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CLS: Nothing Can Keep a Good Market Down

06/24/2014

The CPI is a commonly-used proxy for inflation. It measures the change in prices paid by urban consumers for a representative basket of goods and services. On Monday, the CPI measure was reported for May. The report showed CPI rising 2.1% year-over-year, a higher rate than the market had anticipated, and marking the third straight month of solid gains. Much of the gain may be attributed to higher food and energy prices, with food prices up 0.5% and energy up 0.9% from April.

The CPI report tied in closely with another noteworthy event this week – a two-day meeting of the Federal Open Market Committee. The Fed maintains a long-running inflation target of 2%. Measures higher than this indicate that the Fed may choose to tighten monetary policy sooner rather than later in order to keep inflation within their targeted zone. Despite the higher CPI reading, the Fed directive and press conference indicated ongoing patience to remain accommodative.

Historically, higher inflation has a tendency to indicate higher bond yields.  Higher bond yields due to inflation have had a tendency to pressure equity prices due to an expectation of slower economic activity. Interestingly, this was not the case last week, or for the past 12 months, ending May 31, 2014, during which equity price advances on days when yields have risen have significantly outpaced price movements when yields have fallen. Total return for the S&P 500 Index on up yield days has been 24.9% versus 16.5% for the full year period.  Cyclical sectors, like technology and industrials, have benefited the most.

Why would signs of advancing inflation and higher bond yields correlate with higher stock prices? Most likely, investors are saying that improving employment trends and global economic activity can tolerate a modest uptick in yields and inflation. There is $1.233 trillion – equivalent to 90 weeks of net income – sitting on the balance sheets of S&P 500 companies.  With this much cash, companies are in a better position to grow without relying on higher cost debt to slow earnings momentum.

For now, we appear to be in an equilibrium state where equity price momentum and employment trends say that corporate conditions are strong enough to withstand higher rates and modest inflation.  Where do we invest in these conditions? CLS believes that Technology and Energy, two of our innovation sectors, appear to be attractive investments.

 

 

The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change.  No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report.  You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recom­mended in this report and should understand that statements regarding fu­ture prospects may not be realized.  You should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Investing in any security involves certain unavoidable risks called non-diversifiable risks.  These risks include market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies. The S&P 500® Index is an unmanaged composite of 500-large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market. The index is composed of the 3,000 largest U.S. stocks. The Russell 2000® is an index comprised of the 2,000 smallest companies on the Russell 3000 list and offers investors access to small-cap companies. It is a widely recognized indicator of small capitalization company performance. Bonds are a type of debt instrument issued by a government or corporate entity for a defined period of time at a fixed interest rate.  Bonds may be subject to unsystematic risks including, but are not limited to, call risk and reinvestment risk.  High yield bonds, or junk bonds, will be subject to an even greater degree of these risks as well as subject to the credit risk The iShares MSCI Emerging Markets ETF is an exchange traded fund which seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of publicly traded securities in emerging markets, as represented by the MSCI Emerging Markets Index. The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill® Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. The Chicago Board of Exchange (CBOE) Market Volatility Index (VIX) is an index showing the market’s expectation of 30-day volatility.  An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot invest directly in an index.

Bonds are a type of debt instrument issued by a government or corporate entity for a defined period of time at a fixed interest rate.  Bonds may be subject to unsystematic risks including, but are not limited to, call risk and reinvestment risk.  High yield bonds, or junk bonds, will be subject to an even greater degree of these risks as well as subject to the credit risk.

1276-CLS-6/24/2014

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