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1 Market Perspective: Manufacturing Data Reinforces Optimistic Outlook The U.S.

1 Market Perspective: Manufacturing Data Reinforces Optimistic Outlook The U.S. economy has rebounded from its poor showing in the fi rst quarter of the year as the initial estimate for sec- ond-quarter GDP growth is 4 percent. The government will report two more revisions for second-quarter GDP, one at the end of August and one at the end of September. Already, economists are raising their expectations to approximately 4.2 percent since recent reports show that the trade defi cit declined in June. GDP records fi nal sales in order to esti- mate domestic production, so goods imported from abroad are subtracted and goods exported are added. Since oil prices have been falling and oil remains a major import, economists are also raising their growth forecasts for the third quarter. In addition to rising GDP forecasts, the manufacturing PMI remains in expansionary territory. At 57.1 in July (any number above 50 signals expansion), the reading was 1.8 points higher than it was in June. This continued increase signals that the American economy has indeed been ac- celerating as economists predicted. This positive data was offset somewhat by concerns about slowing consumer spending after July’s retail sales were reported to be fl at. A deeper look at the economic data shows why investors should focus on the strong manufacturing number and not the weaker consumer number. The Bureau of Economic Analysis calculates the nation’s GDP report each quarter, but it also calculates another statistic called gross output (GO). Instead of measuring just fi nal sales, GO measures all sales in the economy. For example, GDP will record the fi nal sale of an automobile as the economy having produced a car, whereas gross output will record all the intermediary steps in the production process. GDP records a $16 trillion U.S. economy, but gross output records an economy worth more than $30 trillion. Looking at the economy from the perspective of gross output paints a different picture and calls into question the aptness of the oft-used phrase the “consumer economy.” In- stead of 70 percent of GDP, GO measures consumption to be responsible for 40 percent of gross output. The retail sec- tor comprises only 5 percent of gross output. Conversely, at more than 20 percent, manufacturing contributes a far higher percentage of the total economy than is typically thought. The picture that emerges is an economy affected not only by the consumer, but also by manufacturing as a driving force behind expansion. Unfortunately, collecting all the data needed to calculate GO is time-consuming, so we won’t know the result for the second quarter until October, when third-quarter GDP is also released. However, we do have up-to-date manufacturing data, such as the monthly PMI, to give us some indication of the impact manufacturing will have on GO when that data is fi nally released. Even without gross output data, the excessive focus on con- sumers doesn’t make a lot of sense. Everyone in the econ- omy is a consumer, and we know that as people become wealthier they consume more goods and services. Consump- tion is a good measure of the current state of the economy, but it doesn’t tell us anything about the future, other than possibly that consumers may be starting to spend more of their savings or may be more willing to borrow. From a simplistic perspective, in order to increase consumption, workers must increase their wages. In order for wages to increase, production needs to increase. Moreover, entrepre- neurs must invest in factories, machinery, software and other goods that assist the increase in productivity. Investment and manufacturing are the sources of future economic growth, while consumption tells us what happened in these sectors months or even years earlier. For example, back in Decem- ber 2007, the PMI turned negative (below 50) and stayed there for months, but many economists were too focused on consumer spending to realize until September 2008 that there was an underlying problem. This year, the manufacturing PMI plunged from around 56 in late 2013 to 51.3 in January, which was largely blamed on the brutal winter in North America. Since then, it has been climbing steadily, hitting 57.1 in July. This increasingly strong manufacturing data points to faster GDP growth in the second half of the year. Growth in manufacturing should ultimately lead to an increase in consumption, so the strong manufacturing data overshadows the current weaker con- sumption