this figure, but it seems more likely that we will see a lower than expected print with the weather on the east coast during the month being blamed for the difference. Later during the day on Monday the NAHB Housing Market Index is set to be released with expectations of a small upward tick being shown. It would take a lot for the market to react to this release in any meaningful way. On Tuesday some more US housing market data is set to be released with the building permit and housing starts figures for the month of February being released. Both numbers are expected to post something over 1 million units, just as they did during January. On Thursday initial and continuing jobless claims are set to be released with both numbers not expected to have changed much during the course of the previous week. Wrapping up the week on Thursday is the release of the Philadelphia Fed Index for manufacturing, which is expected to show that manufacturing in the greater Philadelphia area picked up slightly during the month. The other major economic event this week will occur on Wednesday and is the Federal Reserve rate decision for the meeting that ends on Wednesday. While there are almost no expectations that rates will be moved this meeting, everyone will be patiently watching to see if the wording in the language pertaining to when rates may start up has changed.

 

Fun fact of the week—Waffle House

 

The Federal Emergency Management Agency (FEMA) uses something called the Waffle House Index when a natural disaster hits an area. There are three different levels for the index: Green, meaning the store is open and a full menu is being offered; Yellow, meaning the store is open, but a limited menu is being offered; and Red, meaning that the location is closed. During a disaster, all Waffle House locations report their current condition and this information is relayed back to FEMA.

 

Source: Federal Emergency Management Agency Director W. Craig Fugate

For a PDF version of the below commentary please click here Weekly Letter 3-9-2015

Commentary at a glance:

-US markets turned sharply lower on Friday amid speculation about the first fed rate hike.

-What’s that? Egg on Boehner face again!

-National People’s Congress held its annual meeting in Beijing.

-Earnings season in the US has drawn to a virtual close for the fourth quarter of 2014.

-Economic data showed a strong performance on the surface labor market, which tipped off rate hike fears.

 

Market Wrap-Up: After having the Dow break down below its support level two weeks ago last week it was the S&P 500’s turn do to so and it did so in a noticeable way. While the equity markets were moving the VIX was also moving, but to a much more muted degree than one might expect given the decline we saw on Friday. The charts below are of the three major US indexes in green with their respective trading channels being drawn by the red lines. The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 3-9-15

In terms of which of the indexes is currently the strongest, there was no change over the previous week; the NASDAQ is clearly ahead of both the S&P 500 and the Dow. Even with the decline seen last week on NASDAQ, it is still not even close to breaking down into or below its most recent trading channel. In fact, the NASDAQ is closer to making a new all time high than it is to moving back into its trading channel. Both the S&P 500 and the Dow remain well below their respective trading channels and it looks like they are likely not going to make it back to them any time soon. One item that could help the Dow in particular is that AT&T is being dropped as one of the 30 component companies in the Dow and being replaced with Apple. Initially, Apple will have a 4.66 percent weighting in the index, but over the longer term the outlook for Apple is much brighter than it is for AT&T, so it could be a very positive development for the index. After such a decline on the S&P 500 and the Dow, like the one seen on Friday, it would not be unusual for the markets to bounce higher in the following few trading days. This is because the markets tend to overreact both on the positive and on the negative news that moves the markets. Adding to this theory is the fact that the decline last week was done on just average volume and if this was truly the start of a blowout decline, you would normally see volume spiking higher along with the VIX; both of which did not occur last week. In large previous moves to the downside the VIX typically moves noticeably higher and while it did move higher on Friday it did so by less than 10 percent, which means that options traders were not reacting to the market movements, but instead sort of calling its bluff. Looking at trading so far on Monday, it looks like they were correct. Movement of the markets from here is anyone’s guess as speculation on every economic report and speech given by Federal Reserve officials will likely be dissected thousands of times in futile attempts to gain some unknown insight into when the Fed will start to raise interest rates.

 

National News: John Boehner has once again come out looking like the court jester in Congress as he passed a clean Department of Homeland Security (DHS) funding bill last Tuesday. After nearly causing a shutdown of the DHS two weeks ago and passing a temporary bill that allowed the DHS to remain funded for one week, the Republican leadership caved in on Tuesday and passed a “clean” bill that was identical to the bill the Senate passed at the 11th hour on February 27th. Speaker Boehner talked a big game leading up to last week that the Republicans were not going to fund the DHS until they had effectively stopped President Obama’s executive action on immigration. But in the end the Speaker has so little control over even his own party that he was forced to bring the bill up for a vote, which it easily passed 257 for and 167 against. There were a total of 75 Republicans that crossed the aisle and voted in favor of the bill. Why does this matter to the financial markets? It matters to the financial markets because it goes to show that Congress is not working well at this point and that getting much of anything done over the course of the next 18 months will be like pulling teeth. So while most of what Congress does is on autopilot, should something come up that needs congressional approval to move forward, it will likely be hung up in the House and may cause issues by being delayed. It really just adds to uncertainty and uncertainty is something the financial markets are always uncomfortable with. The other big news of the week in the US last week was on the labor front and came in the form of the latest unemployment rate as well as the payroll numbers, wage growth and participation rate.

 

The financial markets in the US turned noticeably lower on Friday last week as investors adjusted everything from fixed income to equity positions as they get ready for interest rates to start to move higher in either June or September. The reason for the excitement on Friday was that the government released its latest figures, which showed that the unemployment rate fell in the US down to 5.5 percent during February, while the payroll figures were very strong for the month as well. What was a little less publicized was the fact that the labor force participation rate fell during the month, as depicted in the chart to the right, created on the Bureau of Labor Statistics’ webpage. LFPR 3-9-15Another measure of underemployment is the so called U6 rate, which measures both the unemployed and the underemployed (i.e. someone working fast food with a masters degree); this rate is still at 11 percent and is one of the rates Fed Chair Yellen likes to use in her analysis. Another variable she looks at is wage growth, which has been nearly dead flat since October of 2009, running at about 2 percent, well under the more typical pace of 3 percent. Until we get the labor force participation rate and wages moving higher, it is hard to believe the labor market is as positive as some pundits on TV are trying to spin it. Nonetheless, the markets took the labor news in aggregate and said it looks good enough that rates may start to move pretty soon. I am still a little skeptical as the surface numbers seem to look okay, but the underlying figures seem like they still have a ways to go and that they are not currently moving in the correct direction. While all of this was going on, earnings season was still rolling for corporate American, but it is quickly winding down.

 

Last week was the first week of the big slow down in earnings announcements. From here through the end of March we will get a few straggler earnings announcements each week. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Abercrombie & Fitch 2% Foot Locker 11% PetSmart 4%
Autozone 2% Greif -19% Progressive pushed
Best Buy 9% H & R Block 54% Revlon pushed
Big Lots 1% Joy Global -34% Smith & Wesson 82%
Costco Wholesale 15% Kate Spade -11% Sotheby’s -10%
Dick’s Sporting Goods 7% Kroger 16% Staples 3%

 

There were no major surprises last week in corporate earnings, but there were a few releases that caught the attention of the markets. Smith and Wesson beat market expectations by 82 percent, despite seeing continued declines in their long guns division as these declines were more than offset by the increased number of handgun sales around the country. Two higher end companies that fell on hard times and reported earnings last week included Kate Spade and Sotheby’s as sales were slightly below expectations at both retailers. Costco saw a positive earnings announcement last week as it looks like the small businesses that shop there in the US were increasing their demand throughout the quarter.

 

According to Factset Research, we have now seen 496 (99.2 percent) of the S&P 500 companies release their results for the fourth quarter of 2014. Of the 496 that have released, 75 percent of them have met or beaten earnings estimates (this is down 1 percent from two weeks ago), while 25 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 58 percent of the companies have beaten estimates (this number is down 1 percent from two weeks ago), while 42 percent have fallen short. The major driving sectors behind the strong earnings announcements have been telecommunications and healthcare, while the laggard not surprisingly continues to be energy. The overall blended earnings growth rate for the fourth quarter of 2014 looks like it will come in at about 3.7 percent. Forward looking guidance changed by only one company last week as there have now been 82 companies that have issued negative guidance, while the number of positive guidance releases by companies has remained unchanged at 15. With only four companies left to report earnings out of the S&P 500 it has become virtually impossible for the numbers, as far as the number of companies beating on earnings or revenues, to change from their current levels. The numbers above are likely what they will be for the quarter, which means the fourth quarter of 2014 will go down as a better than average quarter, but one that saw some darkening clouds on the horizon.

 

This week sees a massive drop off in the quantity of companies releasing their fourth quarter earnings numbers compared to the past few weeks. Although there are still a few companies that are well known it will become even slimmer in the coming weeks. Below is a table of the better known companies that will releases their earnings this week, with the releases that have the most potential to impact the markets highlighted in green:

 

Barnes & Noble Krispy Kreme Doughnuts Ulta Salon
Buckle Men’s Wearhouse Urban Outfitters
Dollar General Revlon Vail Resorts
El Pollo Loco Rosetta Stone Williams-Sonoma
Express Shake Shack Zoe’s Kitchen
Kirkland’s Stein Mart Zumiez

 

Specialty retailers seem to be the name of the game this week for earnings announcements as there are a very high percentage of them releasing earnings. Shake Shack will be closely watched this week as it is the first quarter earnings results release for the company since they went public back on February 2nd of this year. Dollar General will also be very closely watched as it is one of the last “deep discount” retailers to report earnings, a group that so far has not seen the boost that was expected due to the decline in the price of gasoline around the US.

 

International News: International news last week was largely quiet as the world awaits the start of bond buying by the European Central Bank (ECB), which officially starts today! The plan has been years in the making and now we will start to see if this is going to work or if the Europeans will have to go back to the drawing board for a new plan to fix their dwindling economies. Elsewhere in Europe, Ukraine also made a few headlines last week as the cease-fire now looks like it is actually in place with both sides pulling back some of their heavy weaponry and swapping prisoners. Things will likely remain calm over there until Russian President Putin decides that now is another good time to take more land from Europe and decides to push further into the former Soviet states in a modern land grab that no one seems to be willing to stop. The other major news on the international front last week came out of China as the National People’s Congress held its annual session in Beijing last Thursday.

 

The National People’s Congress is similar to the US Congress with many “elected” officials and political party big wigs present to hear from their leaders. The only difference is that there is no debate on anything since China is a command and control driven country. The Premier Li Keqiang gave one of the more important speeches of the day with the “Work Report,” essentially a report about the current state of the economy in China. In the report the growth expectations for 2015 have been lowered to 7 percent from the previously released 7.5 percent. The budget deficit is projected to be 2.3 percent of GDP and, on the jobs front, China wants to create 10 million new jobs during 2015. To give everyone a little perspective on just how many jobs that 10 million goal entails, the US only managed to create a little under 3 million jobs during 2015 with all of the programs in place and help from the government for employees to find work and for employers to hire them. In general, in the US 200,000 jobs being created per month is considered strong growth, so a strong growth year would be anything above 2.4 million or roughly one quarter of China’s goal. While it is a “goal,” the number will be achieved during 2015 because China is notorious for setting a number and achieving that number at all costs, even if it is just completely fabricated. Other highlights from the speech included a pledge not to allow the unemployment rate to go above 4.5 percent during 2015, to cut carbon emissions by 3.1 percent and to achieve trade growth of 6 percent during 2015. In an interesting part of the speech, the Premier mentioned that the government will encourage mergers and the closing of over supplied sectors of the economy. This was seen as a suggestion that some of the very large state run enterprises would likely be buying up smaller companies to extend state control during the year, while at the same time stamping out corruption, which has been the name of the game so far under the new leadership.

 

Market Statistics:

Index Change Volume
NASDAQ -0.73% Average
Dow -1.52% Average
S&P 500 -1.58% Average

 

The NASDAQ could not make it five weeks in a row of gains, finally succumbing last week and posting a weekly decline. Both the S&P 500 and the Dow veered off track two weeks ago when they posted their first weekly declines in several weeks. Last week’s trading was driven almost entirely by speculation as to when the Fed will start to raise interest rates, and the amusing part of the debate is that it doesn’t really matter when they start to increase interest rates in the grand scheme of things, as mentioned above. Volume was low for the week going into Friday, but the market reaction to the jobs report on Friday was enough to pull all three of the major US averages back up to average volume 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
Biotechnology 1.45% Utilities -4.10%
Regional Banks 1.27% Energy -3.66%
Broker Dealers 0.97% Materials -3.52%
Pharmaceuticals 0.55% Residential Real Estate -3.51%
Semiconductors 0.37% Infrastructure -3.33%

With the NASDAQ once again being the best of the three major indexes it was not surprising to see that three of the top five sectors of the market last week were technology based. Biotechnology got a nice boost from a few announcements from the FDA as well as merger speculation as the sector continues to be going through a massive round of M&A as big companies have lots of cash and cheap financing to go and acquire other companies. Utilities continued to see the weakest performance last week as the sector declined as the yield on the 10-year US bond increased. This occurs because as rates move higher on government bonds, and the 10-year in particular, some investors will hop out of the safest of equity sectors like utilities, which pays a nice dividend, in favor of the even more safe US government bonds. This rotation out of equities and back into fixed income as rates increase is one of the aspects of the Fed increasing rates causing some concern for many investors.

