YOUR FINANCIAL FUTUREYour Guide to Life Planning

January 2014

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Sandeep VarmaATS Advanced TrusteeStrategiesATS Wealth Strategist9710 Scranton RoadSte. 340San Diego, CA 92121858-643-5757Fax: 858-643-5756sandeep.v@atsfinancial.comwww.atsfinancial.com

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In This Issue

Weekly Market Commentary | Week of January 27, 2014President Obamas State of the Union (SOTU), scheduled for Tuesday, January 28, is unlikelyto be a big market mover. But three areas of the market may see some impact.

Weekly Economic Commentary | Week of January 27, 2014We expect that the FOMC will vote at this weeks meeting to further taper its purchases ofTreasuries and MBS by $10 billion per month, bringing monthly purchases to $65 billion.

Search For Income | Fourth Quarter 2013Higher yields are the saving grace for income-seeking investors after a difficult 2013.

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Weekly Market Commentary | Week of January 27, 2014

 

Weekly Market Commentary

President Obama's State of the Union (SOTU), scheduled for Tuesday, January 28, is unlikely to be a bigmarket mover. But three areas of the market may see some impact.

Investor's Guide to the 2014 State of the Union Address

Last week the stock market slid 2.6%, reacting negatively to some mixed readings on global economic growthalong with pressures on emerging market countries associated with the Federal Reserve's (Fed) tapering of itsbond-buying program. While we believe global economic growth is improving, the data rarely strengthens in astraight line. We continue to believe these "scare markets" -- temporary pullbacks driven by growth concerns,rather than bear markets driven by a broadly deteriorating environment for the economy and profits -- may bemore common this year as volatility rises from the business cycle low point reached last year. Although it canbe painful to see markets fall for any reason, it is somewhat comforting that the vicissitudes of Washingtonpolitics are not the driver of the decline.

President Obama's State of the Union (SOTU), scheduled for Tuesday, January 28, is unlikely to be a bigmarket mover. In fact, most SOTU speeches see less than a 1% move in the stock market on the following day,and the average move is only 0.15% [Figure 1].

Key Themes

In his SOTU address on Tuesday, President Obama will present key themes that may impact certain sectors.While income inequality (including raising the minimum wage and extending emergency unemploymentinsurance benefits) and health care reform will likely be important themes, they are likely to have little marketimpact, since the broad provisions are well known and have been debated among market participants for sometime. The three areas that we will be listening for with potential to impact the markets are reinstating tax cuts,energy independence, and housing finance.

Reinstating tax cuts. Any mention from the President on a push to reinstate the tax cuts thatrecently expired would be welcome news for stocks in the industrials sector. Reinstating the taxbenefits of accelerated depreciation and the research and development tax credit in an effort topromote growth and jobs could be a boost to capital goods producers in the industrials sector.Energy independence. Any favorable talk about energy independence could be a plus for theproducers and refiners in the energy sector. Alternatively, an emphasis on climate change and toughregulations on coal use by utilities may pressure railroads. However, the impact may be limited, asrailroads are already seeing weak coal volumes-historically a very large portion of carload traffic -- butthis is rapidly being replaced by liquid fuels.Housing finance. The President may provide some insights on housing finance reform along withspecific measures to expand housing credit availability and to compel banks to expand refinancingopportunities for existing borrowers. While the talk is unlikely to affect housing stocks, somemortgage-heavy banks could be impacted.

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 Another topic that could move markets is the upcoming February 7 expiration date for lifting the debt ceiling.Given the bipartisan cooperation to pass the budget a few weeks ago and the fact that the debt ceiling wasultimately lifted last fall with 87 Republican votes in the House, the Treasury bill market is showing little to nosigns of stress over this deadline. We also expect cooperation to lift the limit before extraordinary measures tomeet U.S. obligations run out in late February or early March, although this could be sooner or later dependingin part on daily tax payments and refunds.

However, another showdown like the one last October could be an unwelcome shock to investors. TheRepublican response to the SOTU and leaks from the Republican Party retreat later this week may offer anindication of whether the Republicans intend another fight. It is worth noting that Congress goes on recessfrom February 13-24, which may provide some impetus to get a deal done in the next two weeks.

Competing Drivers

Every President has had both gains and losses in the stock market on the day following their SOTUs. PresidentObama has a two-and-two record of gains and losses. This year's move, up or down, may not have anything todo with the themes discussed. In fact, the move on the day after the SOTU has not only been small, it is oftenunrelated to the themes presented by the President. For example:

The biggest post-SOTU decline was in 2000, when the SOTU focused on the prosperity of the boomingmarkets and economy. Strong readings on economic growth and inflation were reported the followingday, making more aggressive Fed rate hikes likely and prompting a pullback in the market as stocksneared the peak of the internet bubble.

The biggest post-SOTU gain was in 1991, when the SOTU focused on the unfolding first Gulf War.However, the stock market posted a gain as more evidence emerged that the economy was nearing theend of a recession, the Fed was preparing to cut rates by 50 basis points the following day, and positiveearnings results were reported from key technology companies.

This week, the Fed meeting, earnings reports, economic data releases, and global developments are likely to beat least as important as the SOTU in determining market direction. We believe the state of the stock market isfavorable. As outlined in our , we continue to forecast 10-15% gains forOutlook 2014: The Investor's Almanacthe stock market in 2014 driven by stronger growth, but accompanied by higher volatility.

 

 

 

 

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specificadvice or recommendations for any individual. To determine which investment(s) may be appropriate foryou, consult your financial advisor prior to investing. All performance reference is historical and is noguarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanagedindex returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of theperformance of any investment. Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted and there can be noguarantee that strategies promoted will be successful.

Stock and mutual fund investing involves risk including loss of principal.

Quantitative easing is a government monetary policy occasionally used to increase the money supply bybuying government securities or other securities from the market. Quantitative easing increases the moneysupply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

INDEX DESCRIPTIONS

The Standard & Poor's 500 Index is a capitalization-weighted index of 500 stocks designed to measureperformance of the broad domestic economy through changes in the aggregate market value of 500 stocksrepresenting all major industries.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investmentadvisor, please note that LPL Financial is not an affiliate of and makes no representation with respect tosuch entity.

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Weekly Economic Commentary | Week of January 27, 2014

 

Weekly Economic Commentary

We expect that the FOMC will vote at this week's meeting to further taper its purchases of Treasuriesand MBS by $10 billion per month, bringing monthly purchases to $65 billion.We believe the FOMC will taper QE at a $10 billion pace per meeting this year, and we expect QE toend by the end of 2014.In our view, not enough time has passed since the last meeting for FOMC participants' views of theeconomy, labor market, and inflation to have changed significantly enough to warrant a pause intapering. 

Time to Hit the Pause Button?

This week (January 27-31, 2014) the Federal Reserve's (Fed) policymaking arm, the Federal Open MarketCommittee (FOMC), holds the first of its eight meetings this year. The meeting -- which will conclude with theFOMC issuing a statement at 2PM ET on Wednesday, January 29 -- is being held against the backdrop of awave of volatility in global financial markets, as market participants brace for another round of tapering by theFOMC.

We -- and the consensus of economists as polled by Bloomberg News -- expect that the FOMC will vote to taperits purchases of Treasury notes and mortgage-backed securities (MBS) by $10 billion per month. Currently, theFed is purchasing $75 billion in Treasuries and MBS per month as part of its quantitative easing (QE)program. We expect the FOMC to announce this week that it will purchase $65 billion per month until the nextFOMC meeting in March 2014. We also expect that the FOMC will continue to taper QE at this pace ($10billion per meeting) at each of the remaining FOMC meetings this year, which would completely wind downQE by the end of 2014.

Although the market has largely priced in the FOMC's tapering plan, some of the recent volatility in financialmarkets is likely related to the direct and indirect impact of the Fed's policies on emerging market currenciesand economies. In the face of relatively sluggish global demand in recent years, many emerging marketcountries have relied on the extraordinary liquidity provided by the world's central banks to grow theireconomies, at the cost of running current account deficits as they increasingly borrow to import more thanthey export. As global credit conditions tighten (see below for details) and developed market bond yields rise,funding for widening current account deficits becomes scarcer and more costly, putting increasing pressure onthese emerging economies. Emerging market currencies are depreciating as investors find more attractiveyields in more financially stable markets and central banks start to drain global liquidity.

Potential Market Disruptions

The question financial market participants are asking this week ahead of the meeting: Will the FOMC hit thepause button on tapering because of the uptick in volatility? In our view, the hurdle for the FOMC to suspendtapering for a meeting is relatively high, and as of early Monday, January 27, 2014, that hurdle has not yetbeen cleared. The longer the financial market disruptions persist ahead of the meeting this week, the morelikely it is that the Fed pauses. These potential disruptions include but are not limited to:

Widening credit spreads on emerging market sovereign debt;The disorderly decline in the value of emerging market currencies versus the dollar, euro, and yen;The drop in Treasury yields as a result of a "flight to safety;" andSharply decreasing liquidity and trading volumes in emerging market financial instruments.

If the disruptions persist, the FOMC statement will likely at least mention the financial stress in the statement,and note that the Fed is monitoring the situation closely.

Although they have deteriorated over the past week and a half (through Friday, January 24, 2014), thefollowing well-known measures of financial market stress indicate that financial market conditions are inbetter shape today than they were just before the December 18, 2013 FOMC meeting:

The Bloomberg Financial Conditions Index;The St. Louis Fed Financial Stress Index;The Cleveland Fed Financial Stress Index; andThe Chicago Fed National Financial Conditions Index.

Hitting the Pause Button

During the past quarter century or so, the Fed has hit the pause button in the midst of similar market eventson several occasions. For example, in the aftermath of the October 1987 stock market crash, the Fed, whichhad been raising rates to combat higher inflation and a falling dollar, was quite sensitive to the loss of liquidity

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 and the disorderly financial markets and cut rates for several months in late 1987 and early 1988. The Fedbegan raising rates again in February 1988 [Figure 1].

In the mid-to-late 1990s, the Fed raised rates (1994-1995), paused, and even cut rates in 1996, but beganraising rates again in early 1997. Then, in mid-1997, emerging market economies, which were in far worseshape than they are today (see nearby box), began experiencing many of the same disruptions that we areseeing now. The Fed didn't raise rates again in 1997. In the summer of 1998, as the Asia financial crisis came toa head, the Fed cut rates three times (by a total of 75 basis points) between September and November 1998,citing "growing caution by lenders and unsettled conditions in financial markets" and "unusual strains" infinancial markets. By mid-1999, the Fed had resumed the tightening it began in 1997, and tightened untilmid-2000 [Figure 2].

In some cases, the Fed will simply announce -- as it did during the liquidity crisis in August 2007 -- that it isaware of the financial market disruptions and is prepared to act if needed. This seems like the most likelyoutcome this week, assuming conditions don't deteriorate in a disorderly manner early in the week. In August2007 the FOMC said: "[The FOMC] is providing liquidity to facilitate the orderly functioning of financialmarkets" because "in current circumstances, depository institutions may experience unusual funding needsbecause of dislocations in money and credit markets." A month later, the FOMC cut rates, kicking off the nowsix-and-a-half year old easing cycle [Figure 3].

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Pause Unlikely

In our view, not enough time has passed since the last meeting for FOMC participants' views of the economy,labor market, and inflation to have changed significantly enough to warrant a pause in tapering. For example,using the Citigroup Economic Surprise Index [Figure 4] as a gauge, the economic data released in the UnitedStates since the December 17-18 FOMC meeting has exceeded expectations. In addition, the market's inflationexpectations for the next five years have not changed much. Although the December employment report wasweaker than expected, other labor market indicators released since the December 2013 FOMC meeting havepointed to an improving labor market. Should global financial market conditions continue to deteriorate earlythis week, the FOMC will likely at least acknowledge the deterioration in its statement. A sharp and disorderlydeterioration in financial market conditions might prompt the FOMC to hit the pause button. Stay tuned.

 

 

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IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specificadvice or recommendations for any individual. To determine which investment(s) may be appropriate foryou, consult your financial advisor prior to investing. All performance reference is historical and is noguarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be noguarantee that strategies promoted will be successful.

Stock investing involves risk including loss of principal.

The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is chargedunder the United States law with overseeing the nation's open market operations (i.e., the Fed's buying andselling of U.S. Treasury securities).

Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment ofprincipal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.However, the value of fund shares is not guaranteed and will fluctuate.

Mortgage-Backed Securities are subject to credit, default risk, prepayment risk that acts much like call riskwhen you get your principal back sooner than the stated maturity, extension risk, the opposite ofprepayment risk, and interest rate risk.

International and emerging market investing involves special risks such as currency fluctuation and politicalinstability and may not be suitable for all investors.

Quantitative easing is a government monetary policy occasionally used to increase the money supply bybuying government securities or other securities from the market. Quantitative easing increases the moneysupply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

INDEX DESCRIPTIONS

Citigroup Economic Surprise Index (CESI) measures the variation in the gap between the expectations andthe real economic data.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investmentadvisor, please note that LPL Financial is not an affiliate of and makes no representation with respect tosuch entity.

Not FDIC or NCUA/NCUSIF Insured | No Bank or Credit Union Guarantee | May Lose Value | NotGuaranteed by any Government Agency | Not a Bank/Credit Union Deposit

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Search For Income | Fourth Quarter 2013

 

New Year, New Yields

Higher yields are the saving grace for income-seeking investors after a difficult 2013. Most of the price declinesand yield increases occurred over the second and third quarters of 2013, but yields on most high-quality fixedincome sectors ended the year near two-and-a-half year highs. This results in an opportunity for investors tolock in more attractive yields than at any time during the past couple of years [Figure 1].

 

We expect 2014 to be gentler to bond investors compared with 2013, but the battle of rising interest rates andlower prices is likely continue. Bond market total returns could likely be flat as yields rise with the 10-yearTreasury yield ending the year at 3.25 - 3.75%. (Based upon our expectation for a 1% acceleration in U.S. grossdomestic product [GDP] over the pace of 2013, a reduction in Federal Reserve [Fed] bond purchases, andlower bond valuations.) Our view of yields rising beyond what the futures market has priced in warns of therisk in longer-maturity bonds now that conditions have turned for the bond market. Please see our Outlook2014 publication for additional information. The twin forces that drove yields higher in 2013 - the onset of areduction in Fed bond purchases and stronger economic growth - may likely to continue to pressurehigh-quality bond yields higher and prices lower. For 2014, we expect better economic growth to be theprimary driver of higher bond yields.

For two of our income-generating ideas, high-yield bonds and bank loans, rising interest rates did not pose aproblem. Both sectors stayed true to their historical resilience against rising interest rates and prices finished2013 unchanged to higher. The average yield of high-yield bonds actually declined as a result. In general,lower-rated sectors of the bond market fared best in 2013, a trend we expect to continue. Lower-rated bondsectors are often more economically sensitive. An expanding economy in 2014 is likely to support good creditquality metrics - the ability of most borrowers to continue making timely interest payments - and keep defaultsnearhistorical low levels.

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 Both municipal bonds and emerging market debt (EMD) were among the laggards in a difficult 2013 but begin2014 with higher yields and better valuations. In 2013, illiquid trading conditions and steady mutual fundoutflows exacerbated price declines associated with rising interest rates for municipal bonds. Late in 2013,investors began to take note of cheaper valuations, as measured by municipal-to-Treasury yield ratios, andtopquality yields approaching 5%, a key yield level.

 

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The opinions voiced in this material are for general information only and are not intended to provide specificadvice or recommendations for any individual. To determine which investment(s) may be appropriate foryou, consult your financial advisor prior to investing. All performance referenced is historical and is noguarantee of future results. All indices are unmanaged and cannot be invested into directly.

LPL Financial, Member FINRA/SIPC

 

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