After a booming fourth quarter for the stock market, it is difficult to not feel a bit squeamish over how 2014 has begun.  With the S&P 500 Index down over 5% for the year, such a number is hard to ignore. We understand this, and we have been dedicating much time and effort to a temperature check of sorts, in order to assess what the slump means, where it came from, and where we believe it’s headed.

First, we are not overly surprised by the market’s behavior thus far. As we described in our Investment Strategies Newsletter last month, we believed it was very unlikely that the market could sustain itself where it ended the year. We also believed that it would probably come back to reality, with that reality likely being a positive picture, but nothing to write home about, in contrast with the double digit returns of 2013.

We find ourselves still feeling these same convictions, even considering the market’s dismal performance in January. The macroeconomic picture still looks positive, both domestically and globally, and we’d like to offer several key reasons that support this notion.

The US economy is improving, and this is further confirmed by the Fed’s decision to taper another $10 billion—a decision which the Fed described in December as something that would be largely dependent on its ongoing assessment of the health of the economy.  Further, the employment market continues to improve, and inflation remains tame. Therefore, the US Dollar should remain strong. Additionally, although it may not have been celebrated by the markets, this January saw a fairly impressive bout of earnings reports. On average, earnings were slightly better than usual, as well as revenues. As of last Sunday, February 2, 72% of earnings reports and 58% of revenue reports had beaten estimates. Three quarters ago, only 37% of revenue reports beat estimates. Some companies have lowered guidance despite positive earnings and revenues, presumably due in large part to the fact that 2013 was such a positive year.

In terms of Europe, we believe the economy as a whole is slowly coming out of recession, and data should reflect this in the upcoming months.  However, this does not mean the entire region is recovering equally—those nations that have been weakest still remain quite weak, but it seems such nations have at least stopped deteriorating, which is certainly a step in the right direction.  The European Central Bank is continuing to provide liquidity which may weaken the Euro. 

The Japanese economy may hit a bump as the increase in the Value Added Tax (VAT) kicks in April 1, creating a strong fiscal headwind, but the Bank of Japan and Prime Minister Abe continue to aggressively buy bonds and stocks, with no tapering anywhere in sight. This should, in the very least, offset the VAT increase.  China continues to be a risk with its economic growth rate trending lower and no apparent concern from policy leadership. Chinese leaders seem more concerned with infrastructure reform to attract foreign capital over the long term, at the expense of the economy slowing.

Emerging markets offer their own pieces to the puzzle, some of which are positive and others more concerning.  Because of China’s significant trading ties and the unwinding of the “carry trade,"  the expectations for continued strong growth in many of the smaller Southeast Asian nations, as well as Australia, Brazil, Chile, and Canada, are being questioned.  However, many of these nations are reacting by raising interest rates. In the long run, this will be seen as the correct approach, but there will likely be some slower growth in the near term as a result.

In summary, we continue to see better opportunities in stocks versus bonds, and we are focusing our attention on opportunities for stocks in Europe and Japan, as well as in the US. We are not taking lightly the market’s downward momentum thus far, but are instead trying to look at the big picture in order to not simply react viscerally. We still like what we see, and we will continue to monitor the domestic and global scene as some of the current kinks are worked out. As always, please do not hesitate to contact your portfolio manager if you have any questions or concerns.