Fixed income fell off the proverbial cliff last week as investors adjusted their portfolios to the prospects of a rate hike before September:

Fixed Income Change
Long (20+ years) -4.66%
Middle (7-10 years) -2.00%
Short (less than 1 year) -0.01%
TIPS -1.90%

The drop in the long end of the yield curve was almost entirely done on Friday after the jobs report and really shows investors’ willingness to sell the long end of the curve in favor of buying the short end of the curve. This type of trade sets up investors to take advantage of raising interest rates in the future. Last week the US dollar increased in value by 2.38 percent against a basket of international currencies, making it three weeks in a row of gains. The strongest of the major global currencies last week was the Canadian Dollar as it lost 0.85 percent against the US dollar. The weakest of the major global currencies last week was the Swiss franc as it fell by 3.27 percent against the value of the US dollar. This flight to the US dollar is also a function of the prospects of the US Fed raising interest rates sooner and other central banks continuing to embark on quantitative easing actions.

Commodities and metals were mixed last week as oil had a pretty tame week, while metals really took it on the chin:

Metals Change Commodities Change
Gold -3.70% Oil 0.53%
Silver -4.28% Livestock 0.56%
Copper -3.20% Grains -3.62%
Agriculture -2.08%

The overall Goldman Sachs Commodity Index turned in a loss of 2.06 percent last week. Oil experienced one of the more tame weeks that we have seen all year as prices finally look like they have stabilized for the near term.  Metals really took a hard hit last week with Gold declining almost 4 percent, while Silver slid 4.28 percent and Copper dropped 3.2 percent. The decline in Gold appears to have occurred as investors saw the metal fail to stay above the $1,200 per ounce level. Silver is really just a cheaper proxy for Gold, so it was not surprising to see that it traded in the same direction and roughly the same magnitude as Gold. Copper, on the other hand, suffered last week as the slowdown in the Chinese economy seemed to be confirmed by the National People’s Congress meeting, during which the future growth rates for China’s economy were laid out. The soft commodities traded very differently last week as agriculture and grains fell and livestock increased in value.

On the international front last week, South Korea saw the best performance of the week with Se KOSPI Index gaining 1.37. Brazil brought up the rear last week in terms of global index performances as it declined by 3.11 percent after fears continued to circulate that Dilma Rousseff may not be able to hold as much control over business as she has in the past, in addition to reports of poor preparations for the upcoming Olympic Games to be held in Brazil during 2016. Last week was one of the first weeks in a long time that we did not see Russia in either the top or bottom spot in terms of weekly performance as the situation in Ukraine seems like it may be moving toward a diplomatic solution and not a war.

Last week the VIX could not make it three weeks in a row of moving less than 10 percent during the week as it jumped by 13.94 percent. Not all of the upward move was done on Friday when the markets were moving lower. In fact, the VIX moved a very small amount on Friday relative to the size of the move in the overall markets. After touching the lowest level of the year on the last day of trading in February the VIX steadily increased last week, capping off the week with a gain of more than 8 percent on Friday. At the current level of 15.20 the VIX is implying a move of 4.39 percent over the course of the next 30 days. As always, the direction of the move is unknown.

For the trading week ending on 3/6/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -2.51 % 0.31 %
Aggressive Benchmark -1.58 % 1.68 %
Growth Model -2.22 % -0.11 %
Growth Benchmark -1.23  % 1.34 %
Moderate Model -1.84 % -0.41 %
Moderate Benchmark -0.88 % 0.97 %
Income Model -1.54 % -0.41 %
Income Benchmark -0.43 % 0.52 %

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

 

We made no changes to our models over the course of the previous week. We are actively assessing our holdings, looking for areas that need to be trimmed and, more importantly, looking for what to do with any cash we currently hold or may be holding in the near future. The same areas of the market that have been looking good for a few weeks, areas that we already have an established position in, look like they will be the best spots to move into and includes sectors such as healthcare, semiconductors and pharmaceuticals. Our biggest area of concern right now is Utilities and the adverse reaction we saw out of the sector as a whole on pure speculation as to when interest rates will start moving higher. It seems a little strange that investors would jump out of utility equity positions in favor of US government bonds, but that appears to have been the case last week. With yields on the 10-year bond moving north of 2.25 percent, the yield increase by being in utilities (currently yielding about 3.3) is starting to be eroded, while the volatility of the equities is seen as much higher than the alternative fixed income.

 

Economic News:  Last week was a typical week for economic news releases as we started March of 2015. There were two releases that significantly beat expectations highlighted below in green and one release that significantly missed market expectations, highlighted in red below:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 3/2/2015 Personal Income January 2015 0.30% 0.40%
Slightly Negative 3/2/2015 Personal Spending January 2015 -0.20% -0.10%
Neutral 3/2/2015 ISM Index February 2015 52.8 53
Neutral 3/4/2015 ADP Employment Change February 2015 212K 220K
Neutral 3/4/2015 ISM Services February 2015 56.9 56.5
Slightly Negative 3/5/2015 Initial Claims Previous Week 320K 295K
Neutral 3/5/2015 Continuing Claims Previous Week 2421K 2404K
Negative 3/5/2015 Factory Orders January 2015 -0.20% 0.60%
Positive 3/6/2015 Nonfarm Payrolls February 2015 295K 240K
Positive 3/6/2015 Nonfarm Private Payrolls February 2015 288K 230K
Slightly Positive 3/6/2015 Unemployment Rate February 2015 5.50% 5.60%
Neutral 3/6/2015 Consumer Credit January 2015 $11.6B $14.0B

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

 

Last week started off on Monday with the release of personal income and spending for the month of January, which saw income increase slightly and spending continue to decrease. The decline in personal spending can be attributed to the decline in gasoline prices at the pump; the money that was saved at the pump just was not put back into buying other items during the month. This flies directly in the face of many economists who thought that falling oil and gas prices would for sure lead to an increase in consumer spending; so far we have yet to see this phenomenon. Also released on Monday was the overall ISM Index for the month of February, which came in almost exactly as expected by the markets and was a non-market moving event. On Wednesday the first of the employment related releases was released, that being the ADP employment change figure for the month of February, which showed that 212,000 jobs had been created during the month, a number that is not great but not bad either. Also released on Wednesday was the services side of the ISM, which also came in very close to market expectations and was hardly even noticed by the markets. On Thursday the standard weekly employment related figures were released with initial jobless claims missing expectations and jumping over the psychological 300,000 level. While this is concerning we will have to get more than just a single data point for the market to become concerned about the jobs market in any meaningful way. Also released on Thursday was a poor reading on factory orders with orders declining two tenths of a percent, while expectations had been for an increase of six tenths of a percent. The market seemed to overlook this release, however, and focus more on speculating about the employment reports due out the next day. On Friday the government released its latest overall unemployment rate for the month of February and it came in at 5.5 percent, down one tenth of a percent from the 5.6 percent seen during January. Both nonfarm public and private payroll figures came in nicely above market expectations with both figures pushing up near 300,000 during the month. This is the type of job growth we need for the US economy to really start moving forward at a meaningful rate of speed. These releases, however, were also what caused the markets to move significantly lower on Friday as investors are now thinking that an interest rate hike coming from the Fed may be sooner rather than later. While the odds of a Fed rate hike still favor September, the potential of a June hike seems to be increasing with some of these latest economic reports.

 

This week is a very slow week for economic news releases with all of the releases occurring on the last two trading days of the week. The releases highlighted below have the potential to move the overall markets on the day they are released:

 

Date Release Release Range Market Expectation
3/12/2015 Initial Claims Previous Week 306K
3/12/2015 Continuing Claims Previous Week 2421K
3/12/2015 Retail Sales February 2015 0.40%
3/12/2015 Retail Sales ex-auto February 2015 0.60%
3/13/2015 PPI February 2015 0.30%
3/13/2015 Core PPI February 2015 0.10%
3/13/2015 University of Michigan Consumer Sentiment Index March 2015 95.8

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

 

This week starts on Thursday with the release of the standard weekly employment reports; after the spike we saw in the initial jobless claims number last week the markets will be watching closely this week to see if a trend of prints over 300,000 starts or if last week’s numbers were just a fluke. Perhaps more important on Thursday than the jobs figures is the release of retail sales for the month of February, which are expected to be positive, but just by a little, with overall sales expected to post a gain of 0.4 percent, while sales excluding automobiles are expected to post a gain of 0.6 percent. If the number on either of these two releases misses significantly and prints a decline during the month the market will likely react, but the reaction remains unknown as a negative print may make investors think the Fed will hold off on increasing interest rates and thus cause the markets to move higher. On Friday the Producer Price Index (PPI) for the month of February as well as the core PPI for the same time period are set to be released with expectations that prices at the producer level will be shown to have increased very slightly during the month as the prices of raw materials and energy have stabilized and in some cases moved up slightly during the month. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of March, which is expected to show almost no change from the end of February level of 95.4, increasing slightly to 95.8. With all of the other consumer data seemingly pointing to a slowdown in confidence the market may look at this release a little more than normal, but it would take something very out of the ordinary for the markets to really react. In addition to the scheduled news releases there are also three different Federal Reserve officials speaking this week, all on Monday and all at almost the same time, but at different venues. It is highly unlikely they will mention anything that is new, but the market will likely hang on their every word for any insight into when the Fed may start to increase interest rates nonetheless.

 

Fun fact of the week—China

 

By 2030, China will have 200 million college graduates—more than the entire U.S. workforce.

 

Have a great week!

For a PDF version of the below commentary please click here Weekly Letter 3-2-2015

Commentary at a glance:

-US markets failed to gain much traction and move much in either direction.

-Department of Homeland Security—funded, not funded, funded for a week?

-China cut rates once again.

-Chair Yellen had an amusing time on the Hill last week; the markets were less amused.

-Economic data continues to show weakness in the US; consumer confidence is the latest casualty.

 

Market Wrap-Up: There was only one major change that occurred last week from a technical standpoint on any of the three major US indexes and it was a negative development. The charts below are of the three major US indexes in green with their respective trading channels being drawn by the red lines. The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 3-2-15

From a technical standpoint the standout index remains the NASDAQ (lower left pane above), which is much higher than its most recently trading range and looks like it will keep trying to advance. Much of the move on the NASDAQ could be because it is finally closing in on a new all time high over the technology bubble level seen back in early 2000, as mentioned last week. Both the S&P 500 (upper left pane above) and the Dow (upper right pane above) look much less exciting and, in fact, one of them turned negative last week. Over the course of the previous week the S&P 500 moved from the middle of its trading channel down toward the lower end of the channel. While it stopped short of breaking through the lower end of the channel, it is still a concerning technical move. The Dow, on the other hand, is even more concerning based on this trading channel indicator, as it failed to stay within its range last week, falling below the lower edge of the channel during trading on Friday. This move does not necessarily mean a further decline is imminent, but it does raise a yellow cautionary flag. If you think of the three indexes as different levels of risk with the NASDAQ being the highest risk the S&P 500 being in the middle and the Dow being the least risky of the three, last week was a “risk on trade” as the NASDAQ was pushed higher, while the Dow suffered a decline. Going forward it really looks like the markets will meander around waiting for something to provide it with direction, with the exception of the NASDAQ running for a record close. This direction could easily come in either a positive form or negative, but from several valuation metrics the markets are a little over priced, meaning a downward move may be the likely outcome from any unforeseen events. While the markets were searching for direction, so too was the VIX as it moved to a new low for 2015, but did not make much of a percentage move over the course of the week.

 

National News: While Washington DC may have been unusually quiet two weeks ago, it made up for the lack of attention last week as there was a lot happening and not happening at the same time. The first news of the week was the official veto of the “Keystone XL Pipeline Approval Act” early last week with the President citing a lack of “thorough consideration of the issues” as one of the reasons for his vetoing the bill. The bill is now being sent back to the Senate where its future is very uncertain. At least in current form it looks like there are not enough votes (approximately 3 short) for the measure to get a presidential veto override. So that leads us to the current debate in Washington DC surrounding the funding of the Department of Homeland Security (DHS). Late last year during a budget fight the Republicans got a measure attached to the budget that allowed for the passage of the budget, but that only funded the DHS through the end of February 2015. This was done so the Republicans could try to force the President’s hand on the new immigration laws he signed into law with executive order late last year. Since the DHS is the department responsible for enforcing the new laws or not enforcing the old laws, this was the target group of the debate. On Friday, there was a lot of horse trading going on, but in the end there was no major deal struck between the two sides in Congress. What did they do? They created a one week extension for DHS funding, in a sense kicking the can down the road a very small distance. What doesn’t make any sense is that nothing was done over the past three months, despite everyone knowing that the funding was going to dry up at the end of February, and nothing was able to be accomplished in the last minute dealing last week, so why is anything substantially better expected to be hammered out this week? Wall Street, while concerned about the DHS, does not seem to be reacting to the gridlock that permeates Washington DC, but Wall Street does seem to be a little more on edge because the gridlock shows that Congress may not have the wherewithal to do anything should an actual emergency that requires their approval actually come up. In addition to the debates about DHS funding and the Keystone XL Pipeline, last week there was a special guest on the Hill, the Chair of the Federal Reserve Janet Yellen, who gave her semiannual testimony about the state of the US economy to both chambers of Congress over Tuesday and Wednesday last week.

