Markets heat up...
After a difficult January, financial markets rebounded in February. The Dow Jones Industrial Average was up 6.01 percent, while the S&P 500 Index climbed 5.75 percent and the Nasdaq rose 7.08 percent. All of the major U.S. indices are now in positive territory for the year, a reversal of the situation at the end of January.
Several factors drove the strong performance. Corporate earnings were somewhat stronger than expected in late January. Despite the effects of low oil prices on energy companies and the strong dollar on multinationals, 76 percent of companies in the S&P 500 reported earnings above estimates, with six of ten sectors reporting earnings gains. Moreover, earnings growth rates were up to 3.7 percent at the end of February, above last year's estimated figure of 1.7 percent, per FactSet.
Sales increases were also better than expected, with fourth-quarter 2014 growth up 2.1 percent, as opposed to revenue growth of 1.1 percent as of late December. In addition, eight of ten sectors reported revenue growth for the last quarter of 2014. Sales data is important because it reflects actual customer demand, and higher sales-growth rates help support the prospect of future earnings growth.
Technically, the markets started February below their 50- and 100-day moving averages, due to the declines in January, but they bounced off support levels and moved back into technically healthy territory. With improving fundamentals, the more robust technical outlook suggests that market risks may not be at high levels for the near term.
Technically, there are reasons for some concern. Both the Dow and S&P dropped below their 100-day moving averages, although they remain above their 200-day averages. The international indices are still below their 200-day moving averages, despite their recent improved performance, suggesting continued risk. Although none of this is necessarily a red flag, it suggests that investors should exercise caution.
Developed international markets also performed well, with the MSCI EAFE Index up 5.98 percent, in line with the U.S. indices. Meanwhile, the MSCI Emerging Markets Index was up less-2.98 percent. Developed and emerging markets are now up for both months of the year, which reflects the nascent economic recovery in Japan and Europe, as well as the respite in the confrontation between Germany and Greece.
After a strong run, fixed income was down in February, with the Barclays Capital Aggregate Bond Index declining 0.94 percent, giving back some of its January gains. The loss was driven by higher bond yields, with interest rates rising and the 10-year U.S. Treasury ending the month with a 2-percent yield, up 32 basis points. Rates rose on the expectation that the Federal Reserve would likely increase rates soon, but Fed chair Janet Yellen's testimony before Congress at month-end led to some doubt about how soon that increase would come. High-yield bonds returned a respectable 2.41 percent in February, according to the Barclays Capital U.S. Corporate High Yield Index.
. . . Even as economy suffers from severe winter weather
The strength of financial markets stood in contrast to a string of weak recent economic data. Severe winter weather resulted in a slowdown in the housing sector, while economic weakness elsewhere in the world slowed factory orders and manufacturing sentiment, much as we saw in 2014. Unlike 2014, however, employment continued to grow, with an increase of 257,000 jobs, and average hourly earnings increased 0.5 percent-the best rate in some time. The unemployment rate increased slightly in January, from 5.6 percent to 5.7 percent, but this was due to more people moving back into the labor force, which is a positive trend (see chart). Other areas of concern included weak growth in retail sales.
The strong employment data was supported by equally strong growth in consumer spending, which is at its highest level since 2006.
At the same time, though, there are signs that growth has slowed from the pace of late 2014. The gain in gross domestic product growth for the U.S. economy during the fourth quarter of 2014 was revised down at the end of February, from 2.6 percent to 2.2 percent. This negative revision was largely due to lower-than-estimated additions to firms' inventory, as well as reduced exports. But, even as private spending growth slowed, many categories of business investment and government spending showed strong growth, which is a positive sign for the future.
Global recovery continues but may be slowing
Economic reports for the rest of the world were mixed. China's economy continued to show growth at lower than historical levels, and the Chinese government continued to slowly increase policy stimulus. China's currency, which is managed by the government, has shown patterns of decline, raising concerns about political conflicts-as other nations, including the U.S., protest China's aggressive currency policy-and also concerns of capital flight.
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Authored by Brad McMillan, senior vice president, chief investment officer at Commonwealth Financial Network.
All information according to Bloomberg, unless stated otherwise.
