The stock market had a good year in 2013 and consensus expectations among Wall Street strategists is for a positive 2014. Below is a summary of the consensus view:

· The U.S. and global economies will continue to improve

· Stocks will move higher as earnings growth accelerates

· Interest rates will move higher (bond prices lower) as the Fed tapers

· Gold prices will continue to fall

As often happens in the investment markets the exact opposite has occurred so far this year. Stocks are down, interest rates are lower and gold is up. So what’s going on? Why is the market moving against all the experts and what is causing all this nervousness in the first few weeks of 2014? I’ll highlight a few reasons why I think the market is down in January:

· Softer economic data (weak PMI/manufacturing) emerged from China. China is the largest of all emerging market countries and is watched closely by investors

· New concerns over China’s banking system

· Political turmoil in Turkey, Argentina, South Africa and the Ukraine

· Emerging market currencies have been in free-fall (higher interest rates/stronger dollar in the U.S. to blame)

· Concern over the impact of Fed tapering back QE bond purchases (currently at $75 billion per month, but expected to be lower as the year progresses)

Mounting concern about the emerging markets and Fed tapering has sparked a “risk off” trade in January. This is where investors shift money from riskier assets such as emerging markets, U.S. stocks and commodities to safer assets like U.S. Treasury bonds and gold. The emerging market/Fed tapering concerns are interconnected. The thesis works like this;

Fed tapering will raise U.S. interest rates, which will strengthen the U.S. dollar, which makes emerging market exports more expensive, which hurts emerging market currencies, which hurts emerging economies, which slows global growth, which hurts U.S. stocks. Simple….right?

There is also the “January Barometer” to consider. This is the belief that as the month of January goes, so goes the rest of the calendar year. The theory is that a bullish beginning to the year boosts investor confidence which bodes well for the entire year and vice versa. If this stock market barometer is indeed an accurate predictor of the rest of the year, then we could be in trouble. In reality the usefulness of January as a return predictor is dubious at best. The chart below shows that January and annual returns have a .30 correlation (not very good). In fact April, May, September, November and December all have higher predictive power than January.

Recent concerns over the emerging markets and Fed tapering have cooled the bullish sentiment investors had going into the year. So far stocks are down over 3%, interest rates have gone from 3.00% to 2.75% and gold is up $50. This is making longer term investors nervous, but let’s keeps in mind:

· One month of soft data from China doesn’t imply a hard landing in the emerging markets

· Fed tapering is a good thing if a strong economy supports it

· A small correction after a strong year should be expected

At Gradient we constantly monitor the health of the emerging markets and Fed policy. The U.S. companies we invest in sell a lot of goods and services into these economies. Today we are in a global marketplace more than ever and we must be aware of the environment. Even though prices are down, market fundamentals are still intact. The U.S. economy strengthened in the back half of 2013 and corporate earnings are still good. The general tone of earnings has been good and the following companies reported nice earnings for the 4th Q of 2013:

Honeywell, Microsoft, Starbucks, Kimberly Clark, Verizon Bank of America, Lockheed Martin, Caterpillar and Netflix

The following weren’t so good;

Intel, Johnson & Johnson, Apple and Coach

We’ll continue to analyze corporate earnings along with the economy; we remain constructive on the markets and believe investors with a sound allocation that fits their investment objectives will be fine. Investors seem to have forgotten that stocks don’t go up every month, and January could be one of those months. There are always concerns in the global investment markets (remember last year’s fiscal cliff, budget sequester and debt ceiling debates), but we’re confident the long term rewards investing provides are still intact.

Year-to Date as of January 27th, 2014:

Dow Jones US Moderately Conservative Index is down 0.65% (TR) for the year

S&P 500 closed at 1,781.56 down 3.61% for the year

U.S. 10 year Treasury Futures are yielding 2.77% down 0.20% for the year

WTI Crude Oil futures closed at $95.63 down $3.07 for the year

Gold closed at $1,255 per ounce up $51 for the year