 

As usual, her prepared statement said nothing new and was verbatim from what has been released previously, but the question and answer section of the sessions held some good fun for the chair. The main topic members of Congress wanted the chair to address was the issue of auditing the Fed or Congressional oversight of the Fed. This in general is seen as a very bad idea by most of Wall Street and everyday Americans for several reasons. Congress is not exactly known for making quick and correct decisions and the US Federal Reserve has to be able to act and do so very quickly in some circumstances, such as bailing out big banks in 2008 or risk an all out collapse of the US financial system. Second, Congressional members, for the most part, have no idea about our monetary and fiscal systems in the US and having them make large fiscal decisions would be tantamount to asking them to design the next space shuttle since they can all look up and see outer space. More important to the financial markets were the questions about when the Fed would start to normalize interest rates and by how much Chair Yellen thought interest rates would need to increase. Again, she did a fine job of not giving a straight answer, despite numerous attempts for one from various members of Congress. She did address the term “Patience” in the wording of her Fed statement in saying that just because it may or may not be removed does not mean that an interest rate hike is imminent at the next meeting. In general, it seems she really is going to wait until the data and information she is watching is showing without a doubt that it is time to increase interest rates. The markets are currently pricing in a first rate hike at the September meeting; this is back a little from the June meeting, which was the initial expectation of the markets. Whatever the market is expecting can change very quickly with the release of more up to date economic news releases. Without the presence of inflation there really is no rush for the Fed to take action at this point. Taking action would really just give the Fed more options for dealing with uncertainty in the future as its back would no longer be against the zero interest rate wall as it is currently. While all of this was going on in Washington, earnings season for the fourth quarter of 2014 was starting to wind down.

 

Last week was a very busy week for earnings releases as there were many household names that released earnings with a very wide mix of positive and negative results being shown. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

3D Systems -35% Domino’s Pizza -2% Ross Stores 8%
Alleghany -12% Gap 1% Salesforce.com 0%
Aqua America 4% Hewlett-Packard 1% Sanderson Farms 4%
Babcock & Wilcox 42% Home Depot 12% Sears Holdings 0%
Big 5 Sporting Goods 19% J C Penney -100% SeaWorld Entertainment -50%
Campbell Soup 2% Kate Spade pushed South Jersey Industries -20%
Comcast 0% Kohl’s 2% Sturm Ruger & Co 26%
Cooper Tire & Rubber -27% Liberty Media 5% Target 3%
Crocs -19% Lowe’s Companies 5% TJX Companies 3%
Dillard’s -1% Macy’s 1% Toll Brothers 47%
DISH Network 105% Papa John’s 4% Vitamin Shoppe 0%
Dollar Tree 1% Pinnacle Foods 0% WebMD Health 16%

 

According to Factset Research, we have now seen 485 (97 percent) of the S&P 500 companies release their results for the fourth quarter of 2014. Of the 485 that have released, 76 percent have met or beaten earnings estimates (up 1 percent from two weeks ago), while 24 percent have fallen short of expectations. When looking at the revenue of the companies that have reported, 59 percent of the companies have beaten estimates (up 1 percent from two weeks ago), while 41 percent have fallen short. The major driving sectors behind the strong earnings announcements have been telecommunications and healthcare, while the laggard, not surprisingly, continues to be energy. Forward looking guidance continues to be a major issue for many companies as they are citing a multitude of potential reasons for slower future growth, everything from Europe uncertainty to dollar strength, the US Fed policy or the declining price of oil. In total, 81 component companies of the S&P 500 have announced negative forward guidance; this compares to just 15 companies that have raised their forward guidance after posting their fourth quarter numbers. With such a large percentage of the forward looking guidance being negative it seems the first quarter or two of 2015 for corporate America may be a little more difficult than first thought. At this point it is becoming virtually impossible for the numbers, as far as the number of companies beating or earnings or revenues, to change much from their current levels. The numbers above are likely what they will be for the quarter which means the fourth quarter of 2014 will go down as a better than average quarter, but one that saw some darkening clouds on the horizon.

 

This week sees a massive drop off in the quantity of companies releasing their fourth quarter earnings numbers, as compared to the past few weeks. While there are still a few companies that are well known, it will become even slimmer in the coming weeks. Below is a table of the better known companies that will release their earnings this week, with the releases that have the most potential to impact the markets highlighted in green:

 

Abercrombie & Fitch Foot Locker PetSmart
Autozone Greif Progressive
Best Buy H & R Block Revlon
Big Lots Joy Global Smith & Wesson
Costco Wholesale Kate Spade Sotheby’s
Dick’s Sporting Goods Kroger Staples

 

Best Buy is always a company that is closely watched by the markets as it is a good proxy for higher end, consumer facing technology. With Apple having such a strong quarter it would not be surprising to see Best Buy have a very strong quarter as well. Costco is a good proxy company for smaller businesses and restaurants as these markets make up a lot of the Costco business. H&R Block may be followed more closely than normal this quarter as investors wait to hear what, if anything, the company is doing to try to protect customer identities and combat the false tax return scams that seem to be very prevalent this year given all of the problems TurboTax and its parent company Intuit seem to be having.

 

International News: International news last week was pretty quiet given that numerous countries were closed for part of the week due to the lunar New Year, but there were a few interesting developments. First, Greece failed to make any negative headlines and did actually get its list of reforms and other items to the finance ministers and the Troika for approval, which it easily received from all voting members, even Germany. Some people in Greece are not in favor of many items on the list and there was small scale rioting in the streets in parts of Greece, but it was much calmer than it could have been. So with the deal done, does it mean the situation in Greece is resolved? Certainly not. Greece and the Europeans effectively kicked the can down the road for 4 months to allow Greece time to come up with a longer term plan as to how to repay its debts and actually get its economy, or what is left of it, back on track. Once again the Europeans did nothing to fix the underlying causes of the problem in Europe. This week will be an exciting week as it is the first week the ECB will be buying debt as part of its latest bond buying program. While it will likely take several months to see if the program is actually working, it is nice to see the ECB finally put some money where its mouth is and start a program that has been talked about for years. The future of both the recovery and the Eurozone as a whole may very well depend on the successful outcome of the bond buying program. One other area of the world that made a few headlines last week that I have not recently addressed was China.

 

While Europe has been doing a lot of recent soul searching, so too has China with its still relatively new government running a number of interesting programs, such as trying to stop the shadow banking system in China, root out corruption and keep its economy growing at a much faster than normal pace. The latest move out of China is the decision to lower interest rates by having the People’s Bank of China (PBOC) cut interest rates. The rates were cut to fend off deflation, but there is no deflation in the numbers China prints to speak of. Even the PBOC report released at the same time as the rate cut said that inflation will likely be 1.2 percent during 2015, which is well below the target of 3.5 percent, but still a far cry from deflation (a negative rate). Growth, projected by the PBOC is also expected to slow during the first quarter of 2015 down to an annualized rate of 7 percent from 7.3 percent. Most countries in the world can only dream of growing at 7 percent, but in China 7 percent is a sign of weakness and a major problem. More information will be coming out this week about China as the National People’s Congress holds its annual meeting on Thursday and will likely include an outline of growth targets for 2015 and the next few years as well. All of these numbers have to be taken with a large grain of salt as China is notorious for having target numbers and hitting them at all cost, even if there are large gaps that are fraudulently filled in after the fact.

 

Market Statistics:

Index Change Volume
NASDAQ 0.15% Average
Dow -0.04% Average
S&P 500 -0.27% Average

 

The NASDAQ was the only index of the three major indexes to make it four weeks in a row of gains last week after both the S&P 500 and the Dow posted declines last week. Last week was a lackluster week for the financial markets as there was little information to react to and even fewer logical reasons to move.

 

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 1.65% Energy -1.69%
Semiconductors 1.01% Oil & Gas Exploration -1.66%
Consumer Staples 0.85% Natural Resources 1.53%
Technology 0.78% Aerospace & Defense -1.22%
Global Real Estate 0.72% Transportation -1.05%

Healthcare continued to ride high last week as did Semiconductors, two sectors of the markets that have been performing very well over the past few months. The interesting sector that made it on the positive list last week was the Consumer Staples sector as it is typically a very defensive sector and is rarely in the top 5 performance sectors unless there is a large decline occurring in the markets overall. Energy continues to be the bottom performing sector, as it is nearly every week that oil decides to slide off for one reason or another.

Fixed income was up last week as the world seemed to react to the Greek deal with a healthy bit of skepticism:

Fixed Income Change
Long (20+ years) 2.36%
Middle (7-10 years) 0.98%
Short (less than 1 year) 0.00%
TIPS 1.48%

Last week the US dollar increased in value by 0.04 percent against a basket of international currencies, making it two weeks in a row of gains. The strongest of the major global currencies last week was the British Pound as it gained 0.18 percent against the US dollar. The weakest of the major global currencies last week was the Japanese Yen as it fell by 0.20 percent against the value of the US dollar. Currency trading was much lighter than usual last week as a number of countries were closed for several days last week in observance of the lunar New Year.

Commodities and metals were mixed last week as oil moved lower and almost all of the other commodities advanced:

Metals Change Commodities Change
Gold 0.76% Oil -2.54%
Silver 2.12% Livestock 1.83%
Copper 3.64% Grains 0.77%
Agriculture -0.35%

The overall Goldman Sachs Commodity Index turned in a gain of 0.72 percent last week. The gains experienced in nearly everything other than Energy were enough to offset the declines that once again occurred on Oil. After falling below the psychological $50 per barrel level back in the beginning of January, oil managed to break back above $50 during mid January, but has once again fallen below $50. All of this price movement in oil has wreaked havoc on the prices being paid at the pump for gasoline, but the prices paid are not equal across the country. According to the latest AAA Fuel gauge report, CA is currently paying more than $3.50 per gallon, while Utah is paying only $2.05 per gallon. The disparity in pricing has a lot to do with the regional refineries that have seen everything from striking workers to being out of commission due to seasonal repairs and maintenance. In short, the price paid at the pump has a lot more built into the price calculation than just the price of a barrel of oil. While Oil was down last week all of the metals increased in value and did so in a meaningful way on both Silver and Copper as demand picked up for both metals over the previous week.

On the international front Germany saw the best performance of the week with the Frankfurt based DAX gaining 3.18 percent as Germany looks like it will pull out of its economic funk, despite having to prop up the majority of the rest of Europe economically. Russia was in the dog house once again this week as the MSCI Russia Capped Index declined by 1.16 percent, thanks in large part to uncertainty going forward about the cease-fire that has now been in place, for the most part, during the past three weeks.  Russia cannot seem to catch a break as it has been either the top or bottom performing index of the major global indexes almost every week.

The VIX made it two weeks in a row of moving less than 10 percent on a weekly basis, last week declining by 6.71 percent. As the markets are meandering, as mentioned above, so too is the VIX as investors’ perceptions of fear seem to ebb and flow with the daily news cycle. The market seems to be taking the downward revision in the forward guidance of corporate America in stride, something that is a little unusual. If we see a lot of numbers coming in worse than expected during the next quarter’s earnings season we could see the VIX jump higher, but right now it seems to be perfectly content ignoring the concerns of the markets until they come home to roost. At the current level of 13.34, the VIX is implying a move of 3.85 percent over the course of the next 30 days. As always, the direction of the move is unknown. This VIX is now at the lowest level we have seen so far during 2015 and looks to be headed lower.

For the trading week ending on 2/27/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model -0.18 % 2.89 %
Aggressive Benchmark 0.27 % 3.32 %
Growth Model -0.09 % 2.16 %
Growth Benchmark 0.21 % 2.60 %
Moderate Model 0.06 % 1.46 %
Moderate Benchmark 0.15 % 1.87 %
Income Model 0.21 % 1.14 %
Income Benchmark 0.07 % 0.95 %

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

 

We made no changes to our models over the course of the previous week. We still maintain a little cash from the sale of our real estate holding two weeks ago. We still have only a partial position in healthcare and would like to fill the position, but not at the current prices. Energy also continues to look intriguing, but much like healthcare the current prices still look a little high given the uncertainty over future demand, but there are a few individual names in the energy space that I am currently taking a very hard look at.

