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U.S. Bank Wealth Management: Market & Economic Update
 

U.S. Bank Wealth Management: Market & Economic Update

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We expect geopolitical issues to remain a risk factor for the global economy over the rest of the year.

We expect geopolitical issues to remain a risk factor for the global economy over the rest of the year.

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    U.S. Bank Wealth Management: Market & Economic Update U.S. Bank Wealth Management: Market & Economic Update Document Transcript

    • Please refer to important disclosures on page 4. Page 1 Current economic events Geopolitical issues remained at the forefront of market attention. Israel invaded the Gaza strip in retaliation for the continued rocket attacks. Ukrainian separatists seem to have mistakenly shot down a Malaysian airlines flight. President Obama extended sanctions against additional Russian financial institutions to pressure an end to Russia’s interference in Ukraine. These events led to rising market volatility, but by the end of the week the most important factor remained the easy monetary stance of central banks in the United States, Europe and Japan, leaving markets only modestly changed and positive economic momentum in place. Russia is the exception as economic momentum remains negative, propelled by U.S. sanctions. The only positive issue was a four-month extension for negotiations with Iran over their nuclear development. We expect geopolitical issues to remain a risk factor for the global economy over the rest of the year. However, we are unlikely to see a negative impact on the positive global economic trend, unless these risks lead to a spike in oil prices. U.S. economic data indicated the U.S. economy remains healthy, although the pace of growth does not seem to be accelerating. Retail sales rose just 0.2 percent in June, well below consensus estimates but consistent with modest growth in consumer spending. Unemployment claims fell to their lowest level in seven years (just 302,000 last week), which is consistent with the continued improvement in the U.S. jobs market. Industrial production grew 0.2 percent for June indicating continued expansion in business activity. The week finished with the Conference Board’s index of Leading Economic Indicators rising 0.3 percent, indicating the economy seems to remain on its path of modest expansion. Data from Asia indicated economic growth improved. Second quarter gross domestic product (GDP) growth for China rose to 7.5 percent year over year from a first quarter year-over-year pace of 7.4 percent. An improvement in investment and industrial production drove better data. In Japan, the recovery from the increase in consumption tax seems to have been absorbed by the economy as industrial production improved in May over April. In the eurozone, industrial production fell 1.1 percent in May, perhaps indicating the recent improvements in economic growth may be moderating, likely due to the deleveraging in the financial system. On balance, economic growth seems to be seeing modest improvement around the world. Contributed by: Robert L. Haworth, CFA – Senior Investment Strategist Equity markets Following a volatile week of trading, equities on average trended modestly higher last week with the S&P 500 advancing 0.5 percent, along with the Dow Jones Industrial Average, NASDAQ Composite, MSCI EAFE and MSCI Emerging Market indices which garnered gains ranging from 0.4 percent to 0.9 percent. Among the popular broad-based equity indices, only the small cap-oriented Russell 2000 posted a loss last week. Also worthy of note are the performances of the S&P 500 sectors. Unlike year-to-date trends, last week’s worst performing sectors were the defensive-oriented Utilities, Healthcare and Consumer Staples sectors. Utilities and Healthcare are among the best performing sectors year to date. Week of:  July 21, 2014 U . S . B a n k w e a l t h m a n a g e m e n t Market & Economic Update
    • Please refer to important disclosures on page 4. Page 2 Market & Economic Update — continued Week of: July 21, 2014 From last week’s trading action, several trends can be observed. • Large companies continue to outperform small companies, evidenced by the S&P 500 year-to-date gain of 7 percent versus the negative 1 percent decline of the Russell 2000. The outperformance of the 500 clearly reflects investor preference for the associated predictability, visibility, liquidity and perhaps yield that large companies often offer over their small-cap brethren. At present, 29 percent of the S&P 500 companies offer dividends yielding above the 10-year Treasury yield of 2.5 percent. Additionally, last week’s 0.7 percent decline in the Russell 2000 may partially be attributed to Federal Reserve (Fed) Chair Janet Yellen’s comment that smaller-cap companies appear overvalued. The Russell 2000 is at the high end of its valuation range trading at roughly 16 times current year estimates. Yet, in our view, while elevated, valuation remains below irrational levels. • Among the S&P 500 sectors, the performance of