Presented by Joe Smalley, Accredited Investment Fiduciary® 

Markets bounce around as economy improves

Financial markets were volatile during April, even as most recovered to show little change. The Dow Jones Industrial Average was up 0.87 percent, and the S&P 500 Index gained 0.74 percent, while the Nasdaq dropped 2.01 percent. The small changes in the Dow and S&P 500 masked two intramonth declines of about 2 percent and 3 percent, respectively, driven by growth fears, which hit technology and momentum-oriented equities. This differential drove the Nasdaq, which has a higher population of these stocks, to a worse performance for the month and into negative territory for the year.

Earnings were also a concern. Early reports actually showed a decline in corporate earnings over the previous quarter. Although data from the end of April moved earnings back into growth territory, the numbers were below what had been initially expected. The uncertainty about earnings growth, combined with bad news about the Chinese economy and the Ukraine situation, made investors nervous. These mid-month losses were recovered, but they prevented further gains.

Technical factors also showed weakness during the month. Several technical support levels were violated, although only for a limited time. The averages remain well above the most worrisome levels, but some damage has been done, and this merits watching.

Developed international markets performed more strongly than U.S. markets, with the MSCI EAFE Index up 1.45 percent, although they continued to trail year-to-date. About half of this came from currency appreciation relative to the dollar. The strong month was in part a bounce back from previous underperformance and also reflected less exposure to technology and momentum stocks. The MSCI Emerging Markets Index was up less—0.06 percent—which reflected the uncertainty surrounding China’s economy.

Once again, longer-duration fixed income securities performed best. High-quality, longer-dated bonds and TIPS posted the strongest returns in April, because of investor demand for certainty and yield. The worst-performing area within bond markets was the floating-rate bank loan space, which was essentially flat for the month. Short-duration bonds also experienced lackluster performance. Overall, the Barclays Capital Aggregate Bond Index returned 0.84 percent.

Spring continues for U.S. economy

After the economic weakness of January and February, statistics for March showed the slowdown to be largely due to weather. The employment numbers for March highlighted much stronger job growth, which was confirmed by even better April employment data. Private jobs touched a new high, breaking the level from before the financial crisis, even as unemployment claims averaged at low levels, despite bouncing around. Overall demand for labor was strong, with the average hours per week at historically high levels.

Better employment led to increased consumer confidence and also to higher spending, a primary driver of the economy. Retail sales were up an unusually robust 1.1 percent, which probably partially reflected pent-up demand from the poor weather months but still was well above expectations. Personal consumption, a wider measure of economic activity, rose at a brisk pace.

The news was not all good. Economic growth was reported as 0.1 percent for the first quarter of 2014, but because this largely reflected bad weather in January and February, it was not a significant concern. More worrisome was an apparent slowdown in the housing recovery. Even as prices continued to increase, activity levels slowed, apparently due partially to the weather, but more due to a lack of supply. Although the slowdown is arguably good news, reflecting a more normal market, it remains an issue worth watching (see chart).

Consumption Was Strong, But Other Factors Slowed First-Quarter Growth

Source: BEA

The Federal Reserve continues to taper

As expected, the Federal Reserve (Fed) continued to reduce its bond-buying program by an additional $10 billion, to $45 billion per month. There was speculation that the weak first quarter might have led to a pause, but the Fed concluded that the economic recovery was strong enough to continue the pace of purchase reductions. Despite the continued taper, rates actually fell during April, which should help the housing market continue its growth, and illustrates that, despite the Fed’s reduction in stimulus, an increase in rates is by no means assured.

International uncertainty remains

There were two major worries from around the world for U.S. investors in April. The situation in Ukraine continued to simmer. Although the expectation was for an eventual resolution, investors still worried that tensions seemed to be escalating. There is a growing conflict between the U.S. and our European allies about how to address the situation; Germany in particular is strongly lobbying against increased sanctions.

The second area of concern is China, where signs of a significant slowdown continue to appear. Chinese manufacturing and exports are showing lower-than-expected growth, and there are hints that China’s leaders realize that slower growth may be necessary to unwind some of the country’s financial imbalances. Keep in mind that in this case, slow growth might mean a still healthy 6 percent or so, but this represents a significant change from recent history. Additionally, the potential for policy errors could damage the world economy, as well as China’s.

Spring is here

As we move into the second quarter, it seems clear that spring is here for the U.S. economy after the weather slowdown of the first quarter. Steady improvements in employment and consumer spending are clearly optimistic signs. Even though worries remain, especially about the pace of wage growth, the trends appear not only favorable but improving for the real economy.

Financial markets are less certain. U.S. market results for the month, while not a concern, showed signs of potential weakness. Company earnings, though beating current expectations, are not particularly impressive. Technical damage was also done to the major indices in April, and therefore markets bear watching.

Overall, our stance remains optimistic, but with elements of concern about the financial markets, which remain vulnerable to uncertainty. As always, a diversified portfolio constructed around an investor’s own risk tolerance and time frame should help achieve goals, regardless of what happens in the interim.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. 

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Joe Smalley is a financial advisor located at 213 East Saint Joseph, Lansing, Michigan, 48933.  He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 517.487.4850 or at www.smalleyinvestments.com.

Authored by Brad McMillan, vice president, chief investment officer, and Sean Fullerton, investment research analyst, at Commonwealth Financial Network.

©           2014 Commonwealth Financial Network®