 

Economic News:  Last week was a busy week for economic news releases as we ended the month of February. There was one release that significantly beat expectations, highlighted below in green, and three releases that significantly missed market expectations, highlighted in red below:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 2/23/2015 Existing Home Sales January 2015 4.82M 4.95M
Neutral 2/24/2015 Case-Shiller 20-city Index December 2015 4.50% 4.30%
Negative 2/24/2015 Consumer Confidence February 2015 96.4 99.6
Neutral 2/25/2015 New Home Sales January 2015 481K 470K
Neutral 2/26/2015 Initial Claims Previous Week 313K 290K
Neutral 2/26/2015 Continuing Claims Previous Week 2401K 2400K
Slightly Positive 2/26/2015 CPI January 2015 -0.70% -0.60%
Neutral 2/26/2015 Core CPI January 2015 0.20% 0.10%
Positive 2/26/2015 Durable Orders January 2015 2.80% 1.70%
Neutral 2/26/2015 Durable Goods -ex transportation January 2015 0.30% 0.50%
Negative 2/27/2015 GDP – Second Estimate Q4 2014 2.20% 2.10%
Negative 2/27/2015 Chicago PMI February 2015 45.8 58
Slightly Positive 2/27/2015 University of Michigan Consumer Sentiment February 2015 95.4 94
Neutral 2/27/2015 Pending Home Sales January 2015 1.70% 2.40%

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

 

Last week started off on Monday with the release of the existing home sales figure for the month of January, which came in very close to expectations and gave little insight into the current state of the US housing market. On Tuesday more housing data was released, as well as the consumer confidence figure for the month of February, as measured by the US government. The Case-Shiller 20 City Home Price Index showed an annual gain from December to December of 4.5 percent, which was slightly above the expected 4.3 percent, but well below the high single digit rate many home owners have been accustomed to their homes appreciating by. The consumer confidence figure released Tuesday missed expectations in a pretty big way, falling from the January high of 103.8 all of the way down to 96.4. The reasons for the decline seemed to be pretty broad, but uncertainty about the housing market and interest rates did show up in the data. On Wednesday New Home Sales figures for the month of January were released, but they were lackluster as they beat expectations by just a small amount. On Wednesday the standard weekly unemployment related figures were released with both figures coming in higher than expected, but not high enough to cause alarm. Also released on Wednesday was the latest Durable Goods Orders data for the month of January, which handedly beat market expectations, coming in at 2.8 percent versus expectations of 1.7 percent. Much of the strong performance in orders was in the transportation sector; cars in particular had a great month. On Friday the second estimate of fourth quarter GDP was released and the number was revised down from the initial estimate of 2.6 percent to 2.2 percent. This slowing in growth is going to make it pretty hard to see how 2015 is going to hit the projected growth rate, unless something miraculous happens during the first half of 2015. The weather alone is a cause for concern as various regions of the country have been much less productive during the first quarter than they otherwise would have been, such as in Boston with the 8 feet of snow they have been dealing with. The Chicago area PMI for the month of February also showed a large decline during the month, giving yet another sign that the economy may not be as strong as everyone had been thinking. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of February, which saw sentiment fall off at the end of the month as prices at the pumps in particular seems to have hit consumer sentiment.

 

This is a busy week for economic news releases, in terms of the number of releases set to be released, as we start March and have all of the final releases for February being released. The releases highlighted below have the potential to move the overall markets on the day they are released as the markets seem to be trading with a very event/news driven mentality:

 

Date Release Release Range Market Expectation
3/2/2015 Personal Income January 2015 0.40%
3/2/2015 Personal Spending January 2015 -0.10%
3/2/2015 ISM Index February 2015 53
3/4/2015 ADP Employment Change February 2015 220K
3/4/2015 ISM Services February 2015 56.5
3/5/2015 Challenger Job Cuts February 2015
3/5/2015 Initial Claims Previous Week 295K
3/5/2015 Continuing Claims Previous Week 2404K
3/5/2015 Factory Orders January 2015 0.60%
3/6/2015 Nonfarm Payrolls February 2015 240K
3/6/2015 Nonfarm Private Payrolls February 2015 230K
3/6/2015 Unemployment Rate February 2015 5.60%
3/6/2015 Consumer Credit January 2015 $14.0B

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

 

This week starts on Monday with the release of personal income and spending for the month of January, which are not expected to show much change over the levels seen in December. The markets will likely be watching the overall ISM index much more closely than the income and spending figures as this number could see a large downward revision due to the inclement weather on the east coast. On Wednesday the first of the employment related figures for the month of February is set to be released with the ADP employment change figure for the month. Expectations are pretty low for this reading at 220,000 jobs having been created during the month. If this release significantly misses or beats expectations it could influence how the rest of the employment related releases of the week are looked at by the markets. Later during the day on Wednesday the Services side of the ISM is set to be released and will likely move in the same direction and at roughly the same magnitude as the overall ISM released on Monday, thus it will likely not be a market moving release. On Thursday three more jobs related figures are set to be released, those being the challenger job cuts figure for February as well as the standard weekly employment related figures. None of the releases really have the potential to move the overall markets as they are much less important than the jobs figures released the following day. Wrapping up the day on Thursday is the factory order data for the month of February, which is expected to show that orders increased by 0.6 percent. This seems like a very high target and it would not be surprising to see this figure actually come in negative, with the weather being the culprit for the miss. On Friday the big releases of the week that everyone will have been waiting for are released, those being the official unemployment rate in the US as measured by the government and the payroll numbers, all three for the month of February. The overall unemployment rate is expected to decline from 5.7 percent down to 5.6 percent, while public payrolls are expected to decline and private payrolls are expected to pick up. The participation rate, also released in the unemployment report, will be closely watched. Overall, we will likely see one or two of the releases beat expectations, while the others will likely miss, thus having an offsetting impact on the markets. This week wraps up on Friday with the release of the consumer credit report for the month of January, which is expected to show an increase in credit of $14 billion during the month, as interest rates on loans remain near historically low levels.

 

Fun fact of the week—Department of Home Land Security

 

In 2003 the United States Coast Guard was officially transferred to the Department of Homeland Security, being transferred from the Department of Transportation, which it had been under since 1967.

Source: United States Coast Guard http://www.uscg.mil/top/missions/

For a PDF version of the below commentary please click here Weekly Letter 2-23-2015

Commentary at a glance:

-Markets moved tepidly higher on low volume despite uncertainty.

-Earnings season is now in the home stretch and looking pretty good for now.

-A last minute Greek deal has been made, but items are still needed to secure it.

-Russia seems to be abiding with the terms of the cease fire—about a week late.

-Manufacturing data seems to be slowing on the east coast; the weather is being blamed.

 

Market Wrap-Up: Little changed from a technical standpoint last week as the NASDAQ remains very strong, while the S&P 500 follows and the Dow seems to be content just barely hanging on to its most recent trading channel. All the while, the VIX continues to pursue lower levels. The charts below are of the three major US indexes in green with their respective trading channels being drawn by the red lines. The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 2-23-15

Technology continued to fly high last week as the NASDAQ advanced at a faster pace than the other two major US indexes, now pushing ever closer to the all time high level for the index seen back in early 2000 just prior to the technology bubble bursting. If the NASDAQ continues on the current rate of change we have seen over the past two weeks we could see a new all time high on the index either at the very end of this week or early next week. How good it must feel for investors who actually stuck with the NASDAQ through thick and thin to now, 15 years later, finally to be made whole from their losses. Both the Dow and the S&P 500 have recently been making many new all time highs as well, highs of their respective 2000 levels back in 2007, just before the decline of 2008. Oil continues to be a major driving force behind the recent performance of the three major indexes, as does the lack of exposure to international markets. The NASDAQ is perhaps the least oil and US dollar fluctuation dependant index of the three major indexes, so when oil goes down it is the least exposed. The Dow has a significant weighting to oil, having both Exxon and Chevron as component companies. Additionally, nearly all component companies in the Dow have significant revenues coming from outside of the US and thus are hurt by the strong US dollar. The S&P 500 has about 30 percent of its earnings coming from the energy sector, not to mention a large number of component companies deriving significant amounts of revenue from abroad.  This make up of the indexes alone may largely explain the recent deviations in performance. If the above is true and holds true, we could be in for a long period of time when the NASDAQ out performs the other two major indexes. While all of this movement was occurring in the equity markets, the VIX was slowly meandering lower, seemingly minding its own business. On Friday the VIX hit the lowest level we have seen so far during 2015, during a week with very low volatility on the VIX; more on this below in the markets statistics section.

 

National News: National news last week focused on fourth quarter earnings season as there was little work being done in Washington DC thanks to a holiday and snow storm that shut down the US Federal Government. While the government may have been taking it slow, earnings results certainly were not. Last week was a very busy week for earnings releases as there were many household names that released earnings with a very wide mix of positive and negative results being shown. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Agilent Technologies 0% Hyatt Hotels 0% Nordstrom -2%
Avis Budget Group 28% Iron Mountain -19% Owens & Minor -4%
Barnes Group 2% Jack In The Box 7% Parker Drilling 50%
Bloomin’ Brands 4% La-Z-Boy -13% Public Storage 0%
Deere & Co 35% Marathon Oil -533% Teekay 54%
Denny’s 0% Marriott 5% T-Mobile 33%
EchoStar 55% Medtronic 4% Trulia pushed
Flowserve 3% MGM Resorts -83% Vornado Realty -1%
Genuine Parts 0% Noble Energy 9% Wal-Mart Stores 5%
Goodyear Tire & Rubber 2% Noodles & Co -7% Wolverine World Wide 0%

 

Some of the largest surprises of the week last week in earnings were among the energy related companies and the surprises were both good and bad. Marathon Oil missed by the largest percentage, but this is somewhat misleading as the expected number for earnings per share for the company was $0.03 and they actually turned in a loss of $0.13 per share. So while the percentage may be very large, the actual dollar difference is small. On the flip side, Parker Drilling beat expectations by 50% thanks to quick reactions to the falling oil prices and long term contracts for their rigs; the falling price of oil is not a detriment to all energy related companies. Wal-Mart was the other big announcement last week as the company beat expectations by 5 percent on an earnings per share basis, while revenues came in slightly lower than expectations. This beat by Wal-Mart shows that the discount retailers have been having an easier time than the higher end stores such as Nordstrom or La-Z-Boy, both of which missed their market expectations last week.

 

According to Factset Research, we have now seen 443 (89 percent) of the S&P 500 companies release their results for the fourth quarter of 2014. Of the 443 that have released, 75 percent of them have met or beaten earnings estimates (this is down 2 percent from two weeks ago), while 25 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 58 percent of the companies have beaten estimates (this number is unchanged from two weeks ago), while 42 percent have fallen short. The major driving sectors behind the strong earnings announcements have been telecommunications and healthcare, while the laggard has not surprisingly been energy. Energy earnings will be spoken about frequently in the coming weeks and months as they seem to be almost all of the reason for the decline in forward earnings expectations on the S&P 500 since they made up as much as 30 percent of total earnings for the S&P 500 prior the decline in oil prices. Forward looking guidance continues to be a major issue for many companies, which are citing a multitude of potential reasons for slower future growth, everything from Europe to Dollar strength, the US Fed policy or the declining price of oil. For whatever reason, the expectations of future earnings are being set very low. In the past this has made it much easier for companies to look like they are performing better than they really are, as hopping over a low bar is much easier than a high one; we will just have to wait and see if this is the case this time around. At this point in the earnings cycle it would take a lot of companies announcing earnings that deviate widely from expectations to change the above mentioned numbers pertaining to the number of companies beating or falling short of both earnings and revenues for the fourth quarter of 2014.

 

The focus of this week’s earnings releases will be the retail sales industry as many companies that sell items directly to the US consumers will be releasing earnings. Below is a table of the better known companies that will release their earnings this week, with the releases that have the most potential to impact the markets highlighted in green:

 

3D Systems Domino’s Pizza Ross Stores
Alleghany Gap Salesforce.com
Aqua America Hewlett-Packard Sanderson Farms
Babcock & Wilcox Home Depot Sears Holdings
Big 5 Sporting Goods J C Penney SeaWorld Entertainment
Campbell Soup Kate Spade & Co South Jersey Industries
Comcast Kohl’s Sturm Ruger & Co
Cooper Tire & Rubber Liberty Media Target
Crocs Lowe’s Companies TJX Companies
Dillard’s Macy’s Toll Brothers
DISH Network Papa John’s International Vitamin Shoppe
Dollar Tree Pinnacle Foods WebMD Health

 

After Wal-Mart easily beat expectations last week, the bar has been set a little higher for the other major retailers announcing earnings this week, companies such as Target, Sears and Kohl’s. Deep discount retailers such as Dollar Tree and Ross will also be closely watched to see if any of the money saved on gasoline trickles into their stores. Looking at the higher end of the US consumer, Gap and Toll Brother both release their earnings for the fourth quarter this week and it will be interesting to see if they have seen any change in their businesses due to the falling price of oil.

 

International News: International news last week focused on the same two problems it has been focusing on now for a month: the situation in Ukraine and the tenuous situation in Greece. The situation in Ukraine has been very unsettling over the past week as fighting in and around a few key towns continued, despite the cease-fire that was officially agreed to more than 1 week ago. One town that saw heavy fighting was Debaltseve, a key hub for rail traffic in Eastern Ukraine. At the time of the signing of the cease-fire the Russian-backed Rebels did not have control of the town, so they kept fighting and asking the Ukrainian soldiers surrender. After being shelled for days after the cease-fire the city finally fell to the rebels late last week. This same type of action occurred at several other cities as well last week, eventually giving way to the peace deal now being more fully implemented with a prisoner exchange having taken place as well as a small amount of heavy weaponry being moved back from the front line by both sides. The global financial markets will likely cheer the peace if it holds in the region, as this is one of the major unknowns on the geopolitical landscape that has been adversely affecting the financial markets. The other development last week was in Greece, one that may have kicked the can down the road just a little ways.

