Market Commentary - 2.5.14

January: It's Just Volatility

In January, the S&P 500 lost over 3.5%, sending this index lower for its first monthly pullback since August. This drop has led many to question whether or not the current five-year stock market rally has ended. We do not believe this is the case. Instead, as was the case in January, market volatility will likely be elevated all year as investors brace for the Fed's tapering and its effect on domestic interest rates and growth in China and other emerging markets nations. With signs that global economic growth is improving, coupled with better than expected corporate earnings, we remain steadfast that we anticipate a good, not great, market environment in 2014. We do not anticipate a sharp selloff, however, a market breather is the course of least resistance in our opinion. In a period of market fluctuations, diversification remains an important strategy.

As January came to a close, investors had many concerns to agonize over, most notably Fed tapering and worries about China and other emerging market nations. Late in the month, the Fed announced further plans to taper, or reduce their monthly purchases of government securities. By reducing their purchases, the Fed had begun the process of reversing quantitative easing (QE), which most considered a key driver of market returns over the past few years. By reversing QE, investors fretted that a period of low interest rates may be coming to an end.

Investors have also blamed tapering on weakness in emerging market currencies. Much of the money that the Fed added into the market through its QE program flooded to emerging market economies. With the Fed tapering, this money is leaving these economies, putting selling pressure on currencies. In an attempt to stabilize their currencies, the central banks of India, South Africa, and Turkey raised interest rates. Higher interest rates combined with the perception that the economies of many emerging markets are slowing, further added to selling pressures. Investors took note that China, the world's largest emerging market economy, was showing weakness. In particular, they worried about weak Chinese manufacturing data that showed the poorest reading in six months.

While tapering and its effect on emerging market economies have hurt global markets, we still remain confident in our opinion that U.S. equities will have a good, but not great 2014. Economic data out of the Euro-zone, including manufacturing and consumer sentiment, continues to both exceed forecasts by a wide margin and hit multi-year highs. On the domestic front, corporate earnings continue to suggest a 10% or more growth rate. This is important as stock prices tend to track earnings growth. While there is the possibility of rising costs impacting profit margins, another year of double-digit earnings growth is clearly a market positive.

January was a tough month. Yes, U.S. equities lost value, an event not experienced since last summer. In our opinion, this volatility is normal for the markets. Yes, there are concerns about the Fed's tapering and its effect on interest rates and emerging market economies. However, we believe there are other positive market fundamentals that still remain intact including economic growth in the Euro-zone and continued double-digit corporate profit growth. We feel January was an example of what will be expected for the balance of the year – not negative returns but increased market volatility. We continue to preach the virtues of increased diversification and the use of liquid alternative investments to help smooth periods of market fluctuations.

This information compiled by Cetera Financial Group is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment.

No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular news update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in indices. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security covered in this material may not be advisable or suitable. Please consult your financial professional for more information.

While diversification may help reduce volatility and risk, it does not guarantee future performance. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.

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