Information Technology has greatly improved in recent weeks. The sector is the second-best performing sector year to date (behind Utilities), up 11 percent and was the best performing sector last week increasing 1.5 percent and second-best performing sector so far in July after advancing 2.8 percent as of close on July 18. The strong performance may reflect investor optimism over the current reporting season, expectations for increased capex spending throughout the remainder of 2014 which would benefit the tech space, attractive valuations and, in some instance, favorable dividend profiles. • The varied performance among sectors, with outperformance led generally by defensive sectors, is among reasons for caution. Utilities, Energy, Healthcare and Information Technology have all posted year-to-date returns greater than 10 percent with Consumer Discretionary, Consumer Staples, Financials, Industrials and Telecommunication Services advancing less than 5 percent over the same period. While the performance of cyclical sectors and companies appears to be improving, continued strength among the cyclical sectors is arguably required before declaring with confidence that the broad equity market is destined to trend meaningfully higher. While the popular indices are at or near all-time highs, we continue to believe equities grind higher throughout the third quarter based on a supportive fundamental backdrop. Earnings are increasing, interest rates remain low, valuations are stretched but not at extremes, sentiment is mostly favorable and inflation remains restrained. • The near-term direction of equities is likely to be driven by earnings. To a large degree, this is an earnings- driven market and as earnings go, so, too, goes the overall equity market. As of July 18, approximately 17 percent of the S&P 500 companies have posted second quarter results. While still early in the reporting season, initial results have been modestly stronger than expected. This week will be more telling with 145 S&P 500 companies across many sectors slated to release results. • Geopolitical issues remain a wildcard. With tensions heightened, it seems likely that volatility will remain above recent levels for the foreseeable future. With the macro backdrop being supported by an improving outlook for earnings, a “buy the dips” equity market thesis seemingly remains intact. • Our published price target for the S&P 500 remains 2,030, based on a multiple of 17.5 times our 2014 earnings estimate of $116, approximately 3 percent above current levels. We see upside to our price target based on higher earnings. Contributed by: Terry D. Sandven – Chief Equity Strategist Fixed income markets The 10-year Treasury yield declined slightly as geopolitical unrest generated safe haven demand for Treasuries. In regard to monetary policy, Yellen’s testimony to Congress was consistent with our expectations and largely reflected the tone of the June Federal Open Market Committee (FOMC) meeting minutes. However, Yellen did provide some new information by acknowledging that the labor market is recovering more rapidly than U . S . B a n k w e a l t h m a n a g e m e n t
    • Please refer to important disclosures on page 4. Page 3 Market & Economic Update — continued Week of: July 21, 2014 policymakers anticipated. We see strong potential for the Fed to shift to a less accommodative stance based on the improvement in employment outlook. In our view, Treasury yields are likely to rise throughout the end of 2014 amid better economic data and reduced stimulus from the Fed. We now expect the 10-year Treasury yield to close the year in a range of 3.2 percent to 3.3 percent, which is somewhat lower than our previous estimate of 3.4 percent to 3.5 percent. We adjusted our forecast largely as a result of the dismal first quarter output of the U.S. economy and the resultant downward pressure on Treasury yields. The Barclays Global Treasury ex-U.S. Index has declined in July and we maintain a cautious view of developed market international debt over the next three to four quarters. We anticipate modest U.S. dollar appreciation against the euro and the Japanese yen to weigh on the overall returns of foreign-denominated developed market fixed income. While the Fed is moving closer to exiting some of its extraordinary easing measures, both the European Central Bank (ECB) and the Bank of Japan (BOJ) are likely to maintain very high levels of monetary stimulus over the next 12 to 18 months. We expect dollar strength based on less accommodative policy and higher interest rates in the United States relative to the euro area and Japan. Additionally, European and Japanese bonds currently offer meager income returns and offer little protection against capital losses stemming from a possible increase in interest rates. Puerto Rico is reportedly planning to issue revenue bonds later this year despite recent downgrades to debt from the commonwealth. Puerto Rico’s weak growth outlook, diminished tax revenue and budget struggles have severely curtailed its capital markets access. Overall, following the recent fiscal woes of Puerto Rico and Detroit, we expect investors to examine the credit