 

Greece has been quickly cruising toward the edge of a financial cliff ever since the new government was seated in Greece earlier this year. The new government ran on an anti-austerity and anti-bailout funds platform, both of which now look like campaign promises that cannot be kept. Late last week Greece’s Finance Minster announced that a deal had been made with the European creditors to extend Greece a temporary four month loan, to buy the country time to figure out how it will extract itself from the current situation. The Greeks had initially asked for 6 months, with no strings attached, but Germany quickly smashed this idea with a flat “no” answer. Greece ended up with a deal for four months that includes a list of reforms that Greece will take over the four months to comply with the lenders’ demand. The “list of reforms” has to be drawn up and presented to the international creditors by the end of today, 2/23/15. If the list is not drawn up to the satisfaction of the creditors, the deal will be scrapped all together and Greece will likely find itself once again trying to scramble to secure funding by the end of this month or else risk defaulting and potentially finding itself without the Euro. So what was actually accomplished in the latest deal? Almost nothing is the short answer. While a looming default would be moved from this month to the end of June there has been almost no work to fix the actual problem, like Greece’s debt to GDP being more than 175 percent. It was almost comical last week to hear the Greek government officials try to spin the deal as a victory for them and yet it is not even a done deal at this point. We will just have to wait and see what comes of the “list of reforms” to see if the party comes to an end in Greece quickly or slowly.

 

Market Statistics:

Index Change Volume
NASDAQ 1.27% Below Average
Dow 0.67% Below Average
S&P 500 0.63% Below Average

 

The three major indexes in the US have now advanced three weeks in a row. Overall last week the volume was below average, but nearly all of this can be explained by Monday being a holiday and the US markets being closed for the day. The reasons for the move last week on the three major indexes remain unclear. Earnings announcements, peace in Ukraine and a potential Greek debt deal all potentially played a part in the increase last week. Going forward, earnings season will likely drive the markets as will speculation about the future move of the US Federal Reserve.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Biotechnology 4.01% Energy -2.17%
Aerospace & Defense 3.12% Natural Resources -1.65%
Pharmaceuticals 2.51% Oil & Gas Exploration -1.35%
Industrials 2.20% Telecommunications -0.68%
Healthcare 2.11% Regional Banks -0.52%

With the NASDAQ seeing such strong performance it was not surprising to see that two of the top three sectors in terms of performance last week are heavily listed on the NASDAQ. The Aerospace and Defense sector saw strong performance last week as it looks like the situation in the Middle East with ISIS will be very long and drawn out. Add in uncertainty over the situation in Russia and China and you can easily see why investors think the sector could be seeing a lot more demand in the coming years. On the flip side, energy and oil in particular had a rough time last week as the rally of the past three weeks came to an end last week as oil moved lower.

Fixed income was mixed last week as investors weigh the new deal over Greek debt and the potential impact it will have on the rest of Europe and, in particular, on the ECB’s bond buying program:

Fixed Income Change
Long (20+ years) -1.29%
Middle (7-10 years) -0.54%
Short (less than 1 year) 0.01%
TIPS -0.16%

Last week the US dollar increased in value by 0.20 percent against a basket of international currencies, ending three weeks of declines. The strongest of the major global currencies last week was the Australian Dollar as it gained 1.07 percent against the US dollar. This was a major change of direction for the Australian Dollar as it has been in a free fall since early September as the price of many global natural resources fell. The weakest of the major global currencies last week was the Swiss Franc for the second week in a row as it fell by 0.62 percent against the value of the US dollar. Surprisingly, last week the Euro lost 0.11 percent against the value of the US dollar, despite there being the announcement of a potential deal between Greece and its creditors. Maybe this is a sign that the deal may fall apart at the last minute or that it really is just kicking the can down the road four months.

Commodities and metals all moved lower last week as oil reversed its recent trend and pushed lower:

Metals Change Commodities Change
Gold -2.29% Oil -3.73%
Silver -6.05% Livestock -1.57%
Copper -0.16% Grains -1.17%
Agriculture -1.78%

The overall Goldman Sachs Commodity Index turned in a loss of 2.17 percent last week. Much of the decline in the overall commodities market can be attributed the fall in oil last week, which slid by almost 4 percent as renewed downward pressure seems to be taking hold. Even the safe haven assets such as precious metals were not spared last week as Gold fell by more than 2 percent and Silver sold off more than 6 percent. Agriculture had a rough week as well last week with everything from grains to live cattle and lean hogs declining in value.

On the international front Japan saw the best performance of the week with the Tokyo based Nikkei gaining 2.34 percent, as exporters continue to perform very well thanks in large part to the weakness seen in the Yen over the past few months. This quarter’s earnings from Japanese companies has shown a dramatic increase in demand for exported goods, while imported goods have fallen as they are more expensive than they used to be for Japanese consumers. The only declining index of the major global indexes last week was in Canada and was the Toronto Stock Exchange, which fell by 0.61 percent thanks to the falling prices of oil and the precious metals. It is unlikely that we will see any of the major Chinese indexes make it into either the top or bottom spot this week as the markets are closed for the lunar new year for several days, both last week and this week.

The VIX had a very boring week. It not only moved down by 2.65 percent over the course of the week, but it also did not have any intraday changes greater than 14 percent, something that is pretty rare given the market environment the VIX has experienced over the past few months. I was a little surprised to not see more of a reaction to the announcement of the deal in Greece. I was expecting the VIX to move noticeably lower on the announcement, but that turned out not to be the case.  At the current level of 14.30 the VIX is implying a move of 4.13 percent over the course of the next 30 days. As always, the direction of the move is unknown. This VIX is now at the lowest level we have seen so far during 2015 and looks to be headed lower.

For the shortened trading week ending on 2/20/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 0.97 % 3.07 %
Aggressive Benchmark 0.71 % 3.03 %
Growth Model 0.81 % 2.26 %
Growth Benchmark 0.56 % 2.38 %
Moderate Model 0.65 % 1.40 %
Moderate Benchmark 0.40 % 1.72 %
Income Model 0.55 % 0.93 %
Income Benchmark 0.21 % 0.88 %

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

 

We made two changes in our models over the course of the previous week: one purchase and one sell. The purchase made last week was in the Healthcare sector and was the Rydex Healthcare mutual fund (ticker RYHIX). We took an initial position in the fund utilizing the cash we had on hand. We intend to add to this position in the future in either one or two more steps until we have a full position in the fund. Our sell last week was in real estate as we sold our holding of the Schwab Real Estate ETF (ticker SCHH). Real Estate looks as if it has started to turn over as the trade appears to be linked to the 10-year US government bond yield. This makes a lot of sense because many refinancing and home mortgages rely on the 10-year yield, so if the yield on the 10-year is increasing, then so too are mortgage rates, thus slowing real estate demand. We held the position on the thought that yields may decrease over fears that Greece may be in for more trouble, but with last week’s actions effectively kicking the can down the road it looks like the real estate trade in the US could struggle for a few more months. We allocated the proceeds from the sale of SCHH to cash for the time being and are actively looking to allocate the funds when appropriate. Healthcare, Biotechnology and Pharmaceuticals still look like the most interesting sectors of the market currently.

 

Economic News:  Last week was a slow week for economic news releases as it was a middle of the month week that also included a holiday. There was one release that significantly missed market expectations, highlighted in red, and no releases that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 2/17/2015 Empire Manufacturing February 2015 7.8 9
Neutral 2/18/2015 Housing Starts January 2015 1065K 1070K
Neutral 2/18/2015 Building Permits January 2015 1053K 1065K
Neutral 2/18/2015 PPI January 2015 -0.80% -0.40%
Neutral 2/18/2015 Core PPI January 2015 -0.10% 0.10%
Neutral 2/18/2015 FOMC Minutes Previous Meeting
Neutral 2/19/2015 Initial Claims Previous Week 283K 295K
Neutral 2/19/2015 Continuing Claims Previous Week 2425K 2385K
Negative 2/19/2015 Philadelphia Fed February 2015 5.2 8.5

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

 

Last week started off on Tuesday with the release of the Empire Manufacturing index, which showed that while manufacturing in the greater New York region picked up during February, it did so at a slightly slower pace than was first expected. On Wednesday two housing figures were released with both coming in close to, but under, market expectations, leading to little reaction by the markets. Also released on Wednesday was the Producer Price Index (PPI), which indicated that prices at the producer level declined by 0.8 percent during January, thanks in large part to a continued fall in the price of oil and energy. Released mid day on Wednesday was the FOMC meeting minutes from the last meeting, but they held little if any new information as it looks like the Fed is content on waiting to increase interest rates until there is some more clarity on a number of various topics. On Thursday the standard weekly unemployment related figures were released with initial claims slightly beating market expectations, while continuing claims slightly missed expectations, thus causing the two releases to have an offsetting effect on each other. Wrapping up the week on Thursday last week was the sole truly negative release of the week as the Philadelphia Fed released its index for the month of February, which showed that business is slowing down in the greater Philly region, thanks in part to adverse weather, which has been hampering the region now for almost the entire month.

 

This is a busy week for economic news releases in terms of the number of releases set to be released. The releases highlighted below have the potential to move the overall markets on the day they are released as the markets seem to be trading with a very event/news driven mentality:

 

Date Release Release Range Market Expectation
2/23/2015 Existing Home Sales January 2015 4.95M
2/24/2015 Case-Shiller 20-city Index December 2015 4.30%
2/24/2015 Consumer Confidence February 2015 99.6
2/25/2015 New Home Sales January 2015 470K
2/26/2015 Initial Claims Previous Week 290K
2/26/2015 Continuing Claims Previous Week 2400K
2/26/2015 CPI January 2015 -0.60%
2/26/2015 Core CPI January 2015 0.10%
2/26/2015 Durable Orders January 2015 1.70%
2/26/2015 Durable Goods -ex transportation January 2015 0.50%
2/27/2015 GDP – Second Estimate Q4 2014 2.10%
2/27/2015 Chicago PMI February 2015 58
2/27/2015 University of Michigan Consumer Sentiment February 2015 94
2/27/2015 Pending Home Sales January 2015 2.40%

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

 

This week starts on Monday with the release of the existing home sales figure for the month of January, which is expected to show a reading of just under 5 million homes being sold during the month. With the US housing market softening a little on the increased rates, some positive data on this release to start the week that has several key housing related releases could go a long way. On Tuesday the Case-Shiller 20 City Home Price index is set to be released with expectations of a small increase of 4.3 percent during the month of December. This data is so stale that it would take a very wide deviation from expectations for this release to move the markets. However, released later during the day on Tuesday is the Consumer Confidence Index for the month of February and this release could have a noticeable impact on the overall markets if is misses expectations, and the expectations look pretty high by my estimation. On Wednesday the release of the day is the new home sales figure for the month of January, which is expected to show something just under 500,000 units, the highest level since late 2008 as the US economy was heading into the recession. If this number comes to fruition it could be seen as a very positive development for the overall US economy. On Thursday the standard weekly unemployment related figures are set to be released with expectations of little change over the previous level. Later during the day on Thursday the Consumer Price Index (CPI) is set to be released with expectations that prices will be shown to have declined by 0.6 percent during January, thanks entirely to the falling price of oil and in turn energy. Core consumer prices (prices excluding food, fuel and energy) are expected to have increased slightly during the month. Also released on Thursday is perhaps one of the most important releases of the week, that being the Durable Goods Orders figure for the month of January, which is expected to show a gain of 1.7 percent overall and 0.5 percent when transportation is removed from the calculation. These two releases need to be strong this week or it could really spook the markets. Consumer confidence has been increasing during the recent months, but the spending has not shown the same, meaning consumers are confidently holding cash. We need to get the US consumer spending again in order to get the US economy growing at a faster pace than it currently is doing. On Friday we will get a reading of just how well the US economy is growing as the second version for the fourth quarter GDP figure is set to be released. Expectations are for a reading of 2.1 percent down from the first estimate of 2.6 percent. Anything under 2 percent could cause a problem for the markets while any upside surprises over 2.6 percent could be taken as very positive. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of February, which is expected to show a very small increase from the first expectations of 93.6 for the month. Perhaps more important than all of the releases this week is the testimony of Federal Reserve Chair Yellen as she testifies before the Joint Economic Committee in Congress, during which she will read a prepared statement and then take questions at length from members of Congress. The markets will be watching her testimony very closely for signals as to when and by how much interest rates may start to increase and it could really move the markets.

 

Fun fact of the week—The Oscars, what is a trophy really worth?

 

The value of the raw materials in each Oscar is around $900. Although they shine golden, and are clad in a hefty coat of 24-carat gold, at their core an Oscar is made of a variant of pewter – a special alloy called britannium made especially for Oscar figures.

Source: The Daily Mail http://www.dailymail.co.uk

For a PDF version of the below commentary please click here Weekly Letter 2-17-2015

Commentary at a glance:

-Markets rallied around the world on the heels of positive geopolitical developments.

-Greece and Ukraine—problems solved?

-Earnings season is now more than three quarters behind us and still looking strong.

-Poor retail sales figures for January continue to cause concerns about the US economy.

