MARKET NEWS & VIEWS
WEEK OF JULY 28, 2014
MARKET COMMENTARY
MESSAGE FROM THE PRESIDENT
TOM L. STRINGFELLOW, CFA®, CFP®, CPA®, CIC
President and Chief Investment Officer
Earnings still setting the stage...
Deeper into the new quarter and earnings metrics continue to improve; FactSet reports the blended growth rate for
second quarter S&P 500 EPS now stands at 6.7%, up from 5.3% last week and above the 4.9% expected at quarter end.
It’s also above the 2.1% recorded in Q1 and the four-quarter average of 4.1%. Of the 230 S&P 500 companies reporting
so far, 75% have beat consensus earnings expectations. On the whole, companies are beating consensus earnings
expectations by 4.2%. These numbers reflect a positive trend for corporate earnings, but investors took little notice as
the markets finished the week mixed. Geopolitics continues to be the most convenient scapegoat for a directionless
market.
Fortunately, the riskiest part of the "Sell in May" season is almost over, and, according to ISI data, for the past four
years, on average, the S&P was up +9% from July 28 to year-end. Liquidity is still the market's friend as U.S. money
growth accelerated +6.8% last week, and, in an interesting current development, China's central bank stomped on the
gas pedal, accelerating their money growth to +14.7% in July. Back on the domestic front, ISI's employment company
surveys reported a solid 58.9 versus 53.9 a year ago, mirroring an improving labor picture, and again reminding us that
wage pressure may soon follow. The improving economic picture was also reflected in the balance of the ISI company
surveys (several close to 8-year highs) and also in last week's NABE surveys with readings for Q2 spiking in capex,
employment and wages.
MARKET PERFORMANCE
Key Market
Indices
S&P 500
Russell 2000
NASDAQ Composite
DJ 30 Industrials
Last
Chg
% Chg
1 Week
Chg
1 Week
% Chg
1 Mth
% Chg
YTD
% Chg
12 Mth
% Chg
52 Wk
High
52 Wk
Low
1,978.34
1,144.72
4,449.56
16,960.57
-9.64
-11.54
-22.55
-123.23
-0.48
-1.00
-0.50
-0.72
0.12
-6.89
17.42
-139.61
0.01
-0.60
0.39
-0.82
0.96
-3.21
1.59
0.55
7.03
-1.63
6.54
2.32
17.04
8.59
23.42
9.03
1,991.39
1,213.55
4,485.93
17,151.56
1,627.47
1,009.00
3,573.57
14,719.43
The following has been compiled from information and comments provided by the investment professionals of Frost
Investment Advisors:
EQUITY MARKET & GENERAL MARKET HIGHLIGHTS
DOMESTIC COMMENTARY
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June bookings reflected the third monthly improvement in the Architectural Billings Index, matching a high hit
last September, and consistent with a strengthening recovery in commercial real estate. Per the Financial Times,
growth appears to be strongest in the Midwest and weakest in the West. Architectural billings tend to lead
nonresidential construction by roughly three quarters to one year per the article, boding well for next year's
GDP. Affirming economic data came from the Kansas City Manufacturing Activity Index which was up again in
July. New orders, shipments, production and employment all improved for the month.
Money market rules are set to change following a new edict from the SEC; institutional money market funds will
be required to abandon their stable, $1-share value and allow their prices to float under rules newly adopted by
the U.S. Securities and Exchange Commission. The rules, approved on a 3-2 vote, focus on prime money market
funds, which cater to institutional investors and buy riskier securities, such as bank and corporate-issued
commercial paper. Going forward prime funds will price their shares to reflect price fluctuations in the funds’
securities. Planned implementation is in two years.
WWW.FROSTINVESTMENTADVISORS.COM
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Debt markets are changing, reflecting both a slow-down in mortgage originations and diminishing investor
interest. Today, bonds backed by home loans no longer dominate the overall debt market in the US, with the
amount of corporate bonds outstanding recently reaching $9.9 trillion, surpassing the $8.1 trillion of residential
mortgage-backed securities.
According to Dealogic, sales of junk bonds issued by low-rated companies totals $210.8 billion so far this year,
the highest level for the first half since 2000. Leveraged loans made to junk-rated companies are currently at
$361.5 billion year-to-date, according to S&P Capital IQ, following up a record of $606.9 billion in loans for 2013.
The S&P 500 reached another new high last week,
S&P 500
1,988 on July 24th. There is some technical
divergence, with the number of stocks above their
50-day moving averages declining, even as the
market has trended up; this means that fewer stocks
are pushing the market higher. We have also
mentioned weakness in the small cap space, which
could be a harbinger of wider softness if risk
tolerance was to decline.
