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Investment Strategy

A Normal Correction

By Elliott H. Gue, on Aug. 22, 2014

Between the end of July and the first half of August, US equity markets experienced a roughly 5 percent correction–a healthy bout of profit-taking after an extended rally.

The hyperactive financial media has proposed a number of explanations for this modest selloff, including concerns that the Federal Reserve will hike interest rates, geopolitical tensions in Ukraine and Iraq, and softness in some economic indicators.

We regard this pause as a welcome breather and expect stocks to trade higher through year-end.

Earnings and Economy

With 477 of the 500 companies in the S&P 500 having reported quarterly results, 65 percent delivered a positive surprise on the top line, compared to 54 percent in the first three months of the year. Meanwhile, 75 percent of the firms that have announced numbers beat the Bloomberg consensus estimate for profits. All 10 of the S&P 500 economic sectors posted year-over-year earnings growth.

Simply put, second-quarter earnings season delivered some of the strongest results in the past five years.

As for the US economy, trends point to steady, if unspectacular, growth.

The Institute for Supply Management’s Purchasing Managers Index (PMI) for the manufacturing sector surged to 57.1 in July—the strongest reading since 2011 and a solid recovery from a first quarter ruined by adverse weather. (PMI numbers greater than 50 indicate an expansion in economic activity, while data points below 50 imply a contraction.)

Digging into some of the PMI’s sub-indexes suggests that this momentum should continue. The index’s new orders component, for example, surged to 63.4 in July, suggesting that this influx of orders for manufactured goods will lead to higher output and activity.

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