Volatility Conitnues

Highlights of This Week’s Update:

1. Market volatility continued last week, with 13 of the last 19 trading sessions seeing triple digit moves in the Dow.
2. Stock indices dropped around 3% last week, but interest rates fell and gold rose.
3. The S&P 500 is only 5.3% off its closing high on September 18^th, so this is not technically even a market “correction” (10% move or more) at this time.
4. Oil continued its slide.
5. There are both negative forces and positive support to possibly make the current downturn limited and temporary.
6. Our outlook is still unchanged, staying underweight stocks for all risk levels and flat to lower interest rates ahead.
7. We don’t see the recent market weakness as the start of a major and extended market downturn.

READ ON FOR ADDITIONAL DETAILS………………………………………………

The Markets:

If you’ve been reading the paper or watching business news lately, the bumpy ride in stocks hasn’t escaped your watchful gaze. Recognizing that a triple-digit move in the Dow today isn’t the same as when it hovered at much lower levels, we’ve now witnessed 100 plus point changes in the Dow in of 13 the last 19 sessions (St. Louis Federal Reserve).   Six of those days were up and seven were down. This includes last week’s biggest advance, up 275 points on Wednesday, which was quickly followed by the week’s biggest decline on Thursday – down 335 points (St. Louis Federal Reserve).

Last week, the Dow Jones Industrial Average dropped 2.74% while the Standard & Poor’s 500 stock index gave up 3.14%.  The Dow is now basically flat for the year, down 0.20%.  Interest rates continued to fall, with the yield on the 10 year U.S. Treasury now at 2.31%.  Oil prices slid last week, with the price of crude oil ending at $85.52 per barrel on Friday, $4.19 lower than the previous week.  Gold rose, jumping $24.00 per ounce, finishing at $1,219.00.  Mortgage rates ended last week at their 2014 lows, with the average 30 year fixed rate mortgage at 4.00% and the 15 year rate ended at 3.11%.  (MarketWatch, U.S. Treasury, CNBC, Energy Information Admin., and Bankrate.com)

Some might be tempted to blame October for the weakness. The month has a spooky reputation, as market swoons in 1929 and 1987 happened in October.  However, a review of the data going back nearly 45 years helps dispel the myth that October is traditionally bad for stocks. Fact: September has historically been an off month for stocks, not October.  But October can be volatile. Since 1929, there have been 91 times that the S&P 500 Index has been up or down at least 6% in one day. Of those, 49 were up and 42 were down. Interestingly, 23 of those daily swings occurred in October (S&P Dow Jones Indices, CNBC).

Note: Percent change from month end to month end; Oct, Nov, Dec data through 2013

Below are some of the possible reasons for recent market weakness, but also several positive forces that remain in place.

First, the Negatives:

1. Global economic worries, especially as it relates to Europe. Last week, German industrial production and exports fell at their fastest rate since January 2009 (Bloomberg, EU Observer). Always be cautious with one data point, but comparisons to early 2009 are never favorable.
2. The International Monetary Fund downgraded the global outlook and significantly raised the odds Europe will enter a recession (IMF.org).
3. While the S&P 500 Index is down just 5.3% from its closing peak on September 18, smaller company stocks have had a rougher ride. The Russell 2000 Index⁶, which is a gauge of smaller companies, is down nearly 13% since early July (Big Charts). Anything below 10% is what analysts call a correction.
4. Fears the strong dollar will weigh on revenues of multinationals.
5. Worries about an eventual rate increase next year by the Federal Reserve have weakened junk bonds; problems in the junk bond market can seep into stocks.
6. The Fed’s bond-buying program is scheduled to end this month. It’s a well-known fact, but nonetheless, the expected end of Fed liquidity may be creating volatility.
7. As far as its monetary response, the European Central Bank remains behind the curve, even with some of its more recent measures.
8. It’s been 3 years since a 10% correction in the S&P 500 Index (St. Louis Federal Reserve). The big run-up in stocks and current valuations provide just the right excuse to book profits.

But let’s not discount the Positives—

1. U.S. fundamentals are solid. Nowhere is this more evident than in the labor market, where a number of indicators (including the ramp-up in hiring; BLS – nonfarm payrolls data) are signaling further economic growth, which in turn supports corporate profits.
2. Earnings season is upon us. It’s very early, but estimates at this stage of the cycle are above recent estimates at similar stages (Thomson Reuters).
3. Global economic concerns, especially in Europe, are creating anxieties. However, according to S&P Dow Jones Indices, European companies accounted for 9.7% of S&P 500 revenues in 2012; Goldman Sachs estimates 7% in 2013. Europe just isn’t that significant a source of revenue.
4. The U.S. exported $262 billion in goods to Europe last year, but that compares to a $17 trillion U.S. economy (BEA). The 2012-13 euro-zone recession didn’t cause a slump in the U.S. and the U.S., economy is stronger today. Therefore, it’s unlikely another euro-zone slump will cause a U.S. contraction.
5. Falling oil prices are a plus for U.S. manufacturers and consumers.
6. The drop in mortgage rates could help the real estate market and aid  both home buyers and reduce costs via refinancing for existing homeowners.
7. The Fed isn’t expected to start raising interest rates until sometime next year. Even then, the general consensus suggests any rate hikes will be gradual. A more accommodative monetary policy has historically been a plus for stocks.

In conclusion, powerful supports remain in place. A 10% or more correction in the S&P 500 Index (if it were to occur), in the context of a growing economy, would likely be healthy for the longer-term well-being of the market, as it mops up excess enthusiasm that can lead to unhealthy exuberance in stocks.  We have been expecting some type of stock market decline, and the current dip may be short-lived given the positives that still remain.  Time will tell.

Our Outlook:

We have remained underweight stocks/equities for some time now, and continue feel the stock market in general has been overvalued.  The current downturn in stocks could be healthy in the longer term, and may give us an opportunity to rebalance and adjust our stock positions.  At the present, we feel the current downturn in stocks may be short-lived, and don’t see an extended drop at this time.  We are watching this very closely and could take a more defensive position if circumstances change.  A recession does not seem imminent moving forward based on current U.S. economic data, so we do not expect a major drop in stock prices for the short term.  We expected interest rates to move lower in the fourth quarter, and we already have seen quite a dip in both U.S. Treasury Bond rates as well a fixed rate mortgages.  The drop in interest rates helps stabilize fixed income/bond prices overall.  We continue to look ahead for the longer term, and are not making any major adjustments to our portfolios at the present.  We will keep you advised.

God Bless,

Your TEAM at F.I.G. Financial Advisory Services, Inc. 

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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; 2013 year-end price fixing at 10:30 a.m. London time; Prices can and do vary; past performance does not guarantee future results.