Market and Economic Weekly Update

Most of the markets ended the week with a slight gain except for the NASDAQ. Poor earnings news on Friday from a few blue chip companies derailed last week’s gains that lasted through Thursday. GE, Microsoft and McDonalds all missed estimates for third quarter earnings. GE trimmed sales targets for the remainder of the year.


Retail sales jumped 1.1% in September. The increase was broad based across all sectors raising hopes for a successful holiday selling season. There was an exceptional jump in sales at electronics stores due to the introduction of the iphone 5.

Rising energy prices were reflected in an increase for the Consumer Price Index. After a large 8.6 increase in August gasoline prices, another increase of 6.7% was posted in September. Core prices rose a much more modest 0.1%.

Output at mines, factories and utilities rose 0.4% in September after a 1.4% decline in August. The results were higher than most analysts expected and helps allay concerns about a broader global recession.

Housing starts jumped at a double-digit pace to 872,000 last month (a four-year high). The gains, which were far above estimates, were seen in both single family and multi-family units. Even more encouraging was the increase in housing permits. This gives encouragement that the housing recovery will last.

Why Hold This instead of That?

I am frequently asked by clients about the Exchange Traded Funds (ETF’s) we use in our portfolio construction. In particular, some clients ask why we hold RSP for broad market exposure instead of the more-well-known SPY. I’d like to explain the difference between the two and why we would use one over the other.


SPY is the first and most well know ETF in U.S. markets. Commonly known as the Spider (SPDR) it was introduced in January, 1993. It corresponds to price movement in the S&P 500. As such, it is a cap-weighted index, meaning that the larger a company is the more weighting or exposure the company has in the index or ETF.

RSP, on the other hand, mirrors the same S&P 500 index but for one major difference; RSP is an equal-dollar-weighted ETF. This means that regardless of the size of a company, each one has an equal weighting in the ETF. In other words: one company, one vote.

When comparing these two ETF’s we look at their relative strength. How do their prices move in relation to each other?

Going back to 1994, if you were to buy and hold SPY you would have a gain of 208.58% not including dividends. If you had bought RSP, your gain would have been 313.85% without dividends. What’s more interesting is, if you followed the relative strength indicators for each of these ETF’s going back 18 years, and made the changes that the indicator recommended, your return would have been over 400%.

As we all know, past performance is no guarantee for future success. However, I feel it is important to pay attention to what the market is telling us and make prudent investment decisions. Following the relative strength indicators over time can help us do just that.

Source: Dorsey Wright & Associates, Inc.

Markets and Economy Weekly Update

Alcoa kicked off earnings season last week by reporting a net loss of $143 million (13 cents a share) loss in the third quarter. The results included the cost of settling a four-year legal battle over bribery allegations but were still slightly better than Wall Street expected. This compares with a 15 cent a share profit a year earlier. Alcoa also cut its forecast for global aluminum demand growth from 7% to 6%. The market didn’t take kindly to the profit warning and the Dow shed 128 points on Wednesday.


Two of the nation’s largest banks, Wells Fargo and J.P. Morgan reported third quarter earnings last week. The improved results were most due to a rebound in the housing sector. Both banks said the housing market had “turned the corner”. Earnings are still under pressure from historically low interest rates.

The International Monetary Fund (IMF) World Economic Outlook report stated “Risks are alarmingly high,” for a slowdown in global growth. The IMF revised their expectations downward 0.2% to 3.3% this year and 0.3% to 3.6% in 2013. The stagnation of global growth is noted by its 5.1% advancement in 2010 and 3.8% in 2011.

Due to the reduction in global growth, Europe continued to be a drag on the domestic markets as France, Spain and other nations in the EU won’t hit budget deficit targets agreed to with EU authorities.

S&P Ratings Services downgraded Spain again in light that country’s deteriorating economy. This put the rating in line with Moody’s downgrade a few months ago.

The trade deficit widened by $2 billion in August to $44.2 billion. The drop was broad based and due to weakening demand from Europe.

The Producer Price Index (PPI) came in higher than expected with a 1.1% jump. Most of the increase came from the energy sector. The widely followed “core” PPI came in unchanged month over. This suggests that suppliers and manufacturers have not been able to pass on cost increases to consumers.

Applications for jobless benefits dropped 30,000 to 339,000 for the week ending Oct. 6th. That was the fewest since February, 2008 and shows the economy is still improving, although at a snail’s pace.

Exchange Traded Funds Make Sense for Investors, but as I Always Say…The Devil is in the Details!

Exchange Traded Funds (ETF’s) are a staple of our managed portfolios and all of our clients know that. Recently I read an article in the Wall Street Journal that highlighted some of the advantages as well as some of the pitfalls of investing in ETF’s. I hope you find it useful.

 

I’ve mentioned in previous weekly market commentaries that while the market has been climbing a wall of worry, money has been flowing out of equity based mutual funds. That money has been making its way into bond funds, hybrid funds, and money market funds. But equity based ETF’s have also seen a positive inflow of cash and with good reason.

 

ETF’s have a number of advantages over the more familiar mutual funds; everyone is well aware of that by now. But the article in the Wall Street Journal highlighted a few things investors need to keep a close eye out for. Here are a few they mentioned:

• Fees. While ETF’s can be much cheaper than mutual funds, some can be expensive. You have to know if the additional operating expense of the ETF is bringing value to you. Commodity based or emerging market ETFs tend to cost more to manage, but you need to make sure there is a reason for investing in any particular sector at any given time. For example, many commodities have been experiencing lower prices while many international markets have turned positive on their charts.   Some firms are adding additional fees to investors such as custodial fees. Since ETF’s have a low cost structure, and most investors consider themselves long-term investors, some firms are seeing their revenue decrease. Be sure you know all the fees you are paying for.
• High trading activity. Some advisers jump in and out of various ETF’s creating too much short-term gains and losses. The tax efficiency of ETF’s in non-qualified accounts is a tremendous benefit for investors. Any repositioning of a portfolio should always be based on changes in relative strength or on chart patterns. I tell people anytime we buy and anytime we sell and there is a technically sound reason for doing it.
• Chasing the latest thing coming down the road. As more and more ETF’s are being brought to the market, there is a concern that thinly traded or ETF’S based on obscure sectors may not last. Also, with little trading and low volume, wider price swings can knock investors for a loop. We’ve seen many ETF’s close over the last couple of years. You have to “check under the hood” to make sure you understand how the ETF intends to work.
• Compounding price movement. Along the same line, some ETF’s compound the upward or downward price movement of a particular sector or index. This type of ETF is best left for institutions which have professional traders watching price movements all day long. Finra and the SEC have both issued warning letters to advisers and brokers warning them of the complexity of this type of ETF.

In my opinion, ETF’s are one of the best ideas to come out of Wall Street. But not all ETF’s are created equal.

Markets and the Economy Weekly Update

The markets were mostly flat last week as things settled down. There was no major bad news out of Europe and here at home it seems things will be slow until we begin the next earnings season in a couple of weeks.


Stock prices in China experienced their worst week in almost a year. This puts the Chinese markets at a 3 ½ year low. I would expect to see this trend continue until slowing growth figures reverse course.

Housing starts were up 2.3% in August. The increase was in both single and multi-family homes but was lower than analysts had hoped for. On the sale side, existing home sales rose a healthy 7.8%

A private sector survey of factory managers in China shows manufacturing in the world’s second largest economic engine shrank for the 11th consecutive month furthering fears of a global slowdown.

Lawmakers on Capitol Hill are looking closely at tighter controls for stock exchanges. Recent articles in the Wall Street Journal have highlighted problems with the complicated programs high-speed trading firms have developed, making things more opaque to ordinary investors. The programs may also be one of the root causes of problems like the “flash crash” that occurred in May 2010.

Is this market overbought?

When we experience a strong period for the equity markets I get asked by clients and friends if this market is overbought and does that mean we’re in for a sell-off. The short answer is…not necessarily.


One of the indicators I look at is a weekly distribution of the S&P 500. If you remember your Statistics 101 course from college, you’ll recall the normal distribution bell curve concept where the “middle” of the bell curve is where things tend to regress or progress to. We track the ten-week trading band for the S&P 500 and plot it on a graph. What’s interesting is when we look at a period where the band trades at the top of that ten-week trading range. One would think the market would regress back to the mean or middle but that hasn’t always been the case.

Over the past 12 years, the S&P 500 has reached the top of this range 14 times. I looked at how the market performed 1, 3, and 6 months after reaching the top of this trading range. There were only two out of 14 instances where the market had produced a loss after one month. Similarly, there were only two times out of 14 that the market produced a loss three months after reaching the top of this range. And, there was only one time that the market produced a loss after a six month period.

While we never attempt to predict what the market will do, it does help having historical data to help put things in perspective. We will soon be entering another earnings announcement season and as we begin to enter a historically strong period for the markets, it will be interesting to see how things progress.

Markets and the Economy Weekly Update

The trade deficit widened slightly in August as both imports and exports slowed. The drops were broad based but the drop in shipments to Europe showed the greatest decline.


Commercial and industrial loans jumped 14% in July. The growth, which is twice as fast as other bank lending activities, is the one bright spot in the banking sector. This trend is not new but analysts are concerned about how long this trend can continue with the economic recovery losing steam.

The CPI rose last month most on higher energy prices which jumped 9%. Retail sales were higher also due to a sharp increase in gasoline and vehicle sales.

Family income has shrunk to levels not seen since 1995 as income fell for the fourth year in a row. The poverty rate which has risen the last four years leveled off in 2011.

In a first, the Securities and Exchange Commission fined the New York Stock Exchange $5 million, alleging the exchange had delivered valuable trading information to preferred customers before sharing with others. The information in question was released only seconds ahead for some customers. However, in this day and age of lightening fast program trading, it still gives firms an advantage to jump ahead of the rest of the crowd. High speed trading is accounting for more and more volume on the exchanges.