data. Even with this said, and despite the fl at con- sumer spending this year, the growth in consumer spending is on track to be 2.5 percent for the year in aggregate, which would be the highest since 2006. But investors are focused on short-term issues, which is why all the major indexes were down over the past month, save for the Nasdaq, which rallied 1.10 percent. Tensions in Ukraine, instability in Iraq, economic sanctions on Russia, the Ebola outbreak and even the drought in the western U.S. states are all headlines that create a negative mood among investors, even if they don’t directly impact the markets. On top of this, the Federal Reserve is still planning to end quan- titative easing in October and there’s disagreement about what this means for the economy, which leads to some un- certainty. Our look beyond the headlines shows that the United States economy is getting stronger. In addition to the PMI indicat- ing an ongoing positive trend for the overall economy, there (continued on next page) MutualFundInvestorGuide.com The eTF Investor Guide Investor Guide Investor Guide MUTUAL FUND Investor Guide August 2014 Matthew d. Sauer Founder & Chief Investment Offi cer Matthew Sauer is the Founder and Chief Investment Offi cer of the Mutual Fund Investor Guide family of newsletters. Each month he analyzes and provides buy, sell and hold recommendations for hundreds of mutual funds and ETFs in three newsletters: The Investor Guide to Fidelity Funds, The ETF Investor Guide and The Investor Guide to Vanguard Funds. Prior to starting the Mutual Fund Investor Guide, Matthew was President and Chief Investment Offi cer of the Fidelity Independent Adviser, ETF Report & Sector Momentum Tracker newsletters. IN THIS ISSUE 1 Perspective 2 Portfolio Updates 3 Model Portfolios 4 Data & Rankings 15 The Best Biotechnology ETFs 2 AUGUST 2014 | PHONE: (888) 252-5372 The ETF Investor Guide Portfolio Updates The S&P 500 Index fell 0.92 percent over the past month, decreasing its return to 5.77 percent for the year through August 15. The Dow Jones In- dustrial Average lost 2.33 percent over the past month, while the Russell 2000 and the MSCI EAFE declined 1.05 and 2.74 percent, respec- tively. The Nasdaq performed well, gaining 1.10 percent. We will make one change to the Model Portfolios this month. In the ETF Aggressive Value Port- folio, we sold half of Vanguard European Stock (VGK) and purchased Market Vector Russia (RSX). With the continued conflict between Rus- sia and the Ukraine, RSX declined significantly over the past month. Similar to our trade a few months ago, we see a short-term rebound oppor- tunity. The Model Portfolios continue to outperform, relative to their objectives. Year-to-date, the mod- erate and aggressive portfolios have outpaced the S&P 500, while the conservative income model trails only slightly. Given the risk adverse posi- tioning of our income portfolio, we are pleased with its performance. The ETF Aggressive Sector Portfolio advanced 0.56 percent in the past month and is now up 6.47 percent in 2014. SPDR S&P Biotech (XBI) rallied 9.66 percent thanks to a successful phase three trial of a breast cancer drug. The company behind the success, Puma Biotechnology (PBYI), is up more than 300 percent in the past month. By itself, this translated into a gain of several percentage points for XBI - on top of a generally good month for the sector. Strength in biotech- nology also helped carry Fidelity MSCI Health- care (FHLC) to a gain of 1.59 percent in the past month. A rally in the Nasdaq was good news for the two technology holdings in the portfolio as well. The ETF Straight Growth Portfolio fell 1.18 percent over the past month; it has now gained 6.02 percent this year. iShares U.S. Pharmaceu- ticals (IHE) lost 1.12 percent as the sector failed to join the broader rally in the healthcare sector. Rydex S&P MidCap 400 Pure Growth (RFG) slipped 1.41 percent, hurt by weakness in smaller and mid cap stocks. Vanguard Dividend Appre- ciation (VIG) counts industrials and consumer staples among its largest sector holdings, two of the weaker sectors last month. The fund also doesn’t have much in the way of biotechnology in its healthcare exposure, resulting in a slide of 1.92 percent slide for the fund. The ETF Balanced Growth Portfolio fell 0.72 percent over the past month and is up 5.86 per- cent in 2014. ProShares High Yield Interest Rate Hedged (HYHG) slipped 1.09 percent as high yield bonds remained under pressure. Treasury yields fell over the past month and that costs HYHG due to having a short uploads/Geographie/ etf-guide-2014.pdf