Market Insights: October 13,2014
Economic Outlook – Amidst Market Volatility, Continued Good U.S. Economic Data…
- The Job Openings and Labor Turnover Survey (JOLTS) has advanced nicely in recent weeks. The most recent survey results for September showed 4.8 million job openings in the United States, which is an increase from an even 4.0 million as recently as July.
- It is worthy of note that this survey includes only job openings which are immediate in need and available to be filled in the next 30 days.
- This particular survey confirms the view we have been discussing over the last several months that underlying U.S. economic strength appears strong. This stands in contrast with much of the rest of the world.
- The underlying strength also seems to be confirmed by the fact that initial jobless claims are remaining at a low level. The most recent four-week-moving average is now below 290,000, at 287,000. The unemployment rate in last Friday’s report sank to 5.9% in September. The rate has not been this low since July, 2008.
- As we noted recently, U.S. domestic oil production has recently passed Saudi Arabia, making the United States the world’s largest oil producer. This has been reflected to a degree in the price of WTI crude oil, which is now down in the mid 80’s per barrel.
- Lower oil prices may not be good news for energy stocks, but they are good news for consumers. The strength of the consumer is almost 70% of the U.S. economy.
- Consumer spending also benefits from the present environment of low interest rates. The 10 year U.S. Treasury note closed last week at a yield of 2.31%, as we note below. This benchmark rate affects many other interest rates, which in turn impact consumer purchasing power.
- While the higher economic activity in the U.S. will likely ultimately lead to an increase in interest rates, we believe that the Janet Yellen Fed is likely to maintain these low rates for some time. Yellen wants to be firmly convinced that the recovery is intact and that wage rates are recovering, before monetary tightening begins. Therefore, while we believe we have shifted to a multi-year cycle where rates will rise, we see no likelihood of significant interest rate increases in the near-term.
- Despite increased financial market volatility, which we discuss below, U.S. corporations are in good financial shape. Corporate balance sheets are strong with significant cash, leverage is low, and businesses are returning cash to shareholders in the form of dividends and stock buy-backs.
- We are also seeing signs of increases in capital expenditure by U.S. businesses and this should bode well for the economy in some areas that have not been strong participants in the economic recovery in recent quarters.
Equities Outlook: Does Volatility Equal Correction?
- Anyone watching the equity markets last week noticed the significant increase in volatility. We had multiple days of swings in the Dow Jones Industrial Average (among others), which alternated between positive and negative from 100 to 300 daily points on the Dow. The official measurement of this in the VIX has picked up in the past 4-6 weeks.
- For the week, the Dow Jones Industrial Average and most other major averages were indeed down. Most of the gain that had occurred in the market on a year-to-date basis during 2014 has been erased.
- All hand-wringing aside, we should maintain some perspective and note that the market is down less than 5% from its recent peak in September, as measured by either the S&P 500 Stock Index or the Dow Jones Average (take your pick). This decline does not even qualify as half of a market “correction” (which requires a 10% pull-back).
- The increased volatility in the market appears to be attributable to a number of factors. Scary headlines regarding ISIS and Ebola have added fuel to earlier investor fears regarding Russia and the Ukraine. In addition, the effect of some discouraging economic statistics outside the United States has sparked fear of a global slowdown.
- The latest week’s headlines regarding the Ebola scare add to the list of geopolitical risks, which increase market volatility. While volatility increases, it is important to recognize that fear associated with developments like the Ebola virus only ultimately affect the market if they begin to change people’s behavior.
- There is no evidence yet that this is occurring, and therefore we do not therefore believe this will have a major, long-term impact on markets and portfolios. If anything, this might produce attractive entry levels to put additional cash to work in quality equities.
- For reasons that we summarized above, we believe the U.S. economy is behaving largely independent of these influences. Therefore, fundamental shifts in equity valuations do not appear likely in the near-term.
- Most of the secondary indexes of smaller stocks have declined by greater margins than the S&P 500 Index, and have reached or are close to “correction” territory. It is certainly possible that the blue chip indexes will retreat a bit further and reach this same point of a 10% decline from the high and therefore be properly labeled a correction. Since the underlying U.S. economic fundamentals appear sound, we do not believe exposure to this kind of downside volatility warrants any significant portfolio adjustments of a defensive nature.
The Fed and Fixed Income Markets: Low Rates and Fed Signals…
- The interest rate on the Ten-Year U.S. Treasury Note dropped to 2.31% on Friday. This is a bit of a “flight to safety” reaction to some of the market volatility fears and is a noticeable move from last week’s closing yield of 2.44%.
- From the Fed’s recently-released minutes, it is evident that there is active discussion regarding how to manage the glide path and ultimate exit from this significant monetary easing we have observed in the last 4 years.
- The Fed FOMC minutes for the September 16-17 meeting were mostly dovish. However, most FOMC participants want to clarify forward guidance regarding “data dependency”.
- The minutes emphasized that the Fed will be flexible and pragmatic in its exit strategy from the bond purchase program. It is important to recognize that so far, the FED has simply wound down the purchase side of the QE programs. In the long-run, there will be an exit strategy for disposing of the bonds and securities purchased over recent years.
The Week Ahead
- NFIB Small Business Optimism Index (NFIB)
- U.S, Producer Price Index (BLS)
- U.S. Retail Sales (Dept. of Commerce)
- U.S. Housing Market Index (National Association of Home Builders)
- U.S. Housing Starts (Census, Dept of Commerce, HUD)
- U.S. University of Michigan Consumer Sentiment