Mark Levy’s Economic Update – Thursday, August 07, 2014

 The Dow 30 Industrial Average is down 75 points this afternoon and closed at 16,368. That is 745 points below the closing high of 17,113 posted July 22^nd. This drop represents a decline of approximately 4.35 % from the high and if you have been reading these newsletters over the past few months, this decline has been expected. The current news that has spurred equity selling is the tension that has accelerated between the West and Russia. Vladimir Putin recently fired back at Western sanctions yesterday and ordered his own bans on imports of food and other products from the nations that imposed the restrictions. Additionally, Russia has amassed more combat troops in the last few weeks along the Ukrainian border. The U.S. and the North Atlantic Treaty Organization said that the Russian troops were now numbered at 20,000.

In as much as declines are never pleasant, please remember that they are a normal part of the equity market process. I think many investors have forgotten that the last 10% or greater correction hasn’t occurred since the late summer of 2011. LPL Research doesn’t think that this correction will reach 10% but they admit it is possible. The good news for this pullback is that equity valuations have become more attractive. Price / Earnings (PE’s) ratios are the most commonly cited metric when measuring stock market valuations. PE’s measure the price of a stock market index, or single stock, relative to corporate profits, or earnings. Observing the PE ratio of a broad index such as the S&P 500 can measure how expensive or not the broad market may be. The lower the PE, the more attractive stocks are and vice versa.

The current broad market PE is 16.9 and is above the long-term average (since 1927) of about 15, but it is far from the peak of 2000, and it remains in line with the average since 1980. It is important to note that corporate earnings are on pace for the high single digit gains that LPL Research forecasted for this year, and as a result, very little, if any, PE expansion is required for the S&P 500 to reach LPL’s targeted return range of a 10 – 15% return for 2014.

 Unemployment numbers continue to improve, but there is plenty of slack still in the labor market and LPL thinks that the Federal Reserve (Fed) is not likely to raise interest rates until late 2015, or even late 2016. The ISM manufacturing report recently released showed strength with a reading of 57.1 (a reading above 50 shows an expanding economy) and the inflation adjusted GDP rose at an annualized 4.00% for the second quarter. An expanding economy with low interest rates is a good recipe for growth and after the corrective activity concludes, LPL Financial believes this equity bull market still has teeth. – Mark

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Some of this research material has been prepared by LPL Financial. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested into directly. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors. Referenced material: LPL Financial Weekly Economic Commentary and LPL Financial Weekly Market Commentary, both dated August 4, 2014. Tracking #:1-297378.