Peak Financial Management, Inc. ∞ 281 Winter Street, Suite 160, Waltham, MA 02451 ∞ 781-487-9500 ∞ www.peak-financial.com Highlights Emerging market weakness has created an undeserved drag on US stocks, and current headlines are not new. Higher corporate earnings will push US stock prices higher. This earnings growth will come from economic recovery in the US, and toil in emerging markets isn’t likely to have a significant impact. Pran Tiku, President; Kerry Luria, Vice President; Neel Tiku, Director of Research; James Sichenzia, Research Analyst; Dennis Lagace, Research Analyst MONTHLY MARKET UPDATE DESPITE EM CONCERNS, US CORPORATIONS ARE POISED TO MAINTAIN EARNINGS GROWTH FEBRUARY, 2014 Any economic impact to the US would be muted. Despite clear reasons to be careful with emerging mar- ket investments, US stocks are still attractive. We still believe the US economy is positioned best in the world. Economic growth is positive and rising, unemployment is falling, and monetary stimulus is being pulled back. Corporate earnings will likely drive returns in 2014, and these earnings are not significantly impacted by emerg- ing markets. The US does about half its trade with emerging and developing countries. This is a pretty significant amount, about $2 trillion in 2012, and imports are high- er than exports. This means that US corporations are buying goods from overseas and are not dependent on foreign sales. In addition, foreign exposure tends to be concentrated in specific sectors, like luxury retail, that are less exposed to national debt risk. Higher earnings will come from increasing domestic growth rather than foreign sales, a trend we think will continue throughout the coming year. Beyond systemic weakness in emerging market curren- cies, the selloff began last May when Ben Bernanke announced slowing Quantitative Easing. QE has kept the dollar weak, but there is less need for such a loose mon- etary policy now that the US economy is recovering. “Taper Talk” was the catalyst last spring, so it’s no sur- prise to see the market react now that reduced policy is in effect. Some risks do exist. While falling currency values may dampen returns to international investors, greater risks exist. High short- term debt creates dependence on borrowing from for- eign investors. An emerging market may find it difficult to regularly refinance outstanding debt, particularly if the country has a weak currency. This increases the risk of default. In addition, if one country were to default, it’s likely that several others would as well because lending among emerging markets is common. This is referred to as the risk of contagion, and widespread emerging mar- ket defaults could significantly alter the structure of global capital markets. Fortunately, these risks are remote. Many emerging markets are investment grade and can readily borrow from other countries, including the World Bank. Pru- dent leadership is replacing corruption as these coun- tries develop further, and the European debt crisis showed global leaders the potential fallout of national default. We believe the most likely outcome is less valuable currencies, a trend that has persisted over the past year. Renewed optimism in the market drove valuation multi- ples higher in 2013, paving the way for real corporate growth to shine in 2014. However, a pullback over the month of January shows that confidence may be waning. China’s indicators point to weaker growth and the Fed- eral Reserve tapered another $10 billion, triggering a shockwave through emerging markets and causing investors to flee for more stability. We believe the cor- rection in emerging markets has been an undeserved drag to US stocks this year . The drawdown actually started last year and, while some risks do exist, the effect on US stocks will be limited. This has been happening for awhile. Emerging markets have received well-deserved atten- tion. The countries are growing quickly, creating new markets and opportunities to invest. Many are invest- ment-grade and the securities industry has found inno- vative ways to make these opportunities available to the average investor. There are definite challenges that have come along with that growth. Short-term debt has risen, so these coun- tries must refinance their national loans more frequent- ly. Strong international trade led to surplus for many years, but falling commodity prices and a sluggish global economy have caused them to buy more than they sell. These trends are not new and have been headwinds to currency values for a number of years. US earnings don’t depend heavily on emerging markets. EM weakness has been accumulating for years. Your feedback is important! We want to address the issues most relevant to you. If you have any comments, questions, or concerns, please contact Neel Tiku, Director of Research, at (781) 487-9500 or [email protected] Currencies have been falling since “Taper Talk” last May. 12% 14% 16% 18% 20% 22% 24% 26% Short Term Debt as a % of GDP* 0.86 0.88 0.90 0.92 0.94 0.96 0.98 1.00 1.02 Average Change in Currency Value since January, 2013* The start of "Taper Talk" No taper in September... ...but the Fed did taper twice. -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Current Account Balance as a % of GDP* * For a basket of 20 emerging markets Graph Source: Bloomberg -700 -600 -500 -400 -300 -200 -100 0 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 Net Exports to Emerging and Developing Countries (billions) 0% 2% 4% 6% 8% 10% 12% S&P 500 Earnings Growth - Historical and Projected Historical Projected