The King is back, so is the Market

- 2014 2nd Quarter


2014 has been a very unusual year thus far.  The economy started out weakly with January showing the worst start to the year since the 2008 financial crisis. Many feared that 2014 would bring the first 20% correction in equity prices since 2008. Encouragingly the second quarter has done an about face with May and June proving to be two of the best months of the year, with broad participation across all global equity markets. So what is going on?

Highlights and Perspectives

The World

Many financial experts and economists believe that the first four months of the year resulted in heavy corrections for many stocks and sectors1. Emerging markets and Japan that underwent significant contractions between December and April are now rebounding strongly.  In fact, Japan is the best-performing equity market for the past six weeks, up about 10%. 

In an effort to spur on growth, the European Central Bank has begun to charge banks for depositing. The move, a so-called `negative interest rate’, is part of wide-ranging measures aimed at combating the crippling combination of slow growth and super-low inflation. The Markets welcomed the measures with European stocks rising broadly, and the German DAX index reaching a record high.

China's economic growth strengthened in the second quarter from the previous three months, but further government support is still needed2. To lift China's weak economic growth, authorities have cut taxes, ordered regional governments to speed up spending and reduced the amount of bank reserves.

Gross Domestic Product (GDP)

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 2.9% in the first quarter of 20143.  The contraction was primarily a result of slowing consumer spending on health care and reduced inventory accumulation. Corporate profits fell by 9.1% (not annualized), after having risen 2.2% in the prior quarter. While the GDP result was discouraging, economists generally believe that the lower inventory accumulation will eventually lead to an acceleration in growth down the road. Inflation remains relatively mild, with the personal consumption expenditures (PCE) index of prices gaining 1.4% during the quarter, up slightly from the 1.1% rate of the prior quarter. The consensus among economists is that the economy has strengthened significantly since the first quarter, with the improving employment situation being a solid indicator.  As a result, analysts expect GDP to accelerate to 3% later this year through 2015.

Housing

The two-year-old U.S. housing recovery is faltering.

The Mortgage Bankers Association lowered its forecast for combined new and existing home sales in 2014 to 5.28 million — a decline of 4.1% which is the first annual drop in four years. The group also cut its prediction on mortgage lending volume for purchases to $595 billion, an 8.7% decrease and the first retreat in three years. Bullish forecasts in early 2014 from MBA, Fannie Mae and Freddie Mac have been sideswiped by rising home prices and an economy that isn’t producing higher paying jobs.4

Employment

2Q, 2014 had a strong showing with the employment sector following up a resilient-but-lackluster first quarter.  Total non-farm payroll employment increased by 288,000 in June, and the unemployment rate declined to 6.1%[5]. Job gains were widespread, led by employment growth in professional and business services, retail trade, food and beverage services, and health care. In June, the unemployment rate declined by 0.2 percentage point to 6.1%. The number of unemployed persons decreased by 325,000 to 9.5 million. Over the year, the unemployment rate and the number of unemployed persons have declined by 1.4 percentage points and 2.3 million, respectively. Experts anticipate employment picking up 300,000 jobs per month in 2015.

[1] i.e. a 20% decline in the Russell 2000 Index and the Nasdaq Composite Index &  former strong sectors like biotechnology and social media also saw bear market declines of 20% or more this year
[2] According to Premier Li Keqiang.
[3] The "third" estimate released by the Bureau of Economic Analysis
[4] Freddie Mac released its U.S. Economic and Housing Market Outlook for June highlighting the following:
  • Low for-sale inventory will help to sustain house price and rent gains but at the expense of affordability in the short term.
  • While the total number of vacant units has decreased by 4.2 % from 1Q, 2010 to  1Q, 2014, the number of vacant units for sale has declined by 24.2 % (485,000 units).
  • Home purchase applications are currently 135% below last year so the forecast is lowered from 5.5 million to 5.4 million.
  • We expect fixed rates to rise gradually during the second half of the year with the 30-year fixed-rate mortgage to end the year around 4.4 percent.
[5] The U.S. Bureau of Labor Statistics


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