 

Market Wrap-Up: Breakout! Last week the NASDAQ managed to breakout to the upside of its channel, a level of technical resistance that had been in place for more than three months. The index has now moved to within 110 points of breaking above the 5,000 level, something that has not been done since the year 2000. The charts below are of the three major US indexes in green with their respective trading channels drawn by the red lines. The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 2-17-15

As you can see in the above charts, all three of the major US indexes moved nicely higher last week as progress was made in several of the key geopolitical hotspots around the world. In terms of technical strength, the NASDAQ is now far and away the strongest of the three major indexes as it broke and closed above its most recent resistance level. While the technicals for the S&P 500 and the Dow were not nearly as exciting as the NASDAQ, both indexes also turned in a good week. The S&P 500 managed to break back into its most recent trading channel and move up toward the middle of the channel, making the index the second strongest of the three. The Dow was the laggard, as you would expect in a week that saw such a “risk on” trade occur, but even the Dow had a positive development. The Dow last week managed to move back into its most recent trading channel; even if it just barely managed to do so, it still made it. At this point it looks like the markets could be positioned to move higher, but all of their recent moves hinge on two main developments: the bailout situation in Greece and the cease-fire achieved in Russia over the weekend, both of which are looked at more closely in the international news section below. While all of the equity markets were moving higher last week, the VIX, as expected, moved in the opposite direction as investors became less worried about volatility in the markets and more concerned about not being in the markets to participate in the most recent rally. The VIX has now ended its heightened volatility level and is at the lowest point we have seen so far during 2015. It would be nice to see a period in which the VIX does not spike higher, as it has three times this year, but with uncertainty still on the horizon it would not be surprising to see the VIX start to rise yet again. So where could the markets go from here?

 

Most likely the markets will continue to move in a very wide trading range, as there have been very few structural changes in any of the issues that led to the most recent round of volatility. Europe is still not competitive and the strong country or countries, however you look at it, are still carrying the deadweight of smaller, less economically meaningful countries. In Ukraine, the situation looks okay for now, but that does not mean Russian President Putin will not coming roaring back in with guns blazing at the slightest report that “Russian” speaking people need to be saved from the Ukrainian government. Both the S&P 500 and the Dow still have room to move higher and remain in their respective trading ranges. The NASDAQ, however, broke well above its most recent trading range and does not look to be headed back lower, at least for now. Oil will also remain one of the key drivers of market performance over the coming weeks as prices at the pump have been slowly increasing as oil prices on the global markets have also been increasing. It does not look or feel like the volatility is over in this market, but rather that it is just taking a break and consolidating before moving ahead once again. This ebb and flow of investments is exactly the type of market where active investment management helps overall portfolio risk and returns. In a market that is chopping like this one, it is imperative to have something in place to protect yourself on the downside so that you do not give up all of your gains, while at the same time having a strategy that is nimble enough to adjust to changing market environments.

 

National News: National news last week was very slow with many politicians seemingly taking the week off for the upcoming holiday weekend. The biggest piece of news last week aside from earnings season is the fact that the Keystone XL pipeline bill has now passed both the US House of Representatives and the Senate and is now on the President’s desk awaiting either his signature or his veto. The support for the measure was bipartisan with nearly all republicans and a number of democrats voting in favor of the measure. If the President vetoes the bill it will be sent back to Congress where a two-third vote in both the Senate and the House is needed to override the President’s veto. If the bill were to be sent back right now it looks like there would only need to be 4 more votes in the Senate in favor of the measure coming from the democratic side of the aisle to get to the two thirds majority. In the House it looks like it could be a little more of stretch to get the votes to override the veto as 12 more votes are needed to get it passed by a two thirds majority. While it is unlikely to garner the votes it needs to override a veto this time around, it seems something will be created over the next few iterations of the bill that will have enough support behind it to pass the bill. One of the driving factors for passing the bill may be public fear as another train carrying oil derailed and exploded over the weekend. While the horse trading is going on in Washington DC, earnings season continues to roll ahead for the rest of the US and it is shaping up to be a pretty good fourth quarter earnings season.

 

Last week was a very busy week for earnings releases as there were many household names that released earnings with a very wide mix of positive and negative results being shown. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Advance Auto Parts 4% J M Smucker 3% Spirit Airlines 4%
AOL 42% Kellogg -7% Tesla Motors -420%
BorgWarner 0% Kraft Foods 16% Time Warner 4%
Cabela’s -18% Martin Marietta Materials 16% Trulia pushed
Cisco Systems 11% Metlife 1% VF Corp -1%
Coca-Cola 5% Molson Coors Brewing -18% Waste Connections 4%
CVS Health 0% Mondelez International 9% Western Union 24%
Dean Foods -20% Panera Bread 3% Whole Foods Market 2%
Flowers Foods 18% PepsiCo 4% Wisconsin Energy -2%
Groupon 200% Red Robin Burgers -4% Wyndham Worldwide 5%
Hasbro 0% Scripps Networks 9% Zillow -67%

 

According to Factset Research, we have now seen 391 (78 percent) of the S&P 500 companies release their results for the fourth quarter of 2014. Of the 391 that have released, 77 percent have met or beaten earnings estimates (this is down 1 percent from two weeks ago), while 23 percent have fallen short of expectations. When looking at the revenue of the companies that have reported, 58 percent of the companies have beaten estimates (down 1 percent from two weeks ago), while 42 percent have fallen short. As we cross over the three quarters mark on earnings season, we are now almost exactly at the levels seen for the third quarter of 2014 as far as the number of companies beating estimates on both earnings and revenues. One big change this quarter is that the future guidance has been slowly coming down. So far 63 companies have revised their earnings expectations lower for the first quarter of 2015 and only 11 companies have issued positive guidance for Q1 2015. Much of the negative outlooks are coming from the energy sector, but the strong US dollar has also been playing into the numbers for large multinational companies that have to sell goods abroad in foreign currencies.

 

The focus of this week’s earnings releases will be the leisure industry as many of the large hotel chains release their earnings. Below is a table of the better known companies that will releases their earnings this week, with the releases that have the most potential to impact the markets highlighted in green:

 

Agilent Technologies Hyatt Hotels Nordstrom
Avis Budget Group Iron Mountain Owens & Minor
Barnes Group Jack In The Box Parker Drilling
Bloomin’ Brands La-Z-Boy Public Storage
Deere & Co Marathon Oil Teekay
Denny’s Marriott International T-Mobile
EchoStar Medtronic Trulia
Flowserve MGM Resorts Vornado Realty
Genuine Parts Noble Energy Wal-Mart Stores
Goodyear Tire & Rubber Noodles & Co Wolverine World Wide

 

This week will focus on the releases of three very large hotel operators: Hyatt, Marriott and MGM. Consumer spending normally includes a healthy amount of money being spent on leisure activities such as traveling and vacations. With such a global footprint, Hyatt and Marriott are in a unique position to see very early on the spending patterns of a large group of people around the world and to determine if they are spending more or less on leisure and vacations. The release of Wal-Mart earnings is always a big release as Wall Street looks to the retailer for guidance on the whole discount shopper and shopping experience. While many people dislike Wal-Mart, its dominance of the discount retail space in the US is hard to argue with. I am looking for any guidance about an increase in spending that Wal-Mart is seeing due to the declining prices in oil that resulted in savings at the pump. Wal-Mart would be one of the first retailers to see such a change and will likely comment about it in the quarterly release. One other major thing to watch for in the release is the holiday sales figures and how well the retailer did in capturing the very coveted holiday shoppers. If Wal-Mart saw sales declining across the board it could prove to be an early warning sign for the US economy as a whole as we have been seeing very confident consumers choose to hold onto their money rather than spend it.

 

International News: International news last week focused on the same two topics it has been focusing on for the past few months: the situation in Greece and the situation in Ukraine. Greece is inching ever closer to the drop dead date for a deal on its debt, as a major payment is due in a few short weeks and Greece does not currently have the funds to make the payment without receiving further bailout funds. These would be the same bailout funds Greece has said in the past it will refuse to take. Last week there was a meeting of the finance ministers of Europe at which they were supposed to agree to either save Greece or let it go; in the end there were no major announcements out of the meeting. Germany is still pounding the table, not wanting to make any changes to existing debts or austerity programs for Greece. As the paymaster for Europe its voice has to be listened too. The odds are now up to 50/50 as to whether Greece will be forced off the Euro and default on its debt in the next 6 months. This is a massive change from the almost zero chance of said actions just a few short months ago. It seems there are still a few chapters in this story that need to be written before we know the actual outcome of the situation. The other situation that made headlines last week and affected the global financial markets was the situation in Ukraine.

 

Yet another cease-fire has been agreed to between Russia, the rebels and the Ukrainian government. This cease-fire is much like the one agreed to back in October and has many of the same points, but for some reason people think this one may actually work. The proposal draws up a demilitarization zone and calls for the withdrawal of troops by both sides from the zone. It also calls for the eastern region to be more autonomous from the government in Kiev and calls for the withdrawal on both sides of the heavy weaponry that is currently being used. It seems odd, however, that Russia would back down to international demands at this point and give in on the situation in Ukraine. The price of oil has been moving higher over the past few weeks and the rebels/Russians have been making pretty significant strides into eastern Ukraine. To fight all this time and then just pack up and go back home does not seem like something Russian President Putin would do, especially with the amount of public support he has received for taking the actions in Ukraine. This is more likely just a stall tactic by Russia or an attempt to get the Ukrainian military to withdraw slightly so that it is easier for the Russians to take new land. Also, while the cease-fire is technically in place there has still been a lot of fighting around a few key cities that are transportation hubs for all of eastern Ukraine—so it is not as peaceful as some may think a cease-fire should be.

 

Market Statistics:

Index Change Volume
NASDAQ 3.15% Average
S&P 500 2.02% Average
Dow 1.09% Average

 

The three major indexes in the US have advanced two weeks in a row. Much of the advance seems to be on optimism on both a Greek debt deal materializing and the belief that the ceasefire between Ukraine and Russia may hold. The movements in the markets last week seemed to indicate that investors were more willing to take on investment risk than they have been over the past few months. This is primarily seen in the drastic outperformance of the NASDAQ versus the other two indexes and in the outperformance of the S&P 500 over the Dow. The standard risk scale for the three major indexes is that the NASDAQ is the most risky, while the S&P 500 is in the middle and the Dow is the least risky index of the three. During a “risk on” trading week you will see performance of the three major indexes in the order seen last week; during a “risk off” trading week the opposite would be true with the Dow seeing the best performance, followed by the S&P 500 and then the NASDAQ. Overall last week the volume was at the average level seen on each of the indexes, which tells me there were no major shifts in asset allocations by large institutional investors.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Semiconductors 5.00% Utilities -2.99%
Technology 4.64% Real Estate 0.19%
Software 3.78% Infrastructure 0.40%
Materials 3.39% Consumer Staples 0.83%
Oil & Gas Exploration 3.21% Telecommunications 0.93%

With the NASDAQ seeing such strong performance it was not surprising to see that the top three sectors of the markets last week were all technology related. Semiconductors is typically one of the most volatile sectors of the markets, but Semiconductors is also the sector that reacts the most positively when the markets are moving higher. One sector that was curiously missing last week in the positive column was Biotechnology, which saw average performance last week, gaining only 2.49 percent for one reason or another. On the downside for the sectors last week, Utilities led the way lower for the second week in a row, giving up almost 3 percent as investors seemed to be favoring more risky investment options. Utilities was the only sector that saw a decline last week as the rest of the major sectors of the markets turned in positive performance.

Fixed income moved lower last week as investors continued to seem willing to step out of the safety of US fixed income investments and into other investment opportunities:

Fixed Income Change
Long (20+ years) -2.12%
Middle (7-10 years) -0.63%
Short (less than 1 year) 0.00%
TIPS -1.05%

Last week the US dollar decreased in value by 0.60 percent against a basket of international currencies, making it three weeks in a row of declines. The decline in the US dollar could have been largely due to the increase in the price of oil as it continues to creep higher with global demand seeming to pick up ever so slightly. The strongest of the major global currencies last week was the British pound as it gained 1.08 percent against the US dollar; the British pound has recently been looking better and better in light of the troubles the Euro has been having. Britain’s decision to opt out of joining the Euro now looks like a very smart decision. The weakest of the major global currencies last week was the Swiss Franc, which fell by 0.59 percent against the value of the US dollar as currency traders around the world continue to adjust their positioning for the newly free floating currency.

Commodities and metals were mixed last week as oil continued to move higher and gold moved lower:

Metals Change Commodities Change
Gold -0.56% Oil 2.11%
Silver 3.18% Livestock -0.52%
Copper 0.52% Grains 0.91%
Agriculture 0.73%

The overall Goldman Sachs Commodity Index turned in a gain of 1.97 percent last week. Oil turned in a positive 2.11 percent for the week, which is a far cry from the nearly 8 percent it jumped higher two weeks ago, but it does represent the third consecutive week of gains. With three weeks in a row of gains on the books some investors are calling the recent move in oil the turn off the bottom, but it still seems early to be making that call. Much of the turnaround in the price of oil could just be short covering, in which someone who was short oil buys it back to close out their short contract. It would be more conclusive to see oil stay in a tight trading range for a little while as the trades all settle out before starting to move one direction or the other. Silver joined the party last week, moving higher by more than 3 percent, while Gold fell by a little more than half of a percent. On the more agriculture side of investing, small gains were seen across most of the investments, while livestock posted slight losses for the week.

