Softer-to-mixed economic data added to worries about the emerging markets this week. Across the globe, Equity markets declined and credit spreads widened as investors exited the riskier asset classes for the safety of bonds. Government yields declined. WTI Oil prices rose, but Brent Oil and Natural Gas prices fell. Metals commodity prices also declined. The U.S. dollar rose against the Looney, Pound and Euro on the week.

Perspective:

At the end of last year a number of Economic Comments readers emailed me with their concern that after such a run-up in 2013 the equity markets were ripe for a fall. The first factor that I looked at to determine if the run-up was excessive was the P/E ratio, the price relative to the earnings. On a 12-month forward basis, the price of the S&P 500 was 17.29 times the past 12 months earnings, certainly not undervalued when the average ratio has been about 15 times. In fact, the 12-month forward earnings projections, using Biriniyi Associates estimates, the S&P 500 is just 15.15 times earnings. So, if the S&P remained unchanged for the rest of the year and earnings estimates held true (no guarantee), then the S&P would be fairly valued at year-end. The significant rise in stock prices over the last five years was matched by earnings improvements and, therefore, stock prices have not reached "irrational exuberant" levels. So, if valuation was not out of line, why is there such turmoil in the equity markets?

The concern is that the political unrest, slower growth rates and economic instability in emerging economies will spread their impact to the developed world. The rapid growth rates in China and its BRIC (Brazil, Russia, India and China) siblings have been an engine of global growth for the last decade. Those worries about emerging economies and recent softer economic data in developed countries were factors, but the most significant factor has been the psychological factor. Like Comments readers, those seeing the run-up in 2013 and initial signs of softer data have created a self-fulfilling market decline, with investors bailing out of risk assets. The natural reaction was wanting to avoid the significant declines we experienced in the Great Recession.

Economic Releases:

Some of the releases in the U.S. were softer than expected. For instance, December's Personal Income, flat to November, came in on the softer side of expectations. In contrast December's Consumer Spending, at +0.4%, came in on the high end of expectations. Some of the PI shortfall may have been weather related, but the weather did not curtail spending. People could not get to work, but they could shop online. The chart below of PI and Spending shows changes from a year ago; PI was -.8%; spending increased to 3.6% on a YOY basis.

Manufacturing also took a hit in December. Durable Goods Orders fell -4.3%; even without the more volatile transportation component, Orders fell -1.6%; November Orders were also revised a percent lower to 2.6%. The YOY trend shown in the chart below is similar with Orders being about flat from a year ago and ex-transportation Orders falling to about 3% above last year's Orders.

Other Economic Releases

The Federal Reserve shrugged off the turmoil in the market and some softer economic data at this week's FOMC meeting. The governors voted to continue to taper by another $10 billion at this, Fed Chairman Ben Bernanke's last meeting as chairman. Asset Purchases dropped to $65 billion. The tone of the post FOMC meeting was still dovish and somewhat optimistic, "The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate." In contrast to the European Central Bank, the U.S. Fed has the dual mandate to promote growth while containing inflation.

Also on the softer side, New Home Sales slipped to 414,000 in December; this was lower than the range of expectations. The +0.6% increase in the median price, bad weather and rising mortgage rates all could have had an impact. Those factors did not have an impact on the Davidson household, which purchased a new condominium in Portland as an extension of our life in Camden.

Initial Claims for Unemployment surprisingly surged 19,000 to 348,000; the four-week average increased to 333,000. On the positive side Continuing Claims dropped 16,000 to 2.991 million.

Overall, fourth-quarter GDP growth in the U.S. of +3.2% was just above consensus, but final demand was not strong due to a drop in government purchases. Inflation remained well contained, up only 1.3% in the fourth quarter. Initial estimates for fourth-quarter growth were below 2%, so this quarter's growth, following the 4.1% growth in the third quarter was positive.