quality of municipal bonds with increased vigor going forward in order to avoid potential reduced or delayed principal or coupon payments. In terms of relative performance, the 10-year municipal bond-to-Treasury yield ratio declined modestly as investor demand for municipals re-emerged following sizable outflows last week. We expect muni-Treasury ratios to be little changed over the coming days as supply for this week is expected to be roughly equal to the 2014 weekly average. Contributed by: Roosevelt D. Bowman – Senior Fixed Income Analyst Commodities markets Despite the downing of Malaysian airlines flight 17, the Israeli invasion of the Gaza strip and new U.S. sanctions against Russian companies and individuals, commodities markets seemed to pause last week. The broad S&P GSCI was virtually unchanged, with losses in gold and natural gas moderated by gains in crude oil and aluminum. Gold prices fell despite continued expansion of conflicts and sanctions, driven by money managers taking profits on their long positions. The fundamentals for gold continue to point toward price weakness driven by an end to Fed quantitative easing, the rising prospect of rising short-term interest rates and improving U.S. economic data. After gaining nearly 18 percent in January due to a colder than normal winter, a mild spring and summer has allowed natural gas inventories to build faster than market expectations. Prices have reversed the bulk of the January gain, losing 11 percent in July, including more than 4 percent last week, leaving a year-to-date gain of less than 2 percent. Natural gas in storage has increased 2.5 times since the end of March, but remains 25 percent below the five-year average level. Long-range weather forecasts indicate mild summer weather is likely to persist, indicating storage injections may continue at the recent pace, bringing natural gas inventories back to average levels before winter. Aluminum inventories have slipped—a consequence of improving global growth—leading prices to add 2 percent last week and more than 6 percent year to date, after three consecutive calendar years of losses. Improving global growth will likely provide further support to aluminum, as well as the rest of the industrial metal complex. U . S . B a n k w e a l t h m a n a g e m e n t
    • Market & Economic Update — continued Week of: July 21, 2014 Page 4 DISCLOSURES This information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. The organizations mentioned in this publication are not affiliates or associated with U.S. Bank in any way. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general. The Dow Jones Industrial Average (DJIA) is the price-weighted average of 30 actively traded blue chip stocks. The NASDAQ Composite Index is a market capitalization price-only index that tracks the performance of domestic common stocks traded on the regular NASDAQ market as well as National Market System traded foreign common stocks and America Depository receipts. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The MSCI EAFE Index is an unmanaged index that includes approximately 1,000 companies representing the stock markets of 21 countries in Europe, Australasia and the Far East (EAFE). The MSCI Emerging Markets Index is designed to measure equity market performance in global emerging markets. The Barclays Global Treasury ex-U.S. Index includes government bonds issued by investment grade countries outside the United States, in local currencies, that have a remaining maturity of one year or more and are rated investment grade. The S&P GSCI is a composite index of commodity sector returns that is broadly diversified across the spectrum of commodities. Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer term debt securities. Investments in lower rated and non-rated securities present a greater risk of loss to principal and interest than higher rated securities. Investments in high-yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer’s ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. Gains in principal are taxable in that year, even though not paid out until maturity. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risks related to renting properties (such as rental defaults). © 2014 U.S. Bank N.A. (7/14) Crude oil found a footing after four weeks of losses with the market adjusting the risk premium for geopolitical conflict on the news of the downed Malaysian airlines flight over Ukraine. Domestic storage of crude oil has continued to return to average levels, providing indications of stronger demand due to good U.S. economic growth. We believe prices likely have an upward bias due to improving economic growth. Contributed by: Robert L. Haworth, CFA – Senior Investment Strategist Markets at-a-glance Fed Funds Target Rate 10-yr Treasury Yield S&P 500 Close DJIA Close LAST WEEK (07/18/14 close) 0.00 – 0.25% 2.48% 1,978.22 17,100.18 Prior Week (07/11/14 close) 0.00 – 0.25% 2.52% 1,967.57 16,943.81 Last Month End (06/30/14 close) 0.00 – 0.25% 2.52% 1,960.23 16,826.60 2013 Year End (12/31/13 close) 0.00 – 0.25% 3.01% 1,848.36 16,576.66 Data Source: FactSet U . S . B a n k w e a l t h m a n a g e m e n t