Market Commentary - 5.30.14
During the June Gloom of Investing, Listen to Southern Californians
In Southern California, the weather is beautiful most of the year. However, there is the annual June Gloom weather pattern that results in cloudy, overcast skies with cool temperatures during the late spring and early summer, most commonly occurring during the month of June. This gloomy period tends to lower the spirits of many Southern Californians. In the financial markets, the June Gloom came a little early this year in the form of a disappointing first quarter gross domestic product (GDP) report.
On May 29th, the Bureau of Economic Analysis (BEA) released its second estimate of real GDP and it showed that output produced in the U.S. declined at an annual rate of 1% in the first quarter. Compared to the fourth quarter 2013 report, when real GDP increased 2.6%, BEA's original estimate of a 0.1% gain, and the fact that the 1% decline would mark the U.S. economy's worst quarter in three years, investors faced a gloomy picture. The decline in GDP was primarily due to a larger decline in inventories, a fall in exports, and weakness in residential and nonresidential investments. Despite this disappointing economic news, U.S. equities rallied on the day. Like Southern Californians in the midst of the June Gloom, investors had anticipated this negative reading on the economy and deemed it to be temporary with good investment weather just around the corner.
Looking beyond this poor GDP report, investors can point to many tailwinds likely to push gloomy economic data clouds away. First, as most of the East Coast suffered from severe snowstorms and freezing temperatures, much of the first quarter weakness was caused by temporary weather related factors. With this bad weather behind us, second quarter GDP should likely bounce back. In fact, second quarter GDP may come in at a not-so-gloomy 3.5 - 4.0%. Second, other reports, including those on housing and the labor markets, continue to show an improving economy. Third, the U.S. economy remains in a low interest rate environment. These historically low interest rates continue to translate into low mortgage, auto, and refinance rates for both consumers and businesses. Lastly, as seen in the most recent earnings reports, corporate profits remain strong. Historically speaking, stock prices tend to track earnings growth.
With all of these potential tailwinds pushing the gloomy market clouds away, why not be more aggressive and over-allocate to equities relative to stated investment objectives? Well, just like in Southern California, seemingly beautiful weather has some hidden dangers including extreme heat, a strong sun, and potential drought conditions. For the financial markets, some hidden dangers, or headwinds, include still sluggish global economic growth, rising geopolitical risks, the Fed's plan of tapering (slow reduction of its quantitative easing policy) and signs of a reversal in economic conditions in emerging market nations.
With this combination of headwinds and tailwinds that is likely to elevate levels of market volatility, how is one to invest? Once the June Gloom dissipates, natives of Southern California are not easily fooled by the beautiful conditions. They understand that while the sun is warm and provides gorgeous weather, you need to prepare for the unexpected including applying sunblock, wearing a hat, and, in some extreme cases, using a sun parasol. For investors to insulate their portfolios today from increased volatility, we would favor spread product such as corporate bonds within fixed income. In the equity component, we would prefer developed-country equities, which are trading at attractive valuations after years of sub-par economic growth. Overall, we continue to believe in staying diversified, especially through the use of alternative assets.
This information is compiled by Cetera Investment Management.
About Cetera Investment Management
Cetera Investment Management LLC provides passive and actively managed portfolios across five traditional risk tolerance profiles to the clients of financial advisors, who are affiliated with its family of broker-dealers and registered investment advisers. Cetera Investment Management is part of Cetera Financial Group, Inc., which includes Cetera Advisors LLC, Cetera Advisor Networks LLC, Cetera Financial Specialists LLC, and Cetera Investment Services LLC.
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