S&P Advances for the Fifth Straight Quarter Despite Many Obstacles

The S&P finished the first three months of 2014 on Monday by gaining for the fifth consecutive quarter, the best such showing since 2007, but this was also its worst quarterly showing since the fourth quarter of 2012. The advance was 1.3 percent and for the entire quarter this index vacillated on either side of unchanged by nominal amounts after its almost 30 percent advance in 2013.

The market, to its credit, did not succumb to the usual and unusual factors that were thrown in its upside path, the most unexpected of which was the negative effects of miserable winter weather that hit many parts of the country. In addition, there was also the negative fallout from the emerging markets, which underwent their own crises at the start of 2014 in addition to the geopolitical stress arising from Russia’s annexation of Crimea and the tensions along the Ukrainian border. These were certainly reasons for our market to sell off, and despite many difficult days, stocks here really held together in a general sense.

Then there was the start of the tapering process of the $85 billion a month in bond-buying stimulus that the Federal Reserve had engineered during the financial crisis whose intention was to keep interest rates at record low levels in order to encourage businesses and consumers to borrow and in order to help the housing market to recover. The program started to get unwound this past quarter at the rate of $10 billion a month, which means that by the fall of this year it will come to an end. Adding to investor concerns is the all-important question of when the Fed will in fact start raising the federal funds rate from current levels of between zero and one-quarter percent, and there was plenty of controversy over this issue as the quarter came to an end.

The United States and the E.U. agreed to work together to prepare potentially tougher economic sanctions in response to Russia’s behavior regarding Ukraine, including the energy sector while at the same time trying to make Europe less dependent on Russian gas. President Obama said that Russian President Putin had “miscalculated” if he thought he could divide the West or count on its indifference over his takeover of Crimea. But at the same time the G-7 decided at quarter’s end to hold off on sanctions that would have targeted Moscow’s economy unless Putin took further action to destabilize Ukraine or other former Soviet republics.

“If Russia continues on its current course, its isolation will deepen, sanctions will increase and there will be more consequences for the Russian economy,” Mr. Obama added. He also said that Europe should develop its own energy resources, which was a veiled reference to the continent’s environmental resistance to shale gas extraction, and not just count on America. His comment was due to the fact that Russia provides around one-third of the E.U.’s oil and gas and 40 percent of the gas is exported through Ukraine.

The reason that things have calmed down a bit as the quarter came to an end is the fact that the World Bank warned that the economic impact of annexing Crimea from Ukraine could drive Russia into a sharp recession this year even if the West stops short of trade sanctions. Their G.D.P. could contract by as much as 1.8 percent if the crisis continues as Russian markets and the ruble have been shaken, resulting in massive capital outflows of around $70 billion in the first quarter alone compared with $63 billion all of last year.

Another issue that investors have had to deal with as the first quarter came to an end is the future course of Federal Reserve policy. On Monday’s last day of the quarter, stocks here made a strong rally after Fed Chair Janet Yellen defended the central bank’s easy money policies when she said that the Fed’s “extraordinary commitment” to boosting the economy, especially the still struggling labor market, will be needed for some time to come. She said that there remains “considerable slack” in the economy and job market, a sign that further monetary stimulus can still be effective. “I think this extraordinary commitment is still needed and will be for some time, and I believe that view is widely shared by my fellow policymakers at the Fed,” Mrs. Yellen said.

The “scars from the great recession remain, and reaching our goals will take time,” she added, as despite the fact that the unemployment rate has declined from a post-recession high of 10 percent in 2009 to 6.7 percent last month and has fallen more quickly than expected, that drop is due in part to the large number of Americans who have given up looking for work and are therefore not counted as part of the labor force.

She concluded by saying that she does not believe that inflation will soon increase because there is at the present time no evidence of worker compensation rising as she pointed to the unexpectedly large proportion of part-time workers and long-term unemployed as reason to believe that further improvement in the labor market could draw people back into better jobs.

Economic reports this past week painted a picture of an economy that is still trying to show better signs of improvement, as the January CaseShiller Home Price Index rose by the smallest rate since last August, March Consumer Confidence increased to the highest level since January 2008, February new home sales declined by 33 percent, the most in five months, February durable goods orders, those meant to last more than three years, rose by 2.2 percent, greater than expected, but this was due to the largest automobile demand in a year. The final estimate for fourth-quarter G.D.P. was raised to 2.6 percent, February pending home sales declined for the eighth straight month, the March Chicago Purchasing Managers’ Survey declined to the lowest level since last August but February personal spending rose by the most in three months.

After these mixed reports at best, investors will perhaps get a more definitive read on how the economy is progressing on Friday when the March jobs report is released. The expectation is for around 200,000 jobs to have been created, which will be the first major post-poor weather economic reading and will go a long way toward determining if the recovery is for real or not.


Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media. 

If you have any questions, contact dselkin@nationalsecurities.com.

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