Market Insights: November 18, 2013
Economic Outlook: A little of this; A little of that…
- The Consumer Sentiment Index has declined a bit further in early November, following the decline we talked about for October in last week’s comments. The October decline is understandable given all the Washington budget maneuvering. It is a bit puzzling to explain the November drop-off, given some pretty good economic numbers (jobs) and a rising equity market.
- The Sentiment Index may represent some reaction by households to the very bumpy rollout of the Affordable Care Act provisions that have received so much press. It is worth noting that a record 37% of the respondents in the NFIB’s Small Business Survey blamed the political climate in Washington as the reason for a depressed outlook.
- The President’s press conference last week was a long one, with many admissions of the defects that have become acutely apparent in the rollout of the ACA provisions and the government insurance website. He has agreed to delay implementation of certain of the Act’s provisions for an additional year. Whether this will mitigate the concerns on the part of consumers that may be weighing on sentiment remains to be seen.
- There has been some political movement, even by Democrats, to a more comprehensive delay of the ACA’s mandate to purchase insurance. If this occurs, it would likely remove this weight on consumer sentiment from the current equation.
- Despite these sentiment numbers, we had a strong final jobs number for October, with a gain of 204,000 – higher than the rolling average for the past six months. (The September gain in jobs stands at a now revised number of 163,000)
- GDP growth for the trailing 12 months now sits below the 2.0% benchmark that economists focus upon (growth rates below 2.0% portend danger of the economy slipping back into recession). However, that may not be the entire story.
- What is interesting is that most of the decline in GDP growth is accountable by the curtailment of government spending (Sequestration and shutdown both having significant influence). The growth in GDP from private sources has actually continued to increase during 2013 and is knocking on the door of 3.0%. This is significantly up from where it was in the first quarter of 2013. And the previous slowdown in state and local government spending seems to be flattening, which removes a negative factor going forward.
- One additional isolated data point: The U.S. produced more oil last month than it imported, for the first time in 20 years.
- Even considering these somewhat conflicting data signals, our judgment is that the odds favor a continuation of this slow, but steady growth in the U.S. economy through year-end and into 2014.
- We spoke a great deal last week about the absence of inflation in the world economy. The ECB lowered its key short-term lending rate by 0.25% week before last and ECB President Mario Draghi cited “further diminishing underlying price pressures,” as one key factor in their decision.
- The CPI number for the Euro-zone in October puts price inflation for the trailing twelve months at below 1.0%, which is below the ECB’s target rate for inflation of 2.0%.
- The production numbers posted most recently indicate that the Euro-zone remains in positive territory in terms of growth, but the rate is still low, and not yet accelerating appreciably. The OECD’s composite leading indicators, designed to anticipate turning points in economic activity, for the Euro-zone as a whole, continue to indicate increased growth momentum
Equities Outlook: The forest versus the trees…
- The equity market has moved dramatically this year and certainly some risks have been introduced. However, let’s not extrapolate to disaster potential. Some of the media predictions in the past few weeks amount to “financial terrorism.”
- We are currently not seeing imprudent lending and speculative borrowing. We are not seeing cash fleeing the sidelines to get invested at any cost. In fact, cash is at all-time highs and we are awash in liquidity.
- The Fed has not even begun to remove accommodation, much less tighten. Tapering may begin in the next few months, but this is simply a slowdown in the rate of accommodation.
- In summary, nothing is yet in place which suggests we have started the end of this market cycle.
- Looking at the intermediate term, we like to ask the three questions suggested by Abby Cohen, strategist for Goldman Sachs [at the Bloomberg Conference last week at Doral Arrowhead Resort north of New York City]: What is the economy likely to do in the coming quarters and years? What does that mean for corporate performance? How are assets priced and what value is priced in?
- Asking those three questions, this stock market is not a screaming buy, but neither does it look like a bubble. Take S&P 500 earnings at a multiple of around 15 and compare it to a bond yield on the 10-year Treasury, assuming that yield might rise to 3.0%. (With inflation running 1.0%-2.0%, there is no immediate prospect for interest rates to rise quickly). The earnings yield of the equity market looks very reasonable.
- Our conclusion: At four years in, we may actually be only about halfway through this grudgingly slow economic recovery and animal spirits have not yet been revived in a major way. We have progressed from being petrified about Armageddon to simply accepting tepid underlying growth. Corporate earnings are growing and likely to continue doing so. This looks much more like a buy-and-hold market.
- As we’ve been saying for awhile, be prepared for some pick-up in volatility and a possible corrective phase as we move into 2014. However, we are not advocating running to the sidelines. There is simply too much whipsaw risk in such a trading strategy. Why? Because despite the averages (a 10% correction every couple of years), there have been many extended exceptions to the rule. October 1990 through October 1997 did not witness a single 10% correction. And there were no 10% corrections in the 2003-7 bull market move.
The Fed and Fixed Income Markets: Steady as she goes…
- In speech in Alabama, Dennis Lockhart, President of the Atlanta Fed, repeated his belief that the economy will need substantial central bank stimulus for some time to come, saying, “monetary policy overall should remain very accommodative for quite some time.” He stated, “the mix of tools we use to provide ongoing monetary stimulus may change, but any changes will not represent a fundamental shift of policy.”
- In her opening remarks to the Senate Banking Committee last Thursday, Fed Chief nominee Janet Yellen said, “I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy,” She reaffirmed that the Fed will be data dependent (a rehash of “that’s our story and we’re stickin’ to it!”) Yellen’s remarks do not suggest a change in policy any time in the very near future, and stock prices responded favorably as the week ended.
- The Ten-Year Treasury finished the week at 2.70%, down in yield just a bit from the previous week’s level.
The Week Ahead: More data…
- Retail Sales
- Release of the FOMC Minutes
- Consumer Price Index
- Existing Home Sales
- Initial Jobless Claims
- Leading Economic Indicators