In the European Union, Economic and Consumer Sentiment increased in January, but Industrial Sentiment declined. EU December Unemployment, at 12.0%, matched the downward revised November data. Germany's Unemployment Rate dropped a tick to 6.8% in December, but its Retail Sales were surprisingly weak, at -2.5%. On the other hand, for January, Germany's Ifo Surveys showed improvement for Economic Sentiment, Current Conditions and Business Expectations. The UK's fourth-quarter GDP grew at +0.7% from the previous quarter and +2.8% from the previous year, matching expectations.

Adding to the worries about emerging economies, China's Purchasing Managers Index fell a point to 49.5, which put it in the contraction zone. The CFLP Manufacturing PMI also fell a point, to 50.5, just above the demarcation between expansion and contraction.

Equities Markets:

Equity markets fell again this week; only the French CAC 40 managed to eek out a gain on the week; and only the Canadian TSE Index managed a year-to-date gain. The investment grade corporate bond market gained on falling interest rates this week despite rising credit spreads. The widening of the credit spreads for the riskier bond markets overcame the falling interest rates to generate losses in the High Yield and Emerging Market indices.

Bond Markets:

Government Bond markets continued to benefit from the second week of "risk-off" trading. Government bond yields fell, but credit spreads widened as investors sought shelter from riskier asset classes and moved into safer markets. The increase in the TIP yield is misleading; the referenced bond changed with a newly issued 10-year TIP. The old 10-year TIP's yield actually fell over the week.

Currencies & Commodities:

The U.S. dollar gained again against the Looney, Pound and Euro on the week, but fell against the Yen. The WTI-Brent spread narrowed as WTI gained and Brent fell on the week. Natural gas and metals commodities declined on the week.

Who is John Davidson?

John W. Davidson, CFA, started writing these Comments more than a decade ago as a personal discipline when he was promoted to from portfolio manager to chief investment officer and CEO.

Most recently, he was the president of PartnerRe Asset Management Corporation, responsible for the management of PartnerRe's invested assets, which grew from $4 billion to $12 billion during his tenure. After joining PartnerRe in the fall of 2001, he hired the staff, built the trading floor and created the infrastructure to manage both fixed income and equity assets internally. He retired from PartnerRe at the end of 2008 and moved to Maine, where he focused on board work.

He has more than 35 years of industry experience, including positions with investment management responsibility for separate institutional accounts, mutual funds, trusts and insurance assets. Prior to joining PartnerRe, he served as president and chief executive officer of two other investment management companies. For various companies he has held positions as chief investment officer, chief economist, head of fixed income and portfolio manager. As a portfolio manager, Davidson managed and traded U.S. Government Securities as well as futures and options on fixed income instruments.

His real world experience is backed by a strong academic foundation, which includes earning a Master of Business Administration in finance and a Master of Arts in mathematics from Boston College, as well as a Bachelor of Arts, cum laude, in economics from Amherst College. He holds the professional designation of chartered financial analyst.

His experiences and credentials have brought him to the public as a television commentator and conference speaker. In addition to his frequent past appearances on CNBC, CNNfn, Bloomberg TV and Yahoo FinanceVision, he appeared as a special guest on Wall $treet Week with Louis Rukeyser. Reuters, Bloomberg and other business press services have quoted his views on the market. He has taught CFA preparation programs, as well as other courses offered by the Stamford and Boston CFA Societies, and the National Graduate Trust Officers' School.

Davidson is a natural leader in both his professional and personal life, having developed those skills early in his career as a naval officer. He spent three years on active duty, which included a year on the rivers of Vietnam, and 24 years in the Naval Reserve, from which he retired as a captain in 1994.

Davidson is treasurer and board member of the Camden Conference. He is also on the investment committee of the Pen Bay Health Foundation. He serves as an independent trustee for mutual funds.

In his leisure time, he is an active sailor, tennis player and skier. With his wife, Barbara, he renovated a 100+-year-old home in Camden, where they enjoy spending time with their two golden retrievers and having visits from their five children. He can be reached at jwdbond@me.com.