PMC Market Commentary: August 15, 2014

A Macro View – Geopolitical Tension

Global equity markets, including the U.S., have been under pressure recently due to geopolitical tensions in various parts of the world, from Iraq to Gaza to eastern Ukraine. The S&P 500 Index has slid as much as 5% since peaking on July 24 and European equities have experienced even more severe losses. Despite plenty of significant corporate earnings news (such as 2Q earnings season) and macroeconomic data, it is the geopolitical news that has dictated market movements. So much so that speculations of what is really inside Russian humanitarian aid trucks can move the market.

Human tragedies and ideological differences put aside, it is our view that the recent geopolitical tensions should have insignificant and non-lasting impacts on the global economy and markets. The military conflict between the Ukraine government and separatist forces is low-scale and low-tech, involving no more than tens of thousands military personnel on each side and little in the way of modern weaponry. Neither the European Union/U.S. nor Russia wants the situation to escalate. It is like a bunch of adults watching two little kids fighting, but none of them wants to fight with each other. The Gaza situation (Israel vs. Hamas) is nothing new and very much a “lawn-mowing” event to some extent. As for Iraq, while ISIS is a relatively “impressive” terrorist organization, it is no match to the mighty U.S. military force. Iraq poses a political challenge, not a military problem.

Masked by this sensational news and media hype, there have been many positive developments in market fundamentals. On the corporate earnings side, nearly two-thirds of S&P 500 companies beat their revenue target in 2Q, a significant improvement from barely half for the past several quarters. S&P companies in aggregate are slated to show 5%-plus revenue growth and double-digit operating earnings growth in 2Q, the much-desired healthy growth pattern not seen for a while. Concerning macroeconomic data, the U.S. economy grew at a 4% pace in 2Q, finally above the 3% long-term trend line and likely to grow faster than the 3% pace again in 3Q.

Geopolitical events, though they make great TV, rarely have significant and lasting impact on the U.S. economy and markets thanks to its enormous size and efficient nature. Far more significant geopolitical events in recent history such as 9/11 Terrorists Attack in 2001 and the 1998 Russian Financial Crisis had limited and temporary impact. On the other hand, we feel that U.S. internal events, such as changes in political landscape and monetary policy, are far more important. As summer is winding down, investors should pay more attention to upcoming domestic events such as mid-term election and the end of quantitative easing tapering. While not as entertaining, it is our opinion that they are the true market movers.

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