A number of different worries have rattled the market to
start 2014. Let’s take a closer look at
what they are and what each of them means for the global economy and markets.
1. Housing Slowdown
Housing represents a very large part of the U.S. economy
(about 20%), which is why economists and investors alike pay close attention to
housing data.
After a strong 2013, the housing market data has
weakened. New home construction surged
in November 2013, but fell in December 2013 and January 2014. Rising interest rates are likely to
blame. Mortgage rates have risen to 4.5%
from their lows around 3.5% in early 2013.
The threat of rising interest rates in 2014 and 2015 has investors
concerned that the weakness in housing may continue.
The lull we are seeing in the data could be a result of last
year’s low rates, which likely pulled forward some purchases that may not have
ordinarily occurred until six months to a full year later. The abnormally cold winter may also be
impacting the data. Bad weather keeps potential buyers indoors, homes off of the market, and building projects on hold.
impacting the data. Bad weather keeps potential buyers indoors, homes off of the market, and building projects on hold.
At this point, it is difficult to find anything conclusive
from the data. Despite December’s
decline, home construction starts are still at their highest annual total since
2007. The only thing we can know for sure is that the housing industry is
much stronger than it has been in many years.
There is still reason to believe it could be a positive contributor to
the economy in 2014.
2. Disappointing Labor Data
January’s employment numbers presented another opportunity
for investors to worry. Total nonfarm
payroll employment rose by 113,000 workers in January, which left the
unemployment rate changed at 6.6%.
January’s data marked the second month in a row of less-than-expected
job growth.
The report was disappointing, but it also provided a couple reasons
to be optimistic about the future:
- Despite one of the coldest Januaries on record,
the number of new construction-related jobs in January 2014 was nearly double
what it was in January 2013. Residential
construction had a strong 8.8% year-over-year increase. Both numbers confirm continuing improvement
in one of the economy’s most critical components.
- Since 2009, the number of Americans actively
searching for jobs has steadily fallen.
In January, the labor force reportedly increased by 500,000 workers –
bumping the participation rate up to 63% from 62.8% last month. If this trend continues, it is more evidence
of a strengthening economy.
 |
| U.S. Participation Rate (source: Bureau of Labor Statistics) |
On top of weakening U.S. data, investors have been dealing with the so-called “Fragile Five” emerging market nations of Indonesia, Brazil, Turkey, South Africa and India.
These countries have large current account deficits so they
rely heavily on external financing from foreign investors. Over the past several years, monetary stimulus
from the Fed has provided more cash for investors and increased investment into
these countries. As Quantitative Easing
(QE) starts to come to a close, currency traders have started pulling money out
of the F5’s currencies.
To combat devaluing currencies and attract investors, F5
central banks raised interest rates. The
problem is that these higher rates crush local consumer demand, which is
exactly what these countries have been working towards creating. Internal demand is also what attracts Western
companies and investors.
While these countries only represent about 7% of the world’s
GDP, investors feared that the crisis in the F5 markets could spark larger
economic slowing – similar to the Asian financial contagion in 1997.
However, other emerging market nations are much stronger
than they were in 1997. China appears to
have stabilized its economy at about 7% GDP growth. Europe is looking stronger. Japan seems to have solved their deflationary
issues, at least for the time being. As a whole, the global economy is in better
shape than it was, even 12 months ago.
The situation in the Fragile Five seems to be isolated, so we don’t see
it as a major threat to continued economic improvement.
What’s Happening in the Market?
The worries have been enough for some analysts to scale back
their growth expectations for 2014. As
investors re-calibrated these new expectations into their models, we saw the
market pullback 5.8% from its January highs.
Many investors sought the safety of “riskless” assets, which caused the
10-year U.S. Treasury bond yields to fall from 3.0% to start the year to below
2.6% in early February.
Over the past week, the market has nearly fully recovered
from the modest pullback and interest rates have risen back above 2.75%. Until additional data validates the direction
of the economy, however, we expect continued volatility in the markets.
What Does It Mean for You?
The modest pullback provided some opportunities to top off stocks that had fallen to good technical levels, but – as we mentioned last week – we don’t anticipate making any major changes. We believe our portfolios are well-positioned to protect on the downside with higher-yielding B and C stocks, while the higher-growth A stocks provide plenty of upside if the economy continues to improve as it has. And, as always, we will continue to look to the dividend as our guide in these volatile conditions.
