U.S. equities came under pressure last week as the S&P 500 declined almost 2.0%.1 Blame was primarily placed on the crisis in Ukraine and the growth slowdown and tight credit environment in China. Safe haven investments such as U.S. Treasuries and gold outperformed. Stocks may have already discounted the weather distortions on early 2014 data, and an overhang is expected to linger into first quarter earnings season. Cautiousness surfaced for investments that support the recovery, including banks and homebuilders.
Investor Sentiment Shaken by World Events
The lack of a diplomatic solution to the crisis in Ukraine was a headwind. Russia reiterated it does not plan to intervene in Eastern Ukraine, but additional military exercises made markets nervous. Tougher talk from the U.S. and European Union emphasized tighter sanctions, which could cause further escalation.
In China, growth decelerated as February exports, commodity imports and credit data came in below expectations. The market weakness attributed to Ukraine and China may have also been from positioning and sentiment dynamics. A more difficult first quarter earnings backdrop is now anticipated.
Weekly Top Themes
1. Consumer confidence dipped slightly with preliminary March numbers on the low side of consensus.2 Confidence has held up fairly well given the historic weather, reduction in food stamps, elimination of extended unemployment insurance and geopolitical crisis in Ukraine. In light of surprising consumer resiliency, moderate job gains combined with improving wage gains should result in faster growth.
2. Retail sales increased 0.3% in February but were revised lower for January and December.3 Although the headline number was higher than consensus expectations, the data was a modest disappointment after the downward revision to the prior months. Weather remains the dominant theme.
3. U.S. economic growth has slowed by approximately 1% since last fall.4 Weather and inventory correction have been the largest contributors to the slowdown in our opinion. The inventory effect counters the upside growth surprise in the second half of 2013 and could weigh on growth beyond the first quarter. But the weather effect should turn positive in the spring, allowing growth to accelerate to roughly 3% after the spring thaw.
4. Growth for the United States must now come from capital spending and exports. The environment is reminiscent of the time after World War II, rather than recent economic expansions with an increase in consumer spending and government expenditures. The U.S. has three natural advantages: 1) population growth, 2) openness to legal immigration and 3) vast stores of natural resources. U.S. access to cheap natural gas and oil through fracking can increase exports and attract manufacturing back to the country.
5. Institutional investors have repudiated U.S. equities and decreased alloca- tions from approximately 40% in 2007 to roughly 25% today. Equities have experienced outflows of $700 billion and more than $1 trillion from active equity managers.5 Companies have been buying the shares that were sold, as corporate management has used approximately 60% of post-dividend free cash flow to buy back their own stock.
The Big Picture
It will require continued improvement in economic data to encourage more investors to extend their investment horizons and assume greater risk exposure. Any policy misstep or backup in government yields will heighten market volatility and increase the likelihood of a pullback. The disinflationary backdrop will likely ensure that global policy remains supportive and that any setback is short-lived. Investor attention must move toward economic improvement, away from the weather slowdown and issues in Ukraine, Russia and China. Despite near-term weakness, we believe the macro environment argues for further cyclical advance in equities. A more durable recovery should bolster investor confidence as the year progresses, encouraging many to gradually increase exposure to equities.
1 Source: Morningstar Direct, as of 3/14/14. 2 Source: Thomson Reuters, “Surveys of Consumers University of Michigan March 2014 Preliminary,” http://www.sca.isr.umich.edu/. 3 Source: U.S. Census Bureau, U.S. Department of Congress, “Advance Monthly Sales for Retail and Food Services February 2014,” March 13, 2014. http://www.census.gov/retail/. 4 Source: U.S. Department of Commerce Bureau of Economic Analysis, “National Income and Product Accounts Gross Domestic Product, Fourth Quarter and Annual 2013 (second estimate)” February 28, 2014, http://www.bea. gov/newsreleases/national/gdp/gdpnewsrelease.htm. 5 Source: Investment Company Institute, “Estimated Long-Term Mutual Fund Flows,” March 12, 2014, http://www.ici.org/research/stats/flows_03_12_14.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specifi objectives, fisituation, or particular needs of any specifi person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non- investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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