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CLS: Earnings Season – Volatility – Liquid Alternatives – ETF Strategists


Week in Review
Global equities finished close to flat in a relatively calm week for global markets. Domestic stocks finished higher, led by small caps. International markets fell, although much of the price declines came from a significantly stronger U.S. Dollar, which reduced the returns from non-dollar denominated investments. Surprise strength in core consumer prices (that is, ex-food and energy) contributed to dollar strength, as investors believe more signs of inflation will lead the Federal Reserve (Fed) to raise interest rates this year. Domestic housing starts also reached a seven and a half-year high.

Overseas, Japan, the world’s third largest economy, grew 2.4% in the first quarter – nearly twice the pace of the previous quarter. Purchasing Manager Index data indicated slowing activity in China, yet continued strength in Europe. In the U.K., retail sales rose nearly 5% year-over-year as consumer prices fell.

Bond markets fell as the interest rate on the closely followed 10-year Treasury bond rose to 2.23%. Commodities also fell on the stronger dollar and better-than-expected global weather conditions hurt prices of some agricultural commodities.

Earnings Season Finale
A share of stock is a piece of ownership in a business. It’s a claim on the future earnings of a company. As a result, through all the noise and day-to-day, minute-by-minute fluctuations, earnings are what drive stock prices. Contrary to recent belief, it isn’t central bank action!

Earnings season for the first quarter of 2015 is winding down, and 94% of the Russell 3000 has reported earnings through last Friday, May 22. Earnings growth for the quarter was approximately 1.4%, dragged down substantially by energy companies; whereas, healthcare, industrials, and technology companies grew earnings the most during the first quarter. Important to point out is most energy companies exceeded their (albeit low) expectations for earnings, providing a boost for the sector’s performance so far this year.

This has been one of the weaker earnings seasons lately, coinciding with slower economic growth in the first quarter.  However, at one point, earnings growth looked to be almost negative 5% for the quarter. Earnings growth has since rebounded back to positive levels following additional earnings reports.

What does this mean going forward? For some time, CLS has referred to the potential for slowing domestic growth and emphasized the importance of allocating to domestic high quality companies and looking abroad for better value. This has worked well this year, as earnings growth on high quality companies has been nearly 5% for the first quarter, and European earnings have grown at nearly 8% (although not all companies report quarterly in Europe). These trends reinforce our allocations in these markets.

Where is the Volatility?
According to Google, there have been approximately 126,000 articles written so far this year about volatility. Despite this fact, global equity markets have been remarkably calm with multiple measures indicating volatility is actually below average. So where is the supposed volatility? Traditional diversifiers, such as bonds, have experienced higher-than-normal volatility. Currencies and commodities have seen exceptional levels of volatility this year. Even REITs, which are sensitive to inflation, interest rates, and housing activity, have shown elevated volatility.

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