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Market Commentary

Market Update for the Quarter Ending March 31, 2014

Posted April 3, 2014


A weak end to a turbulent quarter
March ended with small gains for the Dow Jones Industrial Average, up 0.93 percent, and the S&P 500 Index, up 0.84 percent, though the Nasdaq was down 2.53 percent. The minimal changes masked significant volatility, with markets taking a dive on news of the Russian invasion of the Crimea at the start of the month, before recovering. The rest of March was similar, with markets bouncing up and down.

The same could be said for the quarter. Volatility returned to the markets, driven by unexpected developments on all fronts. Still, U.S. markets ultimately didn't change much by quarter-end, with the Dow down 0.15 percent and the S&P 500 and Nasdaq gaining 1.81 percent and 0.54 percent, respectively, masking a large decline at the end of January.

Fundamentals were mixed during the quarter, with earnings growing but companies projecting slower future gains. Declining growth expectations, combined with rising perceptions of risk outside the U.S. and the ongoing Federal Reserve (Fed) "tapering" of its asset purchase program, made investors more cautious.

Technical factors remained generally strong, and markets closed the quarter well above levels that could be considered red flags. But market action during the quarter broke several major support levels before recovering, and the weak performance during the last weeks of March suggested that the volatility could continue.

International markets performed similarly. The MSCI EAFE Index changed little, down 0.64 percent for the month and up a minimal 0.66 for the quarter, while the MSCI Emerging Markets Index moved up 2.92 percent for the month and down 0.80 percent for the quarter. Both indices were more exposed to risk factors—both geopolitical and economic.

Technical factors were weaker for international markets during most of the quarter, but they improved toward quarter-end. Developed and emerging international markets closed above their 200-day moving averages, even though the emerging markets index spent most of the quarter below this critical level. Arguably, this could be a positive sign for emerging markets going forward.

After Struggling Mid-Quarter, the S&P 500 Broke Above Technical Support Levels

Source: Bloomberg

Within fixed income markets, March brought about a significant change in sentiment, in that emerging market bonds outperformed every other sector, rising 1.08 percent, according to the JPMorgan EMBI Global Core Index. Previously, investors had been fleeing this asset class, as concerns about Fed tapering and slowing economic growth took center stage. At the same time, valuations had become relatively compelling, and this may have been the catalyst behind the reversal of sentiment.

Meanwhile, the Barclays Capital Aggregate Bond Index lost 0.17 percent in March, although the index has still returned 1.84 percent year-to-date. Longer-duration, high-quality bonds have posted the strongest performance, while short-duration bonds and bank loans have struggled in relative terms this year.

U.S. economy goes into a "snowdown"
A principal cause of the volatility and slow growth in U.S. markets was a series of poor economic reports during the quarter. Employment was the primary concern, with job gains for the first two months of 2014 well below expectations. Data in March suggested a resumption of more normal employment growth, with initial jobless claims dropping back to the lows seen before the onset of the financial crisis. Discrepancies between different data series strongly suggest that weather was the primary culprit in the weak reports, and the March data supported this assessment.

Housing also slowed somewhat during the quarter. The available supply of homes for sale has declined to historically very low levels, which has affected sales volume, and new home construction may have been stalled by unusually cold weather. Prices continued to increase for both new and existing homes, suggesting that demand remains strong. While the data has been mixed, the overall conclusion is that, despite some seasonal weakness and supply factors, the housing market remains healthy.

Another indicator that the slowdown was actually a "snowdown" was the increase in consumer confidence. At the end of March, the Conference Board's consumer confidence figure hit a six-year high, with a particular improvement in expectations, suggesting improved consumer and economic demand over the next several months.

With spring now here, economic statistics are returning to recovery levels, and the "snowdown" appears to be over. This, along with improving confidence, should lead to further growth.

Fed tapering continues
The Fed also cited weather as a primary cause of the economic slowdown, and during March continued to reduce its purchases of Treasury and mortgage bonds. The taper has the Fed reducing its amount of stimulus as the economy normalizes, and the rate of reduction remained steady during the quarter.

Notes released from the March Fed meeting indicated that the Federal Open Market Committee believes that the economy is continuing to strengthen. This, along with a comment from new Fed chair Janet Yellen that rates would increase about "six months" after the end of the taper, led to some market turbulence. Still, the Fed's overall message that the economy was exhibiting a sustainable upward trend provided a reason for optimism.

Geopolitical risk reappears
The Russian annexation of Ukraine's Crimea region at the start of March was the major geopolitical news of the quarter. Markets dropped the next day but recovered as the situation appeared to stabilize. Still, the crisis has yet to be resolved. The U.S. continues to use diplomatic actions to penalize Russia, and this has resulted in greater uncertainty. Furthermore, the current concentration of Russian troops near Ukraine's border is a reason for concern.

Other countries in Europe were also affected by Russia's actions. Many European Union nations rely on Russia for natural gas. This has made their decisions regarding how to counter Russian aggression particularly difficult. Even if there is no further military action, harsh negotiation tactics could derail the European recovery.

China also contributed to uncertainty during the quarter. Speculation increased that its economy was still slowing down. Also, ongoing developments in China's financials sector—a corporate bond default and large fluctuations in the interbank lending market—could mean further uncertainty about where that nation's economy is headed.

Overall, we closed March and the quarter with political and international risk very much back in the forefront. Even though markets seem to have largely shrugged that risk off so far, we are keeping a close eye on it over the next couple of months.

Time for caution
While the U.S. economy appears likely to continue its recovery, risks are becoming more apparent—both in the financial markets and in the world at large. The recent "snowdown" reminds us that unanticipated events can make a large difference, and the Russian annexation of the Crimea has only reinforced this lesson.

With Europe facing new geopolitical risks, and China showing more signs of a potential slowdown, risks to financial markets are very real. In the long term, these factors are not worrisome, but they could cause short-term volatility.

Given this uncertainty, investors should maintain a properly diversified portfolio and a long-term focus to maximize their chances for success. Although some concerns may be warranted, most won't significantly affect markets, and long-term return expectations should overcome any short-term worries.

Authored by Brad McMillan, vice president, chief investment officer, and Sean Fullerton, investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The JPMorgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets and is an expanded version of the JPMorgan EMBI+. As with the EMBI+, the EMBI Global includes U.S. dollar-denominated Brady bonds, loans, and eurobonds with an outstanding face value of at least $500 million. It covers more of the eligible instruments than the EMBI+ by relaxing somewhat the strict EMBI+ limits on secondary market trading liquidity. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.



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