The global financial markets cheered the deal that brought the fighting in Ukraine officially to a cease-fire, despite continued fighting in a few key cities, leading to the MSCI Russia Capped Index turning in the best performance of the week after gaining 9.82 percent. If the fighting between the two sides actually comes to an end, it is likely we will see the Russian index continue to climb higher, as hopes for a more lasting peace between the two countries will likely put many people at ease. Hong Kong saw the lowest performance of the week last week as the Hang Seng Index managed to gain just 0.01 percent over the course of the week. Over the next week much of Asia will be closed due to the lunar New Year, so trading on the Asian indexes may be much less than normal.

The third spike so far during 2015 is now officially over for the VIX as it moved lower throughout last week, closing out the week almost exactly on top of the one year average level of the VIX. While we remain significantly higher than we were throughout the majority of 2014, the VIX does appear to be set on moving lower. Much of the recent move hinges on the situation in Greece being worked out and the situation in Ukraine turning from hot to cooler. As always, the VIX is a very finicky index and is prone to very large swings in both directions. At the current level of 14.69 the VIX is implying a move of 4.24 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 2/13/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 1.30 % 2.10 %
Aggressive Benchmark 1.56 % 2.31 %
Growth Model 0.76 % 1.43 %
Growth Benchmark 1.21 % 1.81 %
Moderate Model 0.23 % 0.75 %
Moderate Benchmark 0.87 % 1.31 %
Income Model -0.11 % 0.38 %
Income Benchmark 0.43 % 0.67 %

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

 

We made no changes to our models over the course of the previous week. We continue to look for good investment opportunities going forward. Currently, we are evaluating energy, oil and gas, healthcare and pharmaceuticals for possible investment. Energy as well as oil and gas have come way down and now look like they are trying to turn around, but it still may be early to step in. Healthcare and pharmaceuticals have been performing well over the past few weeks and currently seem to be the most likely candidates for future investment.

 

Economic News:  Last week was a slow week for economic news releases with all but one of the releases being released on Thursday. There were two releases that significantly missed market expectations (highlighted in red) and no releases that significantly beat market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 2/12/2015 Initial Claims Previous Week 304K 285K
Neutral 2/12/2015 Continuing Claims Previous Week 2354K 2395K
Negative 2/12/2015 Retail Sales January 2015 -0.80% -0.40%
Negative 2/12/2015 Retail Sales ex-auto January 2015 -0.90% -0.40%
Slightly Negative 2/13/2015 University of Michigan Consumer Sentiment Index February 2015 93.6 98.3

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

 

Last week started out late on Thursday with the release of the standard weekly unemployment related figures for the previous week. Initial jobless claims came in higher than anticipated while continuing claims came in lower, thus having an offsetting effect on each other. The bigger news of the day on Thursday, however, was the retail sales figure for the month of January, which was awful. Expectations had been for a decline of 0.4 percent on both overall retail sales and retail sales excluding autos. But the release missed these expectations showing that retail sales declined by 0.8 percent overall during January and 0.9 percent when calculated excluding auto sales. This comes on the heels of a -0.9 percent change in retail sales during the month of December, making in two months in a row of falling retail sales. This is concerning as retail sales make up a large percentage of the overall US economy. On Friday the final economic news release of the week was released, that being the University of Michigan’s Consumer Sentiment Index for the month of February (second estimate) and it indicated that the US consumer is less confident than just two weeks ago, coming in at a reading of 93.6 versus a reading of 98.3 two weeks ago. These three releases at the end of the week last week combined are concerning, as it seems to be signaling a slowdown in the US economy, an economy that is already growing at just a little more than stall speed.

 

This is a standard week for economic news releases in terms of the number of releases set to be released. The releases highlighted below have the potential to move the overall markets on the day they are released as the markets seem to be trading with a very event/news-driven mentality:

 

Date Release Release Range Market Expectation
2/17/2015 Empire Manufacturing February 2015 9
2/18/2015 Housing Starts January 2015 1070K
2/18/2015 Building Permits January 2015 1065K
2/18/2015 PPI January 2015 -0.40%
2/18/2015 Core PPI January 2015 0.10%
2/18/2015 FOMC Minutes Previous Meeting -
2/19/2015 Initial Claims Previous Week 295K
2/19/2015 Continuing Claims Previous Week 2385K
2/19/2015 Philadelphia Fed February 2015 8.5

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

 

This week starts off on Tuesday with the release of the Empire Manufacturing index for the month of February, which should provide some insight into the manufacturing that is taking place in the greater New York area. Expectations are for a reading of 9, which means that manufacturing expanded in February in the region, but that it did so at a slower pace than in December when the reading was 9.9. Any deviation of more than one or two points from this figure could cause the markets to move. On Wednesday the housing sector comes into the spotlight with Housing Starts and Building Permits being released for the month of January. Both are expected to maintain a level of more than 1 million units, which would be a very positive sign for the strength of the US housing market. Later during the day on Wednesday the Producer Price Index (PPI) is set to be released with expectations that prices at the producer level will be shown to have fallen by 0.4 percent during January, thanks in large part to the declining prices of energy. Core PPI (PPI minus energy, food and fuel costs) are expected to post a small gain of 0.1 percent during the month. Midday on Wednesday the FOMC is set to release the meeting minutes from their most recent meeting. There is not expected to be much new in the release, but as always the market could react to the release if there is anything that is not expected in the release. On Thursday the standards weekly unemployment related figures are set to be released with little change expected in either initial or continuing jobless claims. Wrapping up the week on Thursday this week is the release of the Philadelphia Fed Index for the month of February, which shows the business and manufacturing conditions in the greater Philly area. This release will likely show a figure that is in the same direction as the Empire Manufacturing index release earlier during the week. Much like the Empire index, any deviation from expectations would have to be more than a point to really make a difference.

 

Fun fact of the week—Snow in Boston

 

  1. Boston set a new record for most snowfall in a 30-day period, with 73.3 inchesbetween Jan. 12 and Feb. 10.
  2. The city’s total accumulation for the winter season is 79.5 inches,according to the National Weather Service.
  3. That means Boston needs 28.2 more inches before spring to top its all-time seasonal record of 107.6, which it reached in 1995-96.

Source: time.com

For a PDF version of the below commentary please click here Weekly Letter 2-9-2015

Commentary at a glance:

-Oil rallied for a second week in a row.

-Greece continues to drive uncertainty.

-President Obama’s budget gets a cool welcome in Capital Hill.

-Strong payroll numbers showed labor market improvement.

 

Market Wrap-Up: Last week saw all three of the major US indexes post gains that met or exceeded the declines seen two weeks ago. All three of the major indexes briefly moved back into their respective trading channels only to see two of the three indexes end the week just below their lower support level. The charts below are of the three major US indexes in green with their respective trading channels drawn by the red lines The VIX (lower right pane below) is drawn with the index in green and the one year average level of the VIX drawn with the red line:

4 charts 2-9-15

“Uncertain” would be the best word to describe the market movements of the past week and so too the movements of 2015 thus far. We have seen six moves on the Dow in excess of 450 points either up or down in just 25 trading days; this represents the epitome of a market that is searching for direction. While the markets have been searching for direction, so too has volatility which, while elevated compared to the average level seen over the past year, remains somewhat muted given the uncertainty being seen around the world. Oil was perhaps the largest driver of performance last week as it rallied for a second week in a row, having now gained more than 16 percent since the low point hit back on January 29th. The reason for the push higher in the price of oil remains unclear. It looks like investors being forced to cover their shorts, some stabilization in global supply and demand and a strike at a few key refineries in the US seem to be helping push up the prices. There is much speculation on the street as to where oil will go from here and the potential impact of such moves. Economists and analysts alike have put targets out on the price of oil that range from $20 to as much as $80 before the end of the year with some longer term estimates of $200 per barrel thanks to a lack of spending by the oil and gas industry. It really is anyone’s guess as to what the price of a barrel of oil will be at any point in the future. More important is what impact the lower price of oil will have on the US economy. The US economy will likely benefit from lower oil prices as it means lower prices at the pump and therefore consumers having more money to spend elsewhere. The trouble with this theory is that we have not seen an increase in spending as prices at the pump have declined. In fact, we have seen the opposite as consumers seem to be pulling back on spending in light of the economic uncertainty around the world.

 

National News: President Obama released his 2016 budget last week and to no surprise many of the items in the budget will be non-starters in Washington DC, with both parties having major issues with many parts of the budget. The budget, called by some a “utopian vision,” in total calls for spending of $4 trillion, while collecting $3.5 trillion in revenues, leaving a deficit of $500 billion over the course of the year. This $500 billion deficit in 2016 would be only slightly higher than it was during 2015 when it came in at $483 billion and a far cry from the more than $1 trillion deficits being consistently run just a few years ago. There are interesting aspects to the budget, such a spending almost $500 billion on public works over the next ten years. There is also spending for education, making two years of community college free and starting and funding a new early learning program for kids nationwide. While some people may disagree on how the money will be spent, there is even more disagreement on how revenues will be increased. The main focus of revenue increases is from new taxes on corporations as well as wealthy individuals. But the tax increases do not stop there; proposed tax increases also span a pack of cigarettes (from $1.01 up to $1.95), the estate tax and the capital gains tax rate. One area of spending that is not addressed in the budget is the rising costs of Social Security and Medicare; these two areas seem to be just too difficult a task for politicians to tackle. In the end, the budget outlined by the President will likely fall on deaf ears, as the Republican controlled Congress will come up with its own budget over the next few weeks and it is highly unlikely that there will be much congruency between the two. One interesting aspect of the budget is that it doesn’t really even matter as the US has routinely operated without a budget since 2007, utilizing continuing resolutions to fund the government instead of an actual passed budget. While the budget fight was just getting started in Washington DC, earnings season across the rest of the US has now passed the halfway mark for fourth quarter 2014 earnings.

 

Last week was a very busy week for earnings releases as there were many household names that released earnings with a very wide mix of positive and negative results being shown. Below is a table of the better known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

1-800-Flowers.Com 1% Chipotle Mexican Grill 1% Level 3 Communications 6% Rent-A-Center -21%
Aaron’s 8% Church & Dwight -3% LinkedIn 300% Ryder System 1%
Aetna 0% Clorox 8% Martin Marietta Materials pushed Sirius 0%
Aflac 0% Cummins 2% McGraw Hill pushed Snap-On 8%
Allstate 3% Dunkin’ Brands -2% Merck & Co 2% Southern -3%
Anadarko Petroleum -55% Equity Residential 4% Moody’s 19% Sprint 22%
Archer Daniels Midland 8% Estee Lauder 8% New York Times 13% Symantec 9%
Arrow Electronics 3% Exxon Mobil 17% News Corp 8% Twitter 29%
Arthur J. Gallagher 4% General Motors 40% Noble -2% Under Armour 3%
Atmel 0% Gilead Sciences 5% O’Reilly Automotive 5% United Parcel Service 0%
Automatic Data Processing 3% GoPro 37% Philip Morris International 24% Walt Disney 18%
AutoNation 11% Hain Celestial Group 2% Piper Jaffray -8% Whirlpool 11%
Ball -1% Humana -6% Pitney Bowes 0% Wynn Resorts -17%
Boston Scientific 5% Intercontinental Exchange 2% Prudential Financial -11% Yum! Brands -6%
Buffalo Wild Wings -2% Jones Lang LaSalle 12% Ralph Lauren -4%

 

LinkedIn received a lot of headlines last week as it picked up new users as well as had a large number of users sign up for the upgraded (paid) version of LinkedIn. Disney had yet another blowout quarter, seeing far more revenues from the Frozen franchise than first expected during the holiday shopping season. On the downside, Anadarko Petroleum saw the effect of falling oil prices really hit its business during the fourth quarter of 2014, as did many of the oil and gas related companies.

 

According to Factset Research, we have now seen 323 (65 percent) of the S&P 500 companies release their results for the fourth quarter of 2014. Of the 323 that have released, 78 percent have met or beaten earnings estimates (this is down 2 percent from last week), while 22 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 59 percent of the companies have beaten estimates, while 41 percent have fallen short. Now with more than 50 percent of the member companies in the S&P 500 having reported earnings, we are past the halfway mark and quickly moving toward the end of the fourth quarter earnings season.

 

The focus of this week’s earnings releases will be the US consumer as many consumer staple related businesses release their earnings. Below is a table of the better known companies that will releases their earnings this week, with the releases that have the most potential to impact the markets highlighted in green:

 

Advance Auto Parts J M Smucker Spirit Airlines
AOL Kellogg Tesla Motors
BorgWarner Kraft Foods Time Warner
Cabela’s Martin Marietta Materials Trulia
Cisco Systems Metlife VF Corp
Coca-Cola Molson Coors Brewing Waste Connections
CVS Health Mondelez International Western Union
Dean Foods Panera Bread Whole Foods Market
Flowers Foods PepsiCo Wisconsin Energy
Groupon Red Robin Gourmet Burgers Wyndham Worldwide
Hasbro Scripps Networks Zillow

 

Kellogg and Kraft foods will likely take much of the spotlight this week in terms of earnings as they are two very large consumer staples companies with very wide reaching business lines. Tesla Motors will also likely catch a lot of attention as it is the darling company of the automotive industry as it continues to gain market share against traditional vehicles and begins to deal with increased competition from the likes of BMW and Ford. Whole Foods will also be a very interesting release this week as it reports on its attempt to lose the stigma of being the “whole paycheck” grocery store in favor of a broader consumer-friendly store.

