Locally based CPA firm since 1956

Year to date the market is up 7.92% as measured by the S&P 500 and the bond market is up just over 3.89% as measured by the Barclays Global Aggregate Bond Index.

Over the past 60 to 90 days we have experienced wild market fluctuations. Volatility returned to the markets with a vengeance largely due to investor focus on global events. The average investor now understands what is meant by “Global Systemic Risk”. The emotional reactions have been big. The good news is that emotional reactions are generally short lived and over time, the price of stocks will follow their respective company’s earnings. We don’t mean to discount geopolitical risks because they are real and they are huge. However, the things that drive economies and monetary policy are; interest rates and the size and speed of interest rate movements, inflation/deflation, and GDP growth vs recession.

The recent volatility reaffirms that a diversified portfolio with proper asset allocation is perhaps the most important tool in portfolio construction. We are reminded that the forefront of proper allocation is to maintain large cap diversification, hold some cash, hold some bonds & U.S. Treasuries, guard against what we call a rolling pullback and most importantly, don’t panic.

A few things to consider:

Industrial production surged 1.0% in September, more than double market expectations, despite a small downward revision to August. Moreover, gains were fairly broad-based with the exception of the auto industry, which took a breather but is expected to pick up again later in the year. Electronics also took a hit, which tends to happen after we see another iPhone launch; the latest was in early September.
Lower oil prices should provide a boost to manufacturers in the near term as energy is a cost of production. The only exception is the burgeoning mining industry, which needs oil prices to remain higher to justify increases in high-cost U.S. production.

Going forward, markets participants are worried that recent manufacturing gains will be derailed by everything from a stronger dollar to weaker growth abroad, particularly in Europe. It takes anywhere from 12 to 18 months for a shift in the value of the dollar to work its way through from currency markets into prices, which, given the five-month drop in the dollar, suggests we could see our competitiveness deteriorate in mid-2015. This is of particular concern to the Federal Reserve, as it is likely to occur at the very moment that the Fed was hoping to achieve a “liftoff” in interest rates.

For now, the good news is that the manufacturing sector appears to be stronger than many expected. This could provide us with a much-needed cushion if the dollar and weaker growth abroad were to take a toll on our competitiveness down the road.

Bottom Line: Industrial production and unemployment claims together provided a ray of light today in an otherwise cloudy mood for markets. We need to see more consistent upside surprises to allay the almost irrational fears that seem to have taken hold of markets in recent days.