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Health & Fitness

Stocks pull back on news from China, emerging markets

U.S. stocks fell 2.6% last week, their worst weekly loss since June 2012. The S&P 500 has now declined in three of the past four weeks, leaving it lower on the year by 3.1%. The proximate causes of the pullback last week were weak manufacturing data from China, and sharply lower values among certain emerging market currencies, exacerbating fears that the rebound in global economic activity may not be as assured as widely assumed.

In China, the HSBC/Markit flash estimate of manufacturing activity in January slipped below the expansion/contraction line for the first time in six months. This comes on top of fears that efforts to deleverage, rein in the banking system and address a buildup of problem loans, will lead to a further slowdown. Financial stocks are already down sharply in China so far this year.

Adding to the anxiety, a bank-sponsored fund invested in coal mining, with the unfortunate name of Credit Equals Gold, is expected to default. Despite reports that investors may be made whole, the episode should offer some painful lessons in free market capitalism. Whether there are more such defaults waiting to follow remains to be seen.

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The weight of these concerns took its toll elsewhere. In the two days following the report on China’s manufacturing slowdown, the MSCI Emerging Asia index fell 1.9%. The MSCI Latin America index fell 4.5%, and matters were only made worse by a 20% plunge in the value of the Argentine peso, mostly the result of self-inflicted gross economic mismanagement. Markets in Turkey and South Africa also fell sharply. Developed markets outside of the U.S. slumped as well.

The larger context for the weakness, especially in emerging economies, is the shift in U.S. monetary policy, and the threat that it will reverse the flow of capital that has poured into emerging economies in search of higher returns.

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As relatively cheap capital becomes increasingly scarce, economic vulnerabilities become exposed, including high inflation, debt and deficits, and political unrest. By no means are all emerging markets in bad shape. It is mostly those that have badly mismanaged their economies or otherwise failed to address imbalances when cheap capital provided an opportunity to do so.

Economic Outlook in the U.S.
In the U.S., these worries fed into the doubts raised a few weeks ago by the weak December employment report. And the economic data since has not been convincing enough to dispel those fears. That may begin to change this week. The Federal Reserve meets and is widely expected to continue the pace of tapering it announced last month. On the economic calendar, December new home sales, durable goods orders, fourth quarter GDP, personal spending and income, PCE deflator, and consumer confidence are scheduled for release. But even these reports may still have the taint of weather related distortion. We may have to wait until the following week to get data mostly free of those distortions, including the January manufacturing and employment reports.

Last week’s equity performance at the sector level in the U.S. during the two days following the China manufacturing data reflected the same worries about the pace of economic activity. Cyclical stocks led the selloff, as materials skidded 5.0%, industrials lost 4.2%, and financials fell 4.0%. While all ten sectors declined, utilities and consumer staples held up better than the rest. During the same two days, bond yields plunged as equity investors sought refuge. The ten-year note yield fell all the way to 2.72% from 2.87. In contrast, the yield on lower quality bonds rose, pushing spreads wider. The Bank of America Merrill Lynch High Yield Master II index yield rose nine basis points to 6.30%.

Up Ahead: More Earnings
Earnings season will continue to command investor attention this week. So far, in the aggregate results have modestly exceeded expectations, although to a lesser extent than previously during the recovery. Companies expected to report include Apple, Caterpillar, Ford, Pfizer, Facebook, Google, Exxon Mobil and Chevron, among many others. In all, another 25% of the S&P 500 will report this week.

How far this pullback has yet to run is impossible to say. Many investors have been expecting a correction, which some would argue is long overdue. After further weakness to start the week in Asia and the Middle-East, European markets are mixed, and U.S. equity futures are pointing higher, as are bond yields. Firmer economic data would certainly go a long way toward calming the waters, as would stronger earnings. But, the 40% spike in the VIX index at the end of last week reminds us that the journey may become more volatile.
  

Disclosure

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The Purchasing Managers’ Index™ (PMI™) is a composite index based on five of the individual indexes with the following weights: New Orders - 0.3, Output - 0.25, Employment - 0.2, Suppliers’ Delivery Times - 0.15, Stock of Items Purchased - 0.1, with the Delivery Times index inverted so that it moves in a comparable direction.

The MSCI Emerging Markets Asia Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. It consists of the following emerging market country indices: China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, Thailand.

The MSCI EM (Emerging Markets) Latin America Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of emerging markets in Latin America. The MSCI EM Latin America Index consists of the following 5 emerging market country indices: Brazil, Chile, Colombia, Mexico, and Peru.

The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.

It is not possible to invest in an index.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.

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