Resistance on the S&P is in the 1980s and again at
2,000, while support levels are 1,944-52.
This week is a big one for earnings; to date about
50% of the S&P’s companies have reported. Some
of the better results are coming from the globallyleveraged multinationals, which helps explain why
earnings can grow despite tepid US growth.
Earnings revisions are also now trending up
indicating expectations of an improving outlook
going forward.
7/21/14, FactSet, BofA
BofA Merrill’s monthly survey of global fundmanagers shows that institutional investors have
their second highest allocation to stocks in 13 years
at 61% (see chart at bottom left). The survey
indicates bullishness for technology, energy, and a
35% overweight to Europe. Investors also remain
underweight bonds (chart bottom right). When we
look at these results the contrarian call would be to
increase bonds and cut back on stocks:
2,200
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2,000
1,800
1,800
1,600
1,600
1,400
1,400
1,200
1,200
1,000
1,000
800
BofA, 7/15/14
2,200
2,000
'10
© S&P, Frost Investment Advisors, LLC
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Max of 1987.98 on 24-JUL-14
Standard & Poors 500 Composite Index, Price Return, USD, Close - United States
Trendline: Linear
BofA, 7/15/14
WWW.FROSTINVESTMENTADVISORS.COM
'11
'12
'13
'14
800
25-JUL-14
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A great chart below from Cornerstone Macro showing the growth in S&P earnings as well as changes in the
price/earnings [P/E] multiple on those earnings. First, we can see that 2013 experienced a meaningful re-rating
of stocks with a large P/E expansion, we think this rate of change is unlikely to be repeated. Nevertheless, we
can also observe that at about 16x P/E the S&P 500 is not as extended as it was even back in 2003.
CSM, 7/21
GLOBAL COMMENTARY
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There are signs of a global economic improvement as we move into the third quarter; data from several regions
highlight improving regional Purchasing Managers’ Index (PMI) reports for the month of July. China’s
Manufacturing PMI climbed to an 18-month high of 52, while the Eurozone showed signs of life with its
composite PMI at a three-month high (despite geopolitical issues in Eastern Europe).
58
Euro-zone PMI: Composite Output
(SA, 50+=Expansion)
60
China PMI: Manufacturing
(SA, 50+=Expansion)
56
55
54
52
50
50
45
48
46
40
44
42
35
09
10
11
12
13
14
09
10
11
Renmac 07.24.2014
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12
13
14
Renmac 07.24.2014
Frontier markets have been on a tear for the past few years, but there are occasional reminders of the more
'exotic' risks that are unique for the class; the most recent being an outbreak of Ebola. The World Health
Organization (WHO) has reported an outbreak in west Africa and their worries about the potential for it to
spread to the region’s larger countries, particularly Nigeria. Authorities in Nigeria are testing a potential case in
the country’s commercial capital, Lagos. The news serves to worry investors and business travelers, and area
mining companies are beginning to pull staff from the region.
WWW.FROSTINVESTMENTADVISORS.COM
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Brazil's central bank just announced a series of measures to ease reserve requirements, freeing up more than
$20 billion, and changing the risk calculation for some loans; according to the Financial Times, the changes will
allow banks to use up to half of their reserve requirements to purchase loan portfolios from eligible financial
institutions. The central bank also increased the number of institutions eligible under the announced program to
134 from 58, while also adjusting minimum capital requirements for retail credit operations. Gee… what could
happen?
COMMODITIES/ENERGY
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Thousands of older rail tank cars would be phased out of operation within the next two years under regulations
proposed this week by the Department of Transportation in response to a series of fiery train crashes over the
past year. The phase-in period for replacing or retrofitting the DOT-111 tank cars is shorter than the Canadian
government's recently announced three-year phased plan. Regulators left open the question of what kind of
tank car will replace the old ones, saying they will choose later from among several proposals.
The proposed regulations would also apply to the transport of ethanol and other hazardous liquids. The
regulations only apply to trains of 20 or more cars, which would include most oil shipments. The proposal makes
mandatory a 40-mph speed limit through urban areas that freight railroads had voluntarily agreed to earlier this
year. Tank cars have ruptured in accidents with speeds as low as 24 mph.
The freight railroad industry has met privately with Energy department and White House officials to lobby for
maintaining the speed limit at 40 mph rather than lowering it. Railroad officials said a 30 mph speed limit would
tie up traffic across the country because other freight wouldn't be able to get past slower oil trains, which are
often 100 cars or longer.
