Month: March 2014

China drove the markets two weeks ago, while the Ukraine was the big story last week. Looking at the week to come, it appears we may both issues in tandem.  Thus far though, only the Chinese news is impacting markets in any significant manner, and only in Asia.

Global asset markets have acted very differently in recent weeks. Asian markets dropped on concerns about China, but European markets responded to the situation in Ukraine. Early Monday was no different: Chinese shares slumped nearly 3 percent on reports that China had a large trade deficit in February, but Europe opened higher due to the lessening of some tension in the Ukraine.

China’s export report poured fuel on the fire caused by the first domestic bond default in the reform era last Friday. Copper prices plunged over concerns that China’s massive stockpiles will be sold to cover bad debts. Copper is now flirting with a major support level of approximately $3.00 per pound, while the Shanghai Composite has fallen to 2000 once again. This level was hit in autumn 2012 and again in summer 2013. Bulls interpreted this testing of support as a double bottom, and now there is a chance it will test a triple bottom. There are already calls for a stimulus program to help the economy. The other possibility is that the market drops another 15 percent and challenges the lows of 2008, in which case there will be global financial turmoil.

In Ukraine, the Russian population of Crimea wants to rejoin Russia. This has put the issue back on top of the headlines, but there is little chance of escalation at the moment. The United States went to war in Kosovo to secure independence for that nation from Serbia, something the Russians do not forget because they strongly opposed that war. Given that the Russian dominated Crimea region was given to the Ukraine by Russia in the 1950s, it’s unlikely the U.S. or its allies will escalate the conflict to prevent a reunion. The main threat is Ukrainian nationalists could attack Russian forces in the country and set off a civil war. Since natural gas flows to Western Europe via Ukrainian pipelines, the economic impact of even limited military action would be grave if the pipelines were damaged.

Meanwhile, back in the U.S. economic data continues to plod along. The main indexes pushed to new highs last week, with the Dow Jones Industrial Average the last remaining holdout. Domestic shares could pull back this week though. They are nearing overbought levels and they have not priced in problems in China and Ukraine.  Even if we experience a pullback, the U.S. remains best suited to endure any volatility.  We don’t expect a near-term correction to be the beginning of something larger.

Economic Reports: Economic data has been weaker than expected in 2014, down from the inflated levels anticipated late last year, but consistent with the “new normal” post-2008. On Wednesday, the federal budget for February will be out. If the economy is weaker or stronger than believed, it will show up in a larger or smaller than expected deficit. Retail sales for February are out on Thursday.

Earnings: American Eagle Outfitters (AEO) and Dollar General (DG) highlight a very light week for earnings reports.

The Russell 2000 enjoyed another strong week as the index rushed through the 1200 level, heading on to new highs along with the other major indexes. The Dow Industrials was notably not among them. Construction spending was better than expected, as were the manufacturing numbers out this week, but overall the move to new highs seemed like a relief rally following the easing of tensions in Ukraine.

The stock market now looks very close to a pullback or a sideways trading period, at least in the next week or two. Stocks have rallied sharply from their lows in early February; the Russell 2000 is up 12 percent versus an 8 percent rally in the S&P 500 Index. The S&P 500 Index is only up 1.55 percent for the year, so a small pullback or a couple weeks of sideways trading would keep it flat for the year. We don’t speculate on short-term market moves, but the technical indicators are signaling that the market will take a breather soon.

Longer-term, investors appear to discount the risk from the Federal Reserve’s decision to taper bond purchases. Although the Federal Reserve has stated it will keep monetary policy loose for an extended period of time, it is tightening monetary relative to its peak easing policy from only a few months ago. Given the strength in the asset markets and the solid manufacturing data of late, the Fed will likely reduce asset purchases once more at the March meeting (March 18 to 19). The effects of an even tighter policy will first be felt in emerging markets, but eventually the effects will make their way back to the United States. The result will be either an economy following manufacturing numbers and showing improvement, whereby pushing up rates, or the economy will weaken and asset prices will suffer.

