Market Perspective For May 16, 2014

While the week started off strong as the Dow again set a new record closing of 16,583.34, the markets have shed their gains over the past few days. The S&P 500, which also set a new high, stumbled as well. The markets did rally a bit today as the Dow was up 0.3 percent and the S&P 500 gained 0.4 percent. For the week the markets were down, continuing a trend of choppy trading we have seen throughout the year.

With the Dow and the S&P 500 hitting new all-time highs, it is reinforcing our belief that the bull market is still intact. Weakness in small caps remains but did show some resiliency today as the Russell 2000 gained 0.63 percent. Despite the negative action over the past few days and continued underperformance of the Russell 2000, we expect the market to again move higher over the coming weeks.

One of the most significant economic stories of the week took place in India; the Bharatiya Janata Party (BJP) secured the biggest electoral victory in 30 years and dealt a stinging blow to the ruling Congress party. The BJP is the first party to have a majority in parliament since 1984, and with coalition partners, they will control more than 60 percent of the legislature. Incoming Prime Minister Narendra Modi led his state to double digit GDP growth over the past decade and he won largely on the desire by the public for a stronger economy. Given the size of India’s role in the region, the election is a major shift and may have an important impact for a decade or more.

Domestically, economic data was generally in line with expectations, although some reports were weaker than we would like to see. Industrial production was negative 0.6 percent and the National Association of Home Builders/Wells Fargo sentiment index fell to 46, the lowest reading since May 2013. If reports continue to be subpar it could become a worrisome sign given that a pick-up in activity is expected over the rest of the year.

Additionally, investment bank economists have reduced their first quarter GDP estimates into negative territory based on weak data from March. If we don’t see the pick-up soon, second quarter GDP estimates may start to decline. On Friday, data turned positive though, with multi-family housing construction permits reaching a 4-year high.

The decline we’ve seen in interest rates seems to be partly driven by the weaker economic data during the first quarter. For now, bond investors are concerned the taper will mean slower economic growth and lower inflation, leading to the purchase of government bonds. Nevertheless, there will be pressure on rates to move higher, so long as the economy stays out of a recession. While long-term bonds have performed well this year, we continue to urge caution. If a rate jump does occur, many of these funds could drop quickly in value.

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