Market Insights: October 14, 2013
Economy: Washington’s shadow and the news from overseas…
- The international economic strength we’ve been talking about is for real. The OECD Leading Composite Index for Europe is up now for 11 consecutive months to the latest reading at 100.5. It has not been this high since July 2011. Even the more distressed countries, like Spain, are participating.
- The UK’s leading numbers are also confirming growth. All of these indicators seem to confirm that the Eurozone economy is emerging from recession. Now the question is simply how strong the recovery will be.
- Japanese Machine orders jump 5.4% month to month in August, and are up 12.7% from one year ago. The Japan Tertiary Index, a measure of 13 major industries’ activity level, increased 0.7% in August and is up 1.3% from one year ago.
- The U.S. economic data is of course limited at the moment since many of the reports that the government releases are delayed or suspended as a result of the shutdown.
- Small business owner optimism remains near highs for the past 2 years and closed September at 93.9 [This index was down near 80 in early 2009]. The share of small businesses planning to increase hiring has been in a steady uptrend during the post-2008 recovery period and stands now at the same level it was at the end of 2007. And the share of firms that raised employee pay rose and stands at the highest level since the spring of 2008 [NFIB Small Business Report].
Equities Outlook: The atmosphere versus the data…
- The stock market rallied big last Thursday on rumors of a thawing in the icy rhetoric around the debt ceiling debate. The move was broad with every single stock in the Dow average gaining. The S&P 500 advanced 2.2%, with all ten sectors showing gains and Financials actually leading the way.
- Why this reaction when all we have is a rumor of a temporary solution to the stalemate? As we have been writing in recent weeks, the economy is actually in considerably better shape than at any time in the past 2-1/2 years. Even the slightest glimmer of light through the fiscal clouds is all the encouragement the market needs to move ahead.
- Further rumors over the weekend were less encouraging as the political players jockeyed their chess pieces. We could give back some of the advance early this week. Time will tell. But the market’s action is basically confirming a positive take on what is happening in the U.S. economy so long as a dysfunctional Congress does not run the train off the track.
- “America has never before found itself unable to meet its obligations. If the debt ceiling is breached the government will have to rely on tax revenues, which currently cover a mere 84% of its expenditures, to pay for everything. It may be able to stiff pensioners while still paying interest on national debt, thus avoiding a cataclysmