(An excerpt from the Schwab Market Perspective.)

Key Points

• Economic headwinds are causing growth expectations to be reevaluated, resulting in choppier action in a majority of asset classes, including stocks. This trend seems likely to continue in the near-term, with uncertainty somewhat elevated over the next few months.  
• The Fed is moving steadily closer to ending its purchases of Treasuries but we don’t believe it’s a major market event. Normalization of monetary policy still seems slow in coming, while a game of brinkmanship in Washington has the potential to rattle markets, although we believe QE2 ending on schedule is nearly certain.
• Europe's debt crisis continues to plague the eurozone. Solutions appear to be limited and agreement is still anything but assured. Meanwhile, China's slowdown is also weighing on investors, but we don’t believe a hard landing is in store.

There has been a downshift in economic growth lately that has caused markets of all types to gyrate. Commodities moved sharply lower before rebounding modestly; Treasury yields have moved even lower; the dollar has shown some strength; and stocks have been more volatile, but have still moved in a roughly sideways fashion. While disconcerting, this type of action is to be expected as some of the "dollar carry trades" unwind and investors adjust to a slower growth phase.

This is an excellent example of why investing with a short-term view can be so difficult. Investing has to be viewed through a longer time horizon with objectives and risk tolerances well established ahead of time. We believe that the most likely path of the stock market over the next few months is sideways, although there is certainly the potential for sizable moves in both directions depending on news flow. We remain confident that the longer-term trend in the stock market is higher, while bond prices are likely to head at least somewhat lower (resulting in higher yields) over time.

Data tells a story of deceleration 

Recent economic data has been somewhat weaker. Regional manufacturing surveys dropped sharply last month, although they are notoriously volatile and mostly remained in expansion territory. Industrial production was flat in April, versus expectations of a gain of 0.4%, while capacity utilization fell 0.1%, and remains 3.5% below the 1972-2010 average. These indications of a slowdown in growth has been confirmed by Treasury yields moving lower, indicating growth concerns trump inflation. It is a bit surprising that investors continue to loan to companies and the government at such low rates; locking in a low return if held to maturity and the potential for somewhat worse results if rates start to move higher. Investors who have over-weighted fixed income may do well to take some profits and look to have a more balanced portfolio.

It's easy to get mired in the disappointing. Growth has indeed slowed and concerns are justified, but the majority of indicators still indicate economic expansion. Additionally, there have been several external factors we believe have impacted data temporarily. The Japanese natural disasters disrupted supply chains that are starting to come back online, while extreme weather impacted production and distribution in the United States. Further, the spike in oil prices above $110 per barrel seemed to have a large affect on sentiment among businesses but we have seen that improve with the recent weaker oil price. And while the Index of Leading Economic Indicators fell 0.3% in April, it was only the second negative monthly reading since March of 2009, and we believe it will resume its positive trend in May as some of these temporary factors dissipate.

Do international issues matter to US investors? 

US investors may wonder how much eurozone debt, the quake in Japan, or a slowdown in China matters. Indeed they do because the globe is more interconnected than ever before and events overseas could reduce global growth. If global growth is reduced, corporate earnings in the United States could also be reduced, although still post solid growth in 2011. Of S&P 500 Index companies reporting foreign sales, roughly 45% of revenues and 40% of net income is from international sources, predominately Europe.

In terms of broader implications, a slowdown in China is a risk to commodity prices. China’s slowdown will likely be concentrated in construction on infrastructure and housing, which constitutes nearly 50% of Chinese economic activity. China represents roughly 40% or more of global consumption of cement, iron ore, coal, steel, aluminum and copper.

As we watch current events unfold, it is important to remember that the best way to address uncertainty is with a risk-appropriate, well-diversified portfolio.

If all that has changed is current events, then your portfolio should likely remain unchanged.  If events in your life have occurred that have altered your outlook and/or financial goals, please contact us at (888) 879-1376, option 1 or by email.

We appreciate your business and the confidence you continue to have in our services.

Envoy Financial

Trusted Advice Along The Way
 
Click here for the full Schwab Market Perspective article.