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Market Insights

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Viewer Discretion Advised

02/07/2014

2014 has begun with a decline in global risk assets that is shaking out some of the overwhelming bullish consensus for the year by the collective investment community. For true passive investors, if you currently have enough evidence at your disposal to suggest a secular high similar to 2000 or 2008 is in place, now is the time for immediate action to neutralize risk exposure in your portfolio. Currently, evidence of a secular peak for risk assets is not present for me.

Therefore, viewer discretion is advised when observing day to day movements of the markets. What I expect has occurred so far this year is that elevated volatility from the emerging markets “fragile five” acted as the catalyst for the speculative hedge fund community to liquidate correlated “trades” to risk-on assets. Look no further than the surprising 3.5% year-to-date appreciation in the global carry trade’s funding currency, the Japanese yen – or last year’s favorite developed market equity index, the Nikkei, down over 10% year to date.

It is prudent to question whether the consensus expectation for accelerating growth in 2014 is correct. Lousy weather has impacted growth. However, let’s not completely dismiss the potential for growth acceleration in 2014 as there still remains evidence toward that.

More likely, 2014 is beginning like 2010, which means a frustrating environment for investors as they watch short-term traders rent select assets from time to time. There will not be any trip to the altar to marry risk assets until the next fundamental tailwind emerges and the end of 2013’s animal spirits return. The tailwind may come in grand form if Japan embarks upon further monetary and fiscal easing to offset its April consumption tax or if there is a resolution for raising the U.S. debt ceiling. The tailwind may also come with the continuance of favorable corporate earnings, as the cost of capital has surprising gotten cheaper again in 2014. Until then, viewer discretion is advised.

S&P 500 Index (SPX) Technical Update

Earlier this week, the SPX broke critical support at 1767.99, fostering a decline toward a low for the week of 1737.92. That level rests directly above a key swing area, and is strong support from last September’s “no taper” SPX high of 1729.86. Any visitation back to those levels does suggest a pending deeper decline to challenge the 200-day moving average of 1711.39. Keep in mind, not much support exists below the 200-day moving average until 1646.47, the low for the month of October. On the upside, a close back above 1800 will neutralize the technical damage of the past two weeks.

Figure 1:  S&P 500 Index (SPX), December 31, 2012 to Present

Source: Bloomberg

S&P 500 Index (SPX) Earnings Update

As of Friday, February 7, nearly 75% of companies in the SPX have reported earnings (Figure 2). Next week, another 56 companies will report, including 25 from the consumer staples and discretionary sectors. While profit margins remain incredibly favorable at 9.435% (Figure 3), this past week’s earnings did see a moderation in overall SPX sales growth and uncomfortably close to unchanged.

Figure 2: SPX EPS and Revenue Growth, as of February 7, 2014

Sector

Reported

Yet to Report

Sales Growth

EPS Growth

Overall SPX

344

155

0.86 %

9.72 %

Consumer Discretionary

44

40

6.82 %

12.86 %

Materials

25

6

3.58 %

43.22 %

Utilities

12

18

2.39 %

5.91 %

Technology

45

20

5.63 %

8.09 %

Telecom

3

3

2.73 %

30.97 %

Industrials

50

13

2.56 %

17.44 %

Consumer Staples

21

19

2.94 %

6.93 %

Health Care

42

12

5.60 %

1.55 %

Financials

67

14

(-11.87%)

20.41 %

Energy

26

19

(-2.93%)

(-8.98%)

Source: Bloomberg

Figure 3: SPX Profit Margins

Source: Bloomberg

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.