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Financial Industry Insights from Advisors Asset Management
On July 14, 2014
Viewpoints from AAM - What Can Investors Expect from the Second Half of 2014?
Entering 2014, most economists predicted an improving economy and higher interest rates. However, we’ve seen first quarter GDP revised downward twice to a -2.9%, and the yield on a 10-year Treasury dropped from 3.02% on December 31, 2013 to 2.51% on June 30, 2014. This is after bouncing off the May 28 low of 2.44%. That represents a greater than 16% movement in yield during the first half of the year – for those of us keeping track. It’s worth noting that as yields have fallen, the Investment Company Institute (ICI) estimates inflows into domestic equity funds near $3.6 billion while bond funds have had inflows over $50 billion. So how should an investor position themselves for the second half of 2014?
Let’s start by looking at where we’ve been. The first half of 2014 was difficult to gauge as the harsh winter weather did have an impact, but what do we need to see in second quarter GDP to represent the “snapback” most economists have been predicting? Second quarter estimates have been recently revised downward with the net effect being that growth for the first half of the year may be flat. This rate of growth, or lack of growth, may have also been confirmed by the marginal reduction in the yield curve.
AAM has always felt the slope of the yield curve is one of the most reliable leading indicators for the economy and we have recently been closely watching the slope of the 30-year Treasury minus the five-year Treasury. The 30-5 spread has been declining (flattening) since November 2013, recently dropping to an intraday level of 164 basis points. This is the flattest the curve has been since 2/25/2009. If the bond market is trying to tell us the economy is slowing, this may be a good time to step back and look at the additional economic data to confirm what the yield curve may be indicating.
Housing
Employment
Source: Bureau of Labor and Statistics & U.S. Department of Labor
Leading Economic Indicator
The Leading Economic Indicators Index continues to show improvement in both the real economy, sentiment and equity components.
As we consider the second half of 2014, let’s keep in mind consumers represents nearly 70% of U.S. GDP, and historically, personal consumption is driven by confidence in your job and wealth created from investments such as housing. It’s interesting that during the first year and a half following the end of the recession in 2009, GDP was over 2.6% and no jobs were being created. Now we’ve added over 1.3 million jobs this year and we’ve seen no GDP growth. I would suggest there was positive growth in the second quarter of 2014, but GDP is a lagging indicator, and that the month-to-month growth in GDP in February and March was simply overshadowed by the transient effects of weather in January.
Although the economic data shown above is positive, headlines will likely create volatility. We feel investors must continue to monitor economic data and focus on leading indicators, corporate earnings, and signals from the bond market. Although the yield curve remains positively pitched, the recent flattening does create some concern and may indicate the need to reduce credit risk at some point in the future.
For now, we don’t feel it’s the time to panic but we need to keep looking for signals.
CRN: 2014-071114-4307R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.
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