 

International News: International news last week was really just a regurgitation of the same old news stories continuing to play out. Violence in Eastern Ukraine flared up once again as Russia and the rest of the world seem to remain at odds over what the outcome of the conflict will be. Russia seems willing and able to continue to help the “rebels” in the region, while the world seems content with trying to negotiate a political deal to end the violence. However, there is no reason to actually believe President Putin will follow any new peace agreement any more than he has followed past deals, which are not worth much more than the paper they were written on. Greece, while technically not at war with the rest of Europe, looks ready to fight with Europe over bailout funds and the impact the bailout terms are having on the Greek economy.

 

Over the course of the past week both Prime Minister of Greece Alexis Tsipras and Greek Finance Minister Yanis Varoufakis went on a multi-country tour of Europe, meeting with various political and financial leaders in Europe. Their story was the same to everyone: they want a reduction in the debts of Greece and more favorable terms for the remaining debts. The reaction was also by and large the same as nearly all of the individuals they met with did not go along with the ideas being pitched. Perhaps the most comical of the meetings was between the German Finance Minister, Wolfgang Schauble, and his Greek counterpart, after which Varoufakis said they had agreed to disagree. No sooner had he said this than Minister Schauble interjected that they did not even agree on that. At the end of the meeting both sides were said to be just as far apart as they had been prior to the meeting and perhaps even a little further apart. The trouble for Greece continued to mount last week as the ECB announced that it would no longer take Greek debt as collateral for loans in the future with the current uncertainty about the government’s pending actions effectively cutting the country off from a potential bailout from the ECB. One more lifeline is gone and time is quickly starting to run out for Greece with the world watching and waiting to see what Greece is willing to do. Former Chairman of the US Federal Reserve Greenspan came out over the weekend and said that he sees Greece leaving the Euro in short order and that it will be better for all involved to not have Greece as part of the monetary union. While Greenspan jumping into the fray may seem like a big deal it is not the first time he has said the Euro is doomed or that it will fail in the long run. He has been saying this for many years. Whatever the outcome, Greece is a very big wildcard right now for the global financial markets, a wildcard that will surely be played in the coming months. Right now the odds of a Grexit (Greek exit from the Euro) are for sure increasing; this is most evident by the rate seen on the 2-year and 10-year Greek government bonds, which are yielding 20.7 percent and 11 percent, respectively. The next big day for Greece and Europe is Wednesday when the Eurozone finance ministers all meet together. It is thought that Greece will request bridge financing for a while, some say through the end of August, to buy time to come up with a better long-term plan. This plan, if pitched, will likely be met with a lot of opposition with opponents rightly saying that if Greece is waiting to get a longer term deal in place it should not be rolling back austerity measures and increasing spending, which the new government wasted no time in doing over the past three weeks. Ultimately, Greece doesn’t have anything to offer the rest of Europe; its economy is microscopic and it is causing massive amounts of headaches, headaches that would be alleviated if Europe just said “no” and stopped the life support for the country. If Greece is locked out of the global capital markets and the banks in Greece cannot get Euros from the ECB it will be forced to move onto its own currency, which may not be such a bad outcome. The real question then becomes how Europe can build in safeguards in the future to stop other countries from bailing on their promises and departing from the Euro, including weak countries like Spain or even strong countries like Germany.

 

Market Statistics:

Index Change Volume
Dow 3.84% Above Average
S&P 500 3.03% Above Average
NASDAQ 2.36% Above Average

 

After being down a large amount two weeks ago it was nice to see the bounce back in the US markets last week as investors seemed willing to once again make more risky investments. Volume overall was above average last week, but a little below the weekly volume we saw two weeks ago when the markets were falling. This imbalance in volume and market movements suggests that the recent movements really have just been investors adjusting positions around the movement of oil and not something larger like investors either pulling out or moving into the markets in any large scale.

 

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

 

Top 5 Sectors Change Bottom 5 Sectors Change
Broker Dealers 7.65% Utilities -3.64%
Regional Banks 7.51% Residential Real Estate -2.34%
Oil & Gas Exploration 6.73% Biotechnology -1.88%
Telecommunications 6.06% Infrastructure -0.24%
Energy 5.81% Healthcare 0.41%

Oil and Gas Exploration made it three weeks in a row last week of gains as oil continued to be the main driving force behind the market movements. This movement spilled over into Energy more broadly last week and was also the leading cause of the decline in the utility sector. With US yields increasing last week from the very low level hit two weeks ago it was not surprising to see Real Estate move lower last week, as much of the US real estate market is tied to yields on the fixed income instrument indirectly through mortgage rates.

Fixed income moved lower last week as investors seemed to be willing to step out of the safety of US fixed income investments in favor of other investment opportunities:

Fixed Income Change
Long (20+ years) -5.29%
Middle (7-10 years) -2.43%
Short (less than 1 year) 0.01%
TIPS -1.53%

Last week the US dollar decreased in value by 0.28 percent against a basket of international currencies, making in two weeks in a row of declines. The decline in the US dollar could have been largely due to the increase in the price of oil or it could have been due to optimism about other currencies, such as the Euro and the Swiss Franc, which have been on wild rides over the past few weeks. With oil moving higher it was not surprising to see that the Canadian Dollar turned in the best performance of the week, gaining 1.62 percent against the US dollar as much of the Canadian economy is based on oil. The weakest of the major global currencies last week was the Japanese Yen, which resumed its downward movement last week, falling by 1.41 percent against the value of the US dollar.

Commodities and metals were mixed last week as oil moved sharply higher and gold and silver slid lower:

Metals Change Commodities Change
Gold -3.90% Oil 8.03%
Silver -3.08% Livestock -2.26%
Copper 3.72% Grains 3.56%
Agriculture 1.12%

The overall Goldman Sachs Commodity Index turned in a gain of 5.43 percent last week. Oil was the big winner of the week last week, gaining more than 8 percent over the course of the week. Some of the gain was due to a shift in global supply and demand, while more of the move was attributed to investors trying to time the bottom of the oil market and catch the turn. This trying to time the bottom for oil can become somewhat of a self fulfilling prophecy; if enough people see what looks like a turn up and then pile into the trade, it will push the price of oil higher. While Oil was moving higher, Gold and Silver were having a rough week last week, falling by more than three percent each, as investors seemed to be pulling out of the precious metals in favor of more risky assets. The more industrially used Copper got a bump last week of almost 4 percent, thanks in large part to emerging markets buying the semi precious metal.

With the fighting in Ukraine seemingly intensifying it was somewhat confusing to see that Russia led the way higher last week out of all the global indexes, gaining 11.29 percent as measured by the MSCI Russia Capped Index. Trying to make heads to tails out of what is going on in Ukraine and how the global financial markets will take the developments seems like an impossible task at the moment. China was on the losing side of the global financial markets last week with the Shanghai based Se Composite Index falling by 4.19 percent over the course of the week as investors call into question the predicted growth rates for the county.

The wild yo-yo ride continues on the VIX as we saw yet another week of drastic movements last week with the VIX giving up more than 17 percent, but still closing the week out above 17 at 17.29. Risk in the form of volatility really seems to be tossing around in the current market as investors attempt to adjust their level of fear on seemingly every little news story about either oil, Greece or Ukraine. This trend in volatility looks like it will be with us for a while to come as we have only had four trading days so far this year that the VIX has been under 17, compared to the 21 days it has been above. For comparison purposes, the VIX during all of 2014 was only above 17 for a total of 29 days. At the current level of 17.29 the VIX is implying a move of 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 2/6/2015, returns in FSI’s hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week Year to Date
Aggressive Model 1.92 % 0.78 %
Aggressive Benchmark 2.23 % 0.74 %
Growth Model 1.57 % 0.65 %
Growth Benchmark 1.73 % 0.60 %
Moderate Model 1.16 % 0.50 %
Moderate Benchmark 1.24 % 0.44 %
Income Model 0.73 % 0.48 %
Income Benchmark 0.62 % 0.24 %

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

 

We made no changes to our models over the course of the previous week. We continue to watch several of our positions to make sure they are still the best current investment option. Performance of our overall models has seemed to be driven by investors’ demand or lack thereof for consumer staples. Many of our equity positions that have long term investment horizons have been moving into and out of favor rapidly so far this year; our thoughts on these positions have not changed. The stocks and companies we own are strong brands that will be around for a long time into the future and they will likely continue to pay nice dividends. So while the day to day or week to week movements may seem like large changes, they really are attributed to the wondering nature of the markets right now and the impact it is having on our overall models. Energy continues to be an area of great interest as it has come down so far from the peak of a few months ago, that it looks relatively cheap, but investments are cheap for a reason and the reasons that made oil as cheap as it is now don’t seem to have fully played out as of yet.

 

Economic News:  Last week was a tame week for economic news releases with the majority of the releases coming in at market expectations. There were two releases that significantly beat market expectations and no releases that significantly missed market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 2/2/2015 Personal Income December 2014 0.30% 0.30%
Neutral 2/2/2015 Personal Spending December 2014 -0.30% -0.20%
Neutral 2/2/2015 ISM Index January 2015 53.5 54.7
Neutral 2/4/2015 ADP Employment Change January 2015 213K 230K
Neutral 2/4/2015 ISM Services January 2015 56.7 56.5
Neutral 2/5/2015 Initial Claims Previous Week 278K 290K
Neutral 2/5/2015 Continuing Claims Previous Week 2400K 2388K
Positive 2/6/2015 Nonfarm Payrolls January 2015 257K 235K
Positive 2/6/2015 Nonfarm Private Payrolls January 2015 267K 225K
Neutral 2/6/2015 Unemployment Rate January 2015 5.70% 5.60%

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

Last week started out on Monday with the release of personal income and spending, with income showing an increase of 0.3 percent, while spending posted a decline of 0.3 percent. Much of this decline in spending was attributed to the decline in prices at the pump, which is good, but it was negative to see that people decided not to spend this savings elsewhere in the everyday activities, opting rather for holding on to their savings. Also released on Monday was the OSM Index, which posted a modest decline in the speed of growth from the level seen in December, but still signaled growth overall. On Wednesday the start of the employment related figures for the week was released with the ADP employment change index for January showing the creation of 213,000 new jobs during the month. This figure was not enough to force any changes in the predictions for the overall unemployment rate, which was released later during the week. On Thursday the standard weekly unemployment related figures were released and there were no major surprises in either of the releases. On Friday the releases everyone was waiting all week for were released, those being the payroll and unemployment data points released by the government. Payrolls, both public and private, increased by more than expected with both figures posting numbers over 250,000. This good news, however, was dampened a little by the overall unemployment rate increasing from 5.6 percent up to 5.7 percent, with the increase being attributed to an increase in the labor force participation rate, which increased from 62.7 up to 62.9 during the month of January. We have seen other small upticks in labor force participation in the past that have ultimately not been the start of a trend, so we will have to wait and see if this uptick is more than just a onetime item, but if a trend of an increasing labor force participation rate does emerge it could be very positive for the overall health of the US economy.

 

This is a slow week for economic news releases as the only releases that really have the chance to make a large impact on the overall movements of the markets are the retail sales figures released on Thursday. The releases highlighted below have the potential to move the overall markets on the day they are released:

 

Date Release Release Range Market Expectation
2/12/2015 Initial Claims Previous Week 285K
2/12/2015 Continuing Claims Previous Week 2395K
2/12/2015 Retail Sales January 2015 -0.40%
2/12/2015 Retail Sales ex-auto January 2015 -0.40%
2/13/2015 University of Michigan Consumer Sentiment Index February 2015 98.3

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

 

This week starts on Thursday with the release of the standard weekly unemployment related figures for the previous week, both of which are not expected to show much of a change over the figures posted last week. In addition to the unemployment related figures on Thursday the government also releases the retail sales figures for the month of January. Retail sales are expected to post a slight decline of 0.4 percent during the month, thanks in large part to the falling prices of gasoline and energy. This decline is also not supposed to have been affected by a change in sales of automobiles, as retail sales excluding auto sales are also expected to have declined slightly. This decline in retail sales, if it comes to fruition, would be the second month in a row of declines since December posted a drop of 0.9 percent. For whatever reason, retail sales are declining at a time when the US economy is supposed to be strong enough for the Fed to start raising interest rates, a trend that may give the Fed pause about taking action. This week wraps up with the release of the University of Michigan’s Consumer Sentiment Index for the month of February, which is expected to show very little change over the level seen at the end of January.

 

Fun fact of the weekBrown is the only color not used for a Euro banknote.

 

The 5-euro note is grey

the 10 is red

the 20 is blue

the 50 is orange

the 100 is green

the 200 is yellow

the 500 is purple.

 

Have a great week!

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