In China there was the first domestic bond default perhaps since the recreation of bond markets during the past 30 years of economic reforms. Financial markets shrugged off the news, but commodities were hit, with copper and iron ore falling in price. China’s central bank has been even more aggressive than the Fed in tightening monetary policy. The banking system is flush with cash at the moment, but this may be in part due to investors exiting the trust market for the safety of large state-owned banks. In the next few months, China will enter a period of heavy debt repayment that will last into 2016, but defaults are already an increasing concern. Any misstep would rattle global financial markets, particularly markets such as U.S. equities that have pushed to new highs.

One sector we’re keeping an eye on is biotechnology. The sector tumbled on Thursday for “no reason”, in the sense that there was no news to trigger a sell-off. Biotechnology stocks are still sitting on huge gains in 2014 even after selling off this week, and they’re only down about 5 percent from the peak. Other momentum leading sectors, such as social media and solar, have not broken down. What makes the drop interesting is that there was no news, which implies it could be due to a shift in short-term investor sentiment. However, given the huge advance in biotech shares this year, the sector could fall another 10 percent and it would still be outperforming the S&P 500 Index for the year.

We are pleased to announce our Model Portfolio Returns, year-to-date through February 28, 2014:

Fidelity Select Sector Fund Portfolio: +4.83%

Fidelity Straight Growth Portfolio:  +2.66%

Fidelity Balanced Growth Portfolio: +1.96%

Fidelity Global Portfolio:  +2.68%

Fidelity Conservative Income Portfolio: +0.91%

Diversified Sector Portfolio:  +5.17%

NTF Straight Growth Portfolio: +0.13%

NTF Balanced Growth Portfolio: +1.09%

Tax Advantage Portfolio: +1.51%

Aggressive Value Portfolio: +5.47%

Absolute Return/Down Market Portfolio: -1.44%

 

Since December 31, 2011, the Model Portfolios have returned:

Fidelity Select Sector Fund Portfolio: +55.07%

Fidelity Straight Growth Portfolio:  +62.28%

Fidelity Balanced Growth Portfolio: +40.84%

Fidelity Global Portfolio:  +42.18%

Fidelity Conservative Income Portfolio: +13.36%

Diversified Sector Portfolio:  +60.24%

NTF Straight Growth Portfolio: +46.06%

NTF Balanced Growth Portfolio: +34.39%

Tax Advantage Portfolio: +33.77%

Aggressive Value Portfolio: +34.09%

Absolute Return/Down Market Portfolio: -3.10%

To learn more about the Investor Guide to Fidelity Funds, call us at (888) 252-5372 or click here.

We look forward to providing you risk-adjusted mutual fund recommendations and Model Portfolios for years to come.  As always, if you have any questions about our perspective on the market, individual funds or models, please call or email me at matt@mutualfundivestorguide.com.

February was a rebound month for the markets following January’s sharp sell-off. The S&P 500 Index gained 4.31 percent and is up 0.60 percent this year. The Dow Jones Industrials Average remains in the red though, down 1.54 percent for the year, while the Russell 2000 and NASDAQ are both in positive territory.

Economic data wasn’t terribly supportive of the rebound. There were some strong housing numbers, but more importantly, we learned the 2013 third quarter boost in inventories was not the start of a faster recovery. The Bureau of Labor statistics lowered the 2013 fourth quarter GDP estimate from 3.2 percent down to 2.4 percent, a large drop from the 4.1 percent growth rate in the third quarter. This doesn’t signal a slowdown in the economy though, which is why stocks shrugged off the number. A 2.4 percent annualized rate is the same rate of growth seen in 2010 and it is faster than the growth rate in 2011 and 2012.

Some economists and media outlets have blamed the weakness on weather, but the evidence is strongly against this interpretation. First of all, Hurricane Sandy was undetectable in national GDP statistics and that was a far worse disaster than several snow storms. Second, weather was blamed for weak retail sales numbers, but online sales also suffered. If people did stay home due to snow, this should have increased online sales. Finally, weather was blamed for weak home sales, but a drop in home sales came from the West, where the weather was warmer than usual, while sales were up in the storm battered Northeast.

Even though economic data wasn’t as positive as we had hoped, stocks still pushed higher. Housing, solar, biotechnology, internet, and social media stocks were a few of the sectors benefiting from rising optimism and merger activity. Facebook’s (FB) purchase of WhatsApp for $19 billion was the exclamation point on a very strong month for Internet and social media stocks. The strength in housing stocks is particularly notable because the home builder stocks have pushed to new 52-week highs. Clearly, investors haven’t been deterred by the weaker than expected economic data in 2014.

