Market Insights: January 13, 2014
Economic Outlook: Assessing sustainability…
- Is the economic recovery running out of gas? Probably not yet. While the pace of the recovery has been good, there remains much slack. Vehicle sales have run below the scrap rate for many years, finally turning only in 2013. Durable goods spending and private investment in software and equipment remain well below normal when measured by share of GDP. The recovery likely continues until these measures normalize. [Neil Dutta, head of U.S. Economics Research at Renaissance Macro Research LLC]
- U.S. Factory Orders increased 1.8% month over month in November. The ISM Services Index has shown a slight downtrend in recent months but remains in solid positive territory at a reading of 53.
- ADP’s Employment Report came in with a 238,000 private payroll gain for December, far above expectation. Consumer Credit raised $12.3 billion in November. Both of these are positive signs for private demand and spending.
- On the negative side, however, Friday’s Nonfarm Payroll increase for December posted at a very disappointing +74,000. This is incongruent with the ADP report and we will have to see if it represents some sort of data blip.
- The latest Unemployment Rate read is at 6.7%.
- The final revision to GDP for the European Union for third quarter, 2013 came in at +1% over the prior quarter and -0.4% over the prior year.
- European Union Economic Sentiment reached the 100 level (its long-run average) for the first time since 2011. The final November retail sales number for the Euro-zone was a 1.4% increase, the best result since 2009. Europe is out of the deep freeze, but we are waiting to see if it can sustain some upside momentum.
Equities Outlook: Picking your spots…
- We spoke last week about the likely follow-through and continuation of the economic recovery. Bob Doll, Chief Equity Strategist for Nuveen Asset Management expects this will indeed provide a foundation of support for the market. All things equal, look for stocks that are cyclical with the economy to show stronger performance in 2014 than the more defensive plays. This would be a continuation of what occurred in the second half of 2013.
- The markets are off to a somewhat choppy start in 2014. However the correlations between stocks and sectors have dropped lower, meaning that there are opportunities to make money despite averages that might be relatively flat. Stock picking and sector selection will be rewarded.
- An example: The Fed Minutes noted that their survey of business contacts appeared “more confident about the outlook than earlier in the fall.” This could bode well for companies in software and equipment, as noted by Neil Dutta above. Deloitte’s CFO survey noted that 54% are upbeat on business outlook in the fourth quarter, compared to 42% the previous quarter.
- Another example: As noted in the Fixed Income comments below, we have a steep yield curve and it will likely remain so. Banks are benefiting from net interest margin expansion and if rates gradually rise, financial companies like insurers will benefit.
- One more: As Europe’s economy gradually improves, consumer discretionary companies will benefit from improved demand.
The Fed and Fixed Income Markets: More thoughts about municipals…
- The Ten-Year Treasury spent most of last week very close to the magic 3.0% yield level. With the poor Jobs Report on Friday morning, it backed down from those levels to close the week at 2.88%.
- The TIPs market produces a “breakeven yield” that is a predictor of future inflation. In December, this has risen to 2.27%. Most inflationary pressure is likely to come from the service sector side and the core CPI Services Index has been holding around 2.25% over the past 18 months. This is something we will keep an eye on, as firmer CPI readings could pressure the yield on the Ten-Year Treasury higher over the course of 2014. This could be a year where the yield range is 3% to 4%.
- That said, Bill Gross of PIMCO predicted last week that the Fed will keep the lid on the short-term rate for 2014 and 2015 at least. This would mean a steep yield curve environment.
- The Fed announced the start of tapering at the December meeting. The minutes of the December meeting released last week give insight into the underlying attitude. The majority of the participants believe the bond purchases still have marginal benefits relative to their costs meaning the December curtailment was a first step. We will probably see further reductions as the year unfolds, but it could develop slowly.
- The Senate confirmed the appointment of Janet Yellen as head of the U.S. Federal Reserve. No great surprise there.
- We’ve spoken several times recently about the challenges to sentiment in the municipal bond market — the headline risks associated with Detroit and Puerto Rico. However, fundamentals are still favorable. State and local budgets are restrained in the current political climate, but at a time when the improving economy and real estate values are increasing revenues. This bodes well on a fundamental basis for municipal balance sheets and therefore General Obligation bonds.
- If the economy continues to recover, the municipal bonds backed by dedicated taxes (sales and income taxes) will likely benefit as consumer spending and household income improve. Essential service bonds backed by water and sewer revenues continue to be attractive in our view. Revenue bonds backed by services where the bond issuers can increase fees without government intervention (toll roads, airports, ports, etc.) continue to look strong as well.
The Week Ahead:
- Retail Sales Report [U.S.]
- Industrial Production [EU]
- PPI (BLS) [U.S.]
- CPI (BLS) [U.S.]
- Housing Starts [U.S.]
- Industrial Production [U.S.]
- Consumer Sentiment [U.S.]