Market Commentary - 11.26.14

The Only Certainly for the Rest of 2014: More Uncertainty

Since the Great Recession, U.S. equities have risen dramatically higher with only the occasional bout of volatility. However, recently, as evidenced by the dramatic increase in the number of days that U.S. equities rose or fell 1%, volatility dramatically picked up. While the estimates for future stock market returns are all over the place, we believe one thing is certain. The combination of market headwinds, or those factors providing potential market resistance, and tailwinds, or those factors providing market support, will fight it out creating a year of sharp market fluctuations.

As we look ahead, market tailwinds that may benefit equity investors are as follows:

  • US economic growth is improving. By most indicators, consumer spending remains strong, the labor market is headed in the right direction, business spending is showing signs of improvement, and government spending seems to be reversing its recent contraction.
  • US interest rates remain low. Despite expectations of a slow rise in interest rates and possible Fed action next summer, current rates remain well below historic standards. Low interest rates allow US consumers and businesses to continue to repair their respective balance sheets through refinancing.
  • Global central banks continue to address slowing global growth. The European Central Bank (ECB), the Bank of Japan, and, most recently, the People's Bank of China, have all pledged to provide stimulus to help their respective economies.
  • Low commodity prices. Recent weakness in commodity prices should continue to benefit corporate profit margins and provide more consumer discretionary income.
While these tailwinds should provide positive directional support to equity investors, we have also identified a number of market headwinds which may counteract these positives.
  • Extended bull market in U.S. equities. The near six-year rally in U.S. equities, which has also stretched valuation levels, is of concern. Stock prices do not usually move straight up and a pullback would not be surprising. There are also questions whether or not we are at the corporate earnings peak and what the result will be of a stronger, less competitive US dollar.
  • Concerns about the global economy. Recent weak data on the European economy, along with comments from the International Money Fund (IMF) and the World Bank, suggest that the global economy is not chugging along as many had expected.
  • The interest rate environment. There has been much debate about the Fed's next action (whether it will raise interest rates or keep them steady next year). There are supporters on both sides of the argument. Uncertainty equals more volatility.
  • U.S. political uncertainty. The recent elections changed the political landscape in Washington. The resultant political gridlock could have economic ramifications. A gridlocked government may limit new initiatives and result in less spending. Likewise, as we have seen in the past, political gridlock may take a toll on business spending, as companies are unsure of when new regulations may appear and, as such, may take a wait and see approach. Reduced government spending coupled with reduced business spending, could negatively impact U.S. economic growth.
  • Other concerns. Increasing geo-political risks in the Middle East and Asia, along with the Ebola scare, may weigh on investor sentiment. Decreasing oil prices may increase instability in Middle East as well.
The constant stream of conflicting news is likely to result in an increase in market swings, both in frequency and magnitude. While we still believe the financial markets are on a solid foundation, as we have noted many times, volatility is likely to remain elevated and portfolios should be positioned accordingly. Beyond favoring developed markets that stand to benefit from global stimuli, a slight overweight in growth over value in stocks, and less interest rate sensitivity in fixed income, we continue to urge greater portfolio diversification that includes an allocation to investments such as alternative strategies, commodities, and REITs, which have demonstrated low correlation to traditional investments like stocks and bonds.

This information is compiled by Cetera Investment Management.

About Cetera Investment Management
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