Still, we cannot overly rely on strong stock prices as a leading indicator for the economy. There are also real concerns that threaten the bull rally and even the economic recovery. The biggest concern is with China, where the government is trying to deflate the credit bubble without bursting it. In January, there were concerns about a default in the trust market and by the end of February the yuan tumbled in value.  It wasn’t a big decline for the yuan, but since the currency is tightly controlled and has been steadily appreciating, the sudden drop was surprising. Furthermore, in February, some lenders stopped loaning to property developers due to the growing risk. If it looks like the economy and financial sector are headed for deeper trouble, and a sharp devaluation of the yuan, this will be unnerving news for commodity producers and nearly all emerging markets.

The crisis in Ukraine is weighing on Europe as well. Russian banks have the most exposure to Ukraine, but Austria also has sizable exposure. European banks are exposed to emerging markets more generally, far more than U.S. banks. Already, the crisis is pushing up oil prices, which is bad news for weak emerging market economies. European stocks also opened sharply lower on the first trading day since Russian troops moved into Crimea. It could be a one-day sell-off by panicked traders, and very often these types of events are great buying opportunities as traders panic and assume the worst potential outcome.

By comparison, U.S. markets remain a safe haven and we are likely to see a bid for U.S. Treasuries as long as there is trouble in Europe’s backyard. The Ukraine situation is likely to calm down politically soon, but economic effects could linger. Russian supplies natural gas to Europe and half of that gas flows through the Ukraine. Thus far there’s been no interruption in service. Still, while Ukraine grabs headlines, China is the more worrisome situation as the economic impact of a sudden slowdown would have a greater global impact.

The decline of domestic stocks in January acted to price in some Chinese risk, though losses were recovered over the past month. The headwinds haven’t gone away; in fact, the Chinese situation has shown signs of further deterioration. Manufacturing data still shows a contraction, while services remain strong. Since manufacturing is the leading indicator, there is risk that services will weaken in the coming weeks. On the positive side, although Chinese yuan continues to devalue, the Chinese stock market did not sell-off further. If further depreciation occurs, while bullish for stocks in the long-run, the immediate impact would be fear and volatility.

Finally, U.S. stocks enjoyed a very strong month in February which is unlikely to be duplicated in March. While we may not see any significant long-term market ramifications from Ukraine, China or other unforeseen issues, investors could expect to see greater volatility over the near-term. Interest rates may decrease whether stocks go up or down, due to safe haven buying, which may be good news for home builders, real estate and utilities.

European shares have underperformed U.S. shares in the past 5 years, a result of the ongoing debt crisis. Germany has held up rather well, but markets such as Greece, Italy and Spain have dragged Europe- wide returns lower. It is unlikely that the debt crisis is over; talk of yet more bailouts for Greece continues. However, unlike American stocks, European stocks have priced in a lot of this risk.

When considering any foreign market, it’s easiest to concentrate on trends making headlines, the biggest of which is currency. The major factor in relative performance between Europe and the U.S. is the relative performance of the U.S. dollar and the euro. As one currency outperforms the other, investors shift assets into that region’s markets. Even if the U.S. and Europe are equally valued, a rising euro will draw in more investment, pushing up European real estate and equity prices. After several years of outperformance, European assets will appear overvalued to American assets and the capital flows will reverse. There are always other factors at work, such as the European debt crisis, but all of this is eventually priced into the currency market.

Typically, currency cycles run for several years; the U.S. dollar bottomed in 2008 after underperforming the euro for roughly 7 years. The U.S. dollar may have peaked in 2010 when the crisis in Greece first erupted and sent the euro below $1.20 (well below the recent exchange rate of $1.38), and since it has been six years into a dollar rally, it could be coming to an end. For certain, European stocks have taken more lumps than U.S. shares. Where Greece, Spain and Italy have had a debt crisis erupt, the U.S. has avoided state level problems for now, even with the bankruptcy of several cities. By comparison, the U.S. market is starting to look rich, with investor optimism on the rise. From this view, there is the possibility Europe could outperform over the next 3 to 5 years.

There are still headwinds though. Heading into 2014, the big risk to Europe is still the credit market. Credit growth was negative 2.2 percent in January, which means there is the possibility of a recession. Adding to that problem are troubles in emerging markets such as Turkey, as European banks are far more exposed to emerging markets than U.S. banks. Finally, the situation in the Ukraine has a greater effect on Europe than the United States; to start the month European shares opened sharply lower in the wake of Russian troops entering Ukraine’s Crimean peninsula.

Simply said, the risks in Europe are very clear and immediate. However, for a long-term investor, the relative value in European shares is becoming more attractive relative to U.S. shares. As long as Europe fares as well as the U.S. economically and financially, it makes sense to pick up the relatively cheap European shares. Short-term investors may want to wait and see whether the continent’s problems are over.

The Investor Guide to Fidelity Funds covers a number of equity funds dedicated to Europe:  Invesco European Growth (EGINX); U.S. Global Eastern Europe (EUROX); Fidelity Europe Capital Appreciation (FECAX); and Fidelity Europe (FIEUX).  Each fund falls into Morningstar’s large blend category, which helps when comparing their portfolios. At this time, however, both FECAX and EGINX are closed to new investors.

Given limited availability, the first option is EUROX due to its focus on Eastern Europe. Obviously, this is the riskier fund of the four and events in Ukraine will have an impact on short-term performance. More than 40 percent of assets are in Russian shares, and Russia is the most highly exposed to Ukraine’s financial system.  Moreover, there are threats of sanctions being brought against Russia by the United States as well as numerous European countries, due to its intervention in the Ukraine.

The presence of Russia also means the fund has a high correlation with BRIC and emerging market funds as well. There is high potential reward if emerging markets, specifically Russia, can rally, but there is also very high risk. Additionally, the fund is expensive with management fees at more than 2 percent.

Of the two diversified European Funds covered in the newsletter and open to new investors, Fidelity Europe (FIEUX) is clearly the best option. It is also the cheapest offering, with low turnover, and delivers solid exposure to developed Europe.  FIEUX has 31 percent of its holdings in the United Kingdom, followed by Germany at 14 percent, France at 13 percent and Switzerland at 12 percent.  It completely avoids Russia and emerging markets.

In addition to these funds, there are international funds with sizable European exposure: Fidelity Total International (FTIEX) and Fidelity Overseas (FOSFX). Of the two, Overseas offers the greater exposure to Europe, with 70 percent of assets on the continent. Another 18 percent of assets are in Japan, making it a European heavy, developed market dominated fund. FTIEX, in contrast, has 50 percent in Europe followed by 20 percent in emerging markets. For investors in search of European exposure, FOSFX is the better choice.

Finally, Fidelity also offers a regional fund, Fidelity Nordic (FNORX). This fund has been an outstanding performer in recent years thanks to several Nordic countries refusing to use the euro.  Sweden and Norway use their own currencies, while Finland did adopt the euro. Denmark also has its own currency, but it is closely pegged to the euro. As mentioned earlier, the difference in currency can often be the deciding factor between investments abroad, but in this case, while FNORX has beaten Fidelity Europe (FIEUX) in the past year, the euro has appreciated against the Swedish and Norwegian currencies.

The main reason Nordic shares have outperformed is because they have less currency risk. It is the same reason the German stock market has held up very well; if the euro were to break apart, investors expect a new German currency to appreciate. Even more so, the Nordic countries that do not use the euro are insulated from this currency risk. The Swedish and Norwegian currencies have seen safe haven buying during flare ups in the European debt crisis. Additionally, Norway’s government is well funded by its oil exports and Sweden’s banking system was reformed in the 1990s, having already gone through a major crisis. This may be an attractive haven for investors wanting European exposure without the currency risk.

While there is significant short and intermediate-term risk for European stocks due to the volatile situation in Russia and the Ukraine, over the long-term, there may be some value opportunities for investors.  Over the next few weeks and months, follow the European markets closely. There may be buying opportunities; with increased volatility due to speculators, you may be able to purchase undervalued funds.

Fund	Fee (%)	Assets ($B)	Turnover (%)
EGINX	1.38	1.9	15
EUROX	2.15	0.1	85
FECAX	1.09	0.4	127
FIEUX	1.02	1.0	59
FOSFX	1.09	3.2	42
FTIEX	1.09	0.4	89
FNORX	1.02	0.6	61