Market Insights: February 19, 2014
Economic Outlook: Short-term stats are unpredictable like (because of?) weather…
- We wrote last week about the gain in hiring by small business employers. The January index reading on Small Business Optimism rose to 94.1 [National Federation of Small Business]. The Sales Expectation component jumped for the second month in a row.
- Optimism by households lines up in sync with the small business indicator. The Consumer Sentiment Index held steady at a healthy 81.2 in January [University of Michigan].
- Somewhat surprising last week: the U.S. House passed a “clean” debt ceiling extension that moves the new deadline out one year. This was passed without conditions by the Republican majority, signaling an end, for now, to the use of the debt ceiling as a bargaining chip in spending negotiations.
- Regardless of one’s political leanings, this decision eliminates for now a source of scheduled uncertainty for the financial markets that has been regularly bumped ahead on the calendar for only a few months at a time. The Senate confirmed the move with its approval on Wednesday afternoon, sending the Bill to the President for a certain signature.
- Retail sales for January posted a decline of 0.4%, mainly due to a decline in auto sales. Retail sales, without the autos component included, were flat compared to December. Weather was certainly a possible factor.
- Likewise, Industrial Production decreased 0.3% in January [Federal Reserve releases]. Again, weather is suspected as a culprit in this directional shift.
- Weather has likely been a factor in a number of economic indicators indicating some pause in the growth story over the past month. One numeric picture can replace a thousand words: 98,000 airline flights have been cancelled since December 1 due to the unusually cold weather in the U.S. Based on the recorded statistics, this is the eighth worst winter in the record books.
- European Union GDP growth for the fourth quarter posted at +0.3% in the Flash Estimate [Eurostat]. This represents the third consecutive quarter for a positive number and was enough to put 2013’s total growth rate in the positive camp at +0.5%.
- We should note, however, that the Eurostat reading for Industrial Production in the Euro-zone closed the year with a 0.7% decline in December, while nonetheless finishing 2013 in positive territory.
Equities Outlook: From whence cometh the strength?
- It was a good week for stocks last week, following on a strong close from the week before. As we wrote last week: back on February 3, the S&P 500 Index closed almost 6% below its high point in mid-January. Since that point, however, virtually all the decline has been erased and we open this holiday-short week within one-half percent of the previous high.
- The strength was broad-based as smaller capitalization stocks also rebounded nearly 3% last week. The smaller stocks are within about 1% of their previous high.
- What explains the strength in the equity markets? In our view, there are a couple of things going on.
- Corporate earnings continue to grow as the economy recovers. Q4 earnings reports so far (about two-thirds of companies have reported) show almost 9% year-over-year earnings growth with revenue gains of just under 2%. While the revenue gains are not strong, the improving profits demonstrate that companies are continuing to effect productivity gains
- Share buy-backs by companies as a way to use excess cash are also helping reported per-share profit reporting. Share buy-backs have steadily increased and there is no let-up in sight.
- Investors (and this includes CFOs of public companies) seem to increasingly recognize that stocks represent a superior value to bonds in any intermediate to long-term time horizon. The corporate bond yield is about 4.5% on high quality corporate bonds. This yield is fixed. The earnings yield on those same stocks is about 6.75%, and this yield is likely to increase with time. At the moment, bonds are not very good competition for stocks in providing potential return.
- 60% of European companies are beating estimates as well. This is unusually high for European companies, as the norm is closer to 50%.
The Fed and Fixed Income Markets:
- The Ten-Year Treasury ticked up a bit this past week on the better sentiment. At week’s end, it closed at a yield of 2.74%, up from the previous week’s 2.68%.
- Janet Yellen had her first shot to testify before Congress as the new Chair of the Federal Reserve. There were a couple of key take-aways for the financial markets.
- She said the recent drop in job growth (see our previous week comments on the Labor Department releases) was not likely to cause the Fed to alter its stance on tapering of QE.
- She more or less confirmed an intention to keep short-term rates “near zero” for a continued period beyond the point at which unemployment drops below the 6.5% rate (currently, we are at 6.6%).
- Some perspective: In tapering, the Fed is simply slowing the rate of accommodation. Last year, it added over $1 trillion of assets to its balance sheet through purchases. It may cut that in half in 2014, but $500 billion is not a small amount. This continues to be a period of accommodation. As the old saying goes, “Don’t fight the Fed.”
The Week Ahead:
- Housing Market Index (National Association of Home Builders) [U.S.]
- Housing Starts (Census, Dept of Commerce) [U.S.]
- PPI (BLS) [U.S.]
- FOMC minutes released [U.S.]
- CPI (BS) [U.S.]
- Conference Board Leading Indicators [U.S.]
- Existing Home Sales (National Association of Realtors) [U.S.]