Investment Commentary – October 7, 2014

Dow – 16,719.39 (10/7/14 close)
S&P 500 – 1,935.10 (10/7/14)
10-year Treasury – 2.35% (10/7/14 close)

· After August’s disappointing employment numbers, the September employment report was a sigh of relief for the market, showing that the weakness was probably a blip. The September unemployment rate dropped to 5.9% driven by gains in the professional services sector, while wages did not change, suggesting that labor force growth has yet to put upward pressure on wages. The data collectively supports the idea that the economy may be able to tolerate a lower unemployment rate than the Fed predicts without raising inflation.

· Employment growth in the absence of wage growth is good news for equities, as it will support higher profits and higher stock market valuations.

· S&P 500 operating earnings were a record $29.45 for the 2nd quarter, representing 11.7%
year-over-year growth and another record high in profit margins at 10%. The contribution of sales growth and margin growth to earnings increased to 5.6% and 5.4%, respectively.

· Last week was marked by increasingly violent moves in equity markets. Although stocks rose on Friday, they were broadly lower on the week while volatility rose to its highest level since last March. Assuming the market gyrations are being fueled by expectations for higher interest rates by the Fed, this is a phenomenon that is likely to continue, particularly with parts of the market looking expensive.

· Another distinguishing characteristic of recent equity market moves is the growing divergence across market segments. To be sure, this is a case of certain segments not doing as badly as others. Since reaching their highs in recent months, U.S. large caps have never been down more than 5%, but U.S. small caps and emerging markets entered correction territory (defined as a decline of 10% or more). The recent weakness in small caps and emerging markets is partly attributable to the pending change in Fed policy, which has had the added effect of strengthening the dollar, now at a 4 year high.

· The economic data today from Germany and France in particular has been weaker than expected. German industrial output fell by 4% in August, with the worse-than-expected drop coming a day after the country’s industrial orders had their largest monthly decline since the global financial crisis in 2009.

· Analysts’ chief concern is how much will the slowdown in the European economy impact the earnings outlook for the 3rd quarter and, more importantly, guidance for the 4th quarter.

· Analysts remain optimistic about the U.S. market. They expect the economy to improve, driven by a recovery in the housing market, low interest rates and better consumer balance sheets. Corporate earnings should continue to grow in line with a strengthening economy and dividends should increase in line with earnings growth.

· Analysts expect stocks to continue to outperform bonds, and credit to beat Treasuries. Senior floating rate loans remain attractive, despite a long run of solid performance.

· Analysts continue to recommend MLP’s (Master Limited Partnerships). MLP’s have generally had a strong year of performance in 2014 so far, and the Alerian MLP Index has outperformed the S&P 500 Index by 11.45% year to date. Good fundamentals and an uptick in merger activity have driven returns, as investors continue to seek attractive real yield and strong growth prospects. A recent report estimates that organic capital spending in the MLP space will likely total over $100B over the next 3 years, as strong oil and natural gas production growth stimulates demand for North American energy infrastructure.

The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.