Highlights of this Month’s Newsletter:
- The major U.S. stock indices dropped in July, producing declines of around 1.5%.
- Commodity prices declined last month, and interest rate inched higher.
- Several global events occurred in July that helped produce uncertainty and volatility.
- Economic data remains mixed, but initial reports show a gain in U.S. growth during the second quarter.
- Our outlook still remains cautious for stocks and continued favor with fixed income and commodity based assets.
Read on for Additional Details in this Update…………………………………………….
July began with positive results from the broad-based S&P 500 Index (a gauge that measures 500 large companies) and the better known but narrower Dow Jones Industrial Average, but a slide in the last week of the month negated July’s advance. The Dow fell 1.6% for the month, while the S&P 500 declined 1.5%. As of August 1st, the Dow is now down 0.5% for 2014 and the S&P 500 is up 4.2%. (MarketWatch)
Last month also saw declines in the price of gold, off $29.75 per ounce, oil down $7.28 per barrel, and bond prices dropped as yields rose slightly. The 10 Year U.S. Treasury yield ended July at 2.58% compared with 2.53% at the end of June. (U.S. Treasury, Energy Information Administration, CNBC)
There were several international events that surfaced in July. A large Portuguese bank delayed an interest payment and announced a large loss, reminding us that euro-zone banking woes are still with us (CNBC, Wall Street Journal).
On the geopolitical front, the festering problems in Ukraine took an ugly turn when the downing of a Malaysian jet took nearly 300 innocent lives. The human toll was enormous but the initial market reaction was muted. The possible fallout from tougher sanctions announced by the European Union (EU) imposed on Russia played a modest role in unsettling markets, with European shares leading to the downside, especially in Germany (MarketWatch data). At this point, it is doubtful Ukraine will have much of an effect on the U.S. economy.
The escalation of the fighting in Israel and Gaza also captured headlines and added to the overall global uncertainties for the month.
The Fed, the economy, and rates
For the Federal Reserve and its low-rate policy, it all boils down to economic growth and job growth. Take a look at Figure 1. Economic activity and job creation have had a close historical relationship.
Following the worst recession since the Great Depression, the Fed has been holding short-term interest rates at near zero in order to stimulate increased buying among consumers and businesses. There have been a number of factors holding back growth, but the lackluster recovery indicates the Fed has had only limited success in meeting its objectives.
Moreover, the data show that the tepid economic recovery is the biggest reason why the labor market has not completely healed from a recession that officially ended five years ago (NBER) – see Figure 1. And it’s the number one reason why the Fed continues to insist that rates should remain at low levels.
Winter snow showers, spring flowers
As July came to a close, the Bureau of Economic Analysis reported that Q2 Gross Domestic Product (GDP), which is the broadest measure of U.S. economic activity, expanded at an annualized clip of 4.0%, per preliminary data. In addition, Q1 was revised from a -2.9% to -2.1%.
The headline number is subject to revisions as more complete data roll in, but it’s becoming increasingly clear the economy is bouncing back from a winter-induced contraction. Downward revisions to growth in 2011 and 2012 however, mitigated some of the good news.
The unemployment rate continues to fall faster than Fed officials have been predicting (Fed Quarterly Economic Projections). However, the significant drop in the unemployment rate has been influenced by very weak growth in the labor force.
Nonetheless, let’s not forget that the recovery has been substandard, leaving many of those who were ravaged by the recession on the employment sidelines. But the recent improvement in job creation has gotten the Fed’s attention.
Although Fed officials did acknowledge the recent improvement in the labor market, most still believe there are plenty of individuals who are ready and able to work – and have the skills to work in today’s modern economy – if economic growth significantly accelerates. If the Fed is correct, holding interest rates at low levels for a considerable period of time can help support the economy without creating much additional inflation. If the Fed is wrong, we could see prices tick up at a faster rate, putting policy makers in the difficult position of having to implement a series of rate hikes in order to contain inflation.
The biggest rise in the Employment Cost Index since 2008 (BLS) likely sparked much of the 317 point selloff in the Dow on the last day of the month, as it suggested falling unemployment is beginning to push up wages/benefits, possibly leading to higher inflation. Still, it’s just one quarter of data and some economists suggested it was payback from a weak reading in Q1.
At this point, we haven’t have had a 10% drop in the S&P 500 Index since mid-2011 (St. Louis Federal Reserve S&P 500 data). But we have had occasional bouts of volatility that create temporary uncertainty. The end of July was only the latest. We have been underweight in stocks/equities since mid-2013, and are of the opinion a correction for stocks is well overdue. Valuations continue to be stretched, and at some point, one of two things very likely could occur: 1. A decline in stock prices to bring current valuations back to normal levels, or 2. Corporate earnings will accelerate to bring stock valuations back in line. Time will tell and we will continue to monitor and keep you informed. At this time, we still favor individual company stocks, fixed income/bonds, and commodity based assets moving forward into the second half of 2014.
Your TEAM at F.I.G. Financial Advisory Services, Inc.
1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly. Past performance does not guarantee future results.
3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly. Past performance does not guarantee future results.
4 New York Mercantile Exchange front-month contract; Prices can and do vary; past performance does not guarantee future results.
5 London Bullion Market Association; gold fixing pricing at 3 p.m. London time; 2012/2013 year-end price fixing at 10:30 a.m. London time; Prices can and do vary; past performance does not guarantee future results
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