Market Commentary - 8.1.14

U.S. Stocks Suffer an Ugly Day

Today, the S&P 500 dropped 39 points (loss of 1.98%), enduring its biggest single-day drop in terms of points since February 3rd. In terms of percentage, this was its worst drop since April 10th, when it fell 2.1%. Driving this loss was a potent mix of concerns that the Federal Reserve may have to raise rates sooner than expected, an Argentine debt default, credit concerns in Portugal, and continued tensions in the Middle East and Ukraine. We continue to expect sharp market swings such as this for the balance of the year as investors sift through conflicting economic and market headwinds and tailwinds.

Looking back at today's market drivers, the greatest overhang was the growing concern that the Fed would have to raise interest rates sooner than expected. Most market prognosticators expect the Fed to raise rates early to mid-2015. However, yesterday's U.S. gross domestic product report showed that the economy expanded at a 4 percent annual pace in the second quarter, confirming the Fed's view that the first quarter weakness was a weather-related anomaly. This strong data, along with a rise in the Fed's preferred measure of inflation to uncomfortable levels, raised the possibility of higher rates sooner than expected.

Outside the U.S., a bond default and rising tensions furthered today's pessimistic market bias. Argentina missed a deadline yesterday to pay $539 million in interest after two full days of negotiations in New York failed to produce an agreement with its creditors from its last default in 2001. As a result, credit agency Standard & Poor's declared Argentina was in default. In Portugal, one of its banks was asked to raise capital, which drove concerns over global credit markets. Lastly, the death toll rose as tensions continued to rise in the Middle East, while further economic sanctions were levied against Russia for its current role in the Ukraine conflict.

When all of these market headwinds are absorbed by investors, their reaction was not a surprise - sell out of riskier assets. While we see the gravity of yesterday and today's market affecting events, we do believe there are tailwinds in place that should help balance out some of these headwinds. First, while interest rates may rise, they are still low by historical standards. Second, corporate earnings growth continues to be trending at a double-digit rate. Third, the economy, especially the labor market, is showing signs of strengthening. Fourth, there are continued signs that Europe and emerging market economies are exiting their respective doldrums.

While these tailwinds may not exactly balance headwinds every day, we expect market reaction to the "headwind or the tailwind of the day"쳌 to drive market volatility. Today, we are not overly bullish or bearish on equities. Instead, and as we have said since the beginning of this year and when U.S. equity indices were at their highs, modest equity markets could be in store for 2014. With this in mind, we continue to stress equity exposure in line with long-term investment objectives, less interest rate sensitivity, and extreme diversification through a greater than normal number of asset classes in portfolios. Extreme diversification includes using REITs, commodities, and alternatives to complement traditional stock and bond investments.

This information is compiled by Cetera Investment Management.

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