Transportation Secretary Anthony Foxx reports that the government's testing of crude oil from the Bakken
region of North Dakota and Montana shows the oil is on the high end of a range of volatility compared with
other crude oils, meaning it's more likely to ignite if spilled.
The Eastern Seaboard is being opened to offshore oil and gas exploration for the first time in decades with the
Obama administration's approval last Friday of sonic cannons to pinpoint energy deposits deep beneath the
ocean floor. The approval opens the coast from Delaware to Florida for exploration by energy companies, in
advance of their application for drilling leases in 2018, when a moratorium is set to expire. This area of the
Atlantic has been closed to oil exploration since the 1980s, when some exploratory wells were drilled, without
any significant production. With advances in undersea mapping technology, companies expect to be able to
pinpoint significant oil and gas reserves. Opposition has been abundant, which likely seems an understatement.
Nissan manufactures the LEAF electric vehicle (EV), a number one selling EV in the U.S., with June sales figures
showing that 2,347 LEAF vehicles have been sold over the past year, up 5.5% over last year. Given its relatively
strong sales performance, one has to wonder about a recent announcement regarding the replacement battery
pack pricing; the replacement lithium-ion battery pack for the LEAF will sell for $5,499, after a credit of $1,000
for the old pack that must be traded in, plus installation fees and taxes. Nissan estimates installation will require
roughly three hours of labor that could add another $300 to the cost. Also introduced was a special installation
kit to make the battery pack “backward compatible” with 2011 and 2012 models, with an additional cost of
$225. In our view, the most interesting development is that the replacement battery pack is being introduced
with new chemistry that will address consumer criticism of vehicle performance, notably loss of charge in
extremely warm climates, like Texas.
KEY NEWS
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Of particular interest this week is the release of the FOMC’s monetary policy statement, which may contain hints
about when the Fed expects to hike rates, especially in light of improvement in the recent job numbers. Friday
has the all-important jobs report, with over 220,000 new jobs expected; this week also sees an update to 2Q
GDP. Overseas we have Chinese manufacturing, Eurozone PMIs, inflation, and unemployment.
Monday: US pending home sales.
Tuesday: US S&P/Case-Shiller home prices, consumer confidence.
Wednesday: FOMC releases statement. US 2Q GDP. ADP US employment. Eurozone bank lending.
WWW.FROSTINVESTMENTADVISORS.COM
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Thursday: Challenger job cuts. China manufacturing PMI. Chicago PMI. German unemployment. Eurozone
inflation.
Friday: US jobs report. US auto sales. Eurozone PMIs. HSBC China PMI. S. Korea trade.
Earnings releases: Another busy week: PFE, AMEX, Merck, Whole Foods, Tesla, Mastercard, XOM, CVX, PG,
Berkshire Hathaway. Int’l: Anheuser-Busch InBev, VW, BP, Nissan, Deutsche Bank, UBS, Siemens, BNP.
TOPICAL READS
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WSJ: Three reasons why it’s a great time to be an investor
The Kremlin’s Machiavelli has led Russia to disaster
Rate increases will test the market mood
Bubble Paranoia Setting In as S&P 500 Surge Stirs Angst
Inflation is needed to calm asset bubbles
Excess buybacks may be impoverishing future shareholder returns
Latest DALBAR report underscores poor long-term performance of individual investors
The Inflation Truther Crank Index
Of course stock corrections occur, but good luck predicting when
The Middle East Friendship Chart (really shows how complex the Mid-East is)
How Geopolitical Threats Affect the Stock Market
The Pentagon's War Against Climate Change
The uninformed debate on inflation
The ‘Good’ Country Index
The speed at which America’s economy can grow without stoking inflation has fallen
The Boom Is Coming, and Sooner Than You Think
The Recession’s Lost Generation of Homeowners Isn’t Millennials – It’s the Middle-Aged
Double-digit stock gains on an annual basis are the norm, not the exception
Second Quarter Outlook 2014 Review and Outlook
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buy or sell, or a recommendation of any security to any person. Managers’ opinions, beliefs and/or thoughts are as
of the date given and are subject to change without notice. The information presented in this commentary was
obtained from sources and data considered to be reliable, but its accuracy and completeness is not guaranteed. It
should not be used as a primary basis for making investment decisions. Consider your own financial circumstances
and goals carefully before investing. Certain sections of this commentary contain forward-looking statements that
are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are
not indicators or guarantees of future performance and involve certain risks and uncertainties, which are difficult to
predict. Past performance is not indicative of future results. Diversification strategies do not ensure a profit and
cannot protect against losses in a declining market. All indices are unmanaged and investors cannot invest directly
into an index. You should not assume that an investment in the securities or investment strategies identified was or
will be profitable.
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