Upside? It’s not because of domestic fundamentals
market view from LMK Wealth Management
Markets had another rough week, with stocks driven lower by fears about the growing emerging market currency crisis. For the week, the S&P 500 lost 0.43%, the Dow fell 1.14%, and the Nasdaq declined 0.59%. The month of January also ended on a low note, with the S&P 500 falling 3.56%, the Dow losing 5.30%, and the Nasdaq sinking 1.74%.
While it’s frustrating to start off the year with some poor market performance, some good news is that this decline is not being driven by domestic fundamentals. What could be happening is that the Fed’s tapering of its quantitative easing policies is driving currency selloffs in emerging markets.
Markets such as Brazil, Turkey, South Africa, and Indonesia became the darlings of international investors seeking the potential for higher returns over the last decade. These investors dumped billions of dollars into their fast-growing industries and delivered a much-needed boost to their economies. When the Fed announced its intentions to explore tapering options in May 2013, most emerging markets were caught off guard.
The problem is that these economies are fragile and when cracks are detected, investors will flee the local currency and buy dollars, putting a lot of pressure on emerging market currencies. This downward pressure risks stoking local inflation and weakening the economy. Currently, the central banks of the affected countries are working feverishly to halt the downward slide of their currencies, some with the help of the International Monetary Fund.
Time to worry?
Should investors be worried? Perhaps not yet, but a burgeoning emerging markets crisis won’t be good news for the global economy. While the contagion hasn’t spread to the developed world yet, some U.S. and European companies may see their growth prospects for the year fall because they have been depending on sales in developing countries to drive profits.
On the U.S. front, the Fed voted to continue its tapering program unchanged, cutting back its monthly bond purchases by an additional $10 billion. In our opinion, this is a sign of strength and shows that the Fed is increasingly confident that the economy is growing modestly. In a way, the emerging market crisis is a big help to the Fed because it’s pulled a lot of money back into U.S. markets, much of it into bonds, which is pushing up long-term yields.
Earnings are also looking up, and with nearly half of S&P 500 companies having released reports; earnings currently stand at over 7%, the best showing since the 7.7% rise in Q4 2012. Thus far, 65% of the report beating expectations, and revenues are up 3.5% across the board.
There’s an old Wall Street quote that says “As goes January, so goes the year.” Since January was a down month for markets, this might be cause for worry about the rest of 2014. Fortunately, when we actually go back and dig through the numbers, we find that out of the 21 Januaries since 1960 in which stocks fell, 12 were followed by rallies in the subsequent year. In short, while we can’t predict markets, we’ve got as good a chance of having a positive year.
- Monday: Motor Vehicle Sales, PMI Manufacturing Index, ISM Mfg. Index, Construction Spending
- Tuesday: Factory Orders
- Wednesday: ADP Employment Report, ISM Non-Mfg. Index, EIA Petroleum Status Report
- Thursday: International Trade, Jobless Claims, Productivity and Costs
- Friday: Employment Situation
Notes: All index returns exclude reinvested dividends, and the 5-year and 10-year returns are annualized. Sources: Yahoo! Finance and Treasury.gov . International performance is represented by the MSCI EAFE Index. Corporate bond performance is represented by the DJCBP. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.