07/16/14   Between Balance Sheet Growth and Reduction

Editor’s Corner

Ron Rowland

Fed Chair Janet Yellen conducted her twice-annual testimony on monetary policy to the Senate and House yesterday and today.  Her prepared speech contained little new and tended to emphasize previous Fed statements.  “Too many Americans remain unemployed, inflation remains below our longer-run objective, and not all of the necessary financial reform initiatives have been completed,” Ms. Yellen reiterated to the Senate Banking Committee.

The Fed recently announced its timetable of ending additions to its balance sheet by October, but little has been revealed about what happens after that.  Today, she told the House Financial Services Committee that the Fed intends to reduce the size of its balance sheet eventually.  When lawmakers pressed her on this subject, she stated the Fed would be in a position to provide guidance by the end of the year.  In other words, they are still working on it.

With asset purchases almost complete and balance sheet reductions still on the drawing board, the attention is turning to when the Fed will start raising interest rates.  Yellen believes that time is far in the future because the 6.1% unemployment rate is not telling the whole employment story and inflation is under control.  One indicator she is keeping an eye on is wage increases, and so far, there has not been any pressure on employers to raise wages.

There appears to be some dissention within the Fed regarding interest rates.  Some members think the time may be ripe to begin raising rates and are voicing their concerns.  According to Kansas City Fed President Esther George, “Today’s economy, with a strengthening labor market and rising inflation is ready for a more normal rate environment.  Waiting too long may allow certain risks to build, that if realized, could harm economic activity.”

Corporate taxes are becoming front-page news as more and more companies reincorporate overseas through inversions in order to receive more favorable tax treatment.  An inversion is defined as “a transaction through which the corporate structure of a U.S.-based multinational group is altered so that a new foreign corporation, typically located in a low- or no-tax country, replaces the existing U.S. parent corporation as the parent of the corporate group.”  The Obama administration is encouraging congress to take immediate action to pass legislation aimed at curtailing this activity.  In an interview today, Treasury Secretary Jack Lew stated his preference that any such legislation be retroactive to prevent a last minute rush by corporations.

Investor Heat Map: 7/16/14


Technology climbed another rung of the ladder to displace Energy at the top of the sector rankings.  The stability of large cap stocks over the past week, coupled with an upside earnings surprise from Intel (INTC), helped Technology grab the lead.  Energy didn’t drop far and is now in second place.  Real Estate performed well and climbed two spots to third, pushing Health Care down to fourth in the process.  Telecom weathered the recent market storm well and rose to fifth from eighth. There is now a three-way tie for sixth place as Materials, Financials, and Consumer Staples crowd together.  Materials weakened enough to fall two spots and join the other two sectors despite a good earnings report from Alcoa (AA).  The recent rise of Consumer Discretionary was partially unwound this week as it fell back three spots to ninth.  A strong performance from the transportation industry helped Industrials move out of last place, while continued weakness for Utilities pushed it to the bottom.


The style rankings are now reflecting a full defensive mode pattern.  Category strength is currently aligned by market capitalization, with the largest stocks on top.  Within each capitalization strata, Value is the strongest and Growth the weakest.  This is defined as a defensive pattern because during times of market uncertainty or weakness, investors favor the blue-chip large capitalization stocks over the more speculative small company equities.  Additionally, stocks exhibiting Value characteristics are considered safer than those tilted toward Growth.  The only two relative ranking changes from last week were the rise of Mega Cap from sixth to first and the fall of Mid Cap Value from first to fifth.  Micro Cap remains at the bottom for a second week, and today it sports a negative momentum reading.


Sometimes a category will jump in the rankings, and sometimes it may surge.  Latin America went from ninth to first over the past week – easily qualifying as a surge.  The region’s recent success is almost entirely due to improvements in Brazil, as Colombia and Argentina lost ground while Mexico and Chile lagged.  China held its second place spot and today reported that its second quarter GDP grew by 7.5% from a year ago.  Canada, in first place for the past two weeks, fell to a third place tie with Emerging Markets.  Japan slipped two spots to fifth, and the U.S. eased down to sixth.  World Equity, Pacific ex-Japan, and the U.K. were all pushed down a peg due to the rapid ascension of Latin America.  EAFE and Europe bring up the rear, and Europe flipped over to a negative momentum reading.


The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“I expect we will be able to give more complete guidance later this year when those discussions are complete, and I fully expect we would reiterate an intention over time to reduce the size of our balance sheet”

Fed Chair Janet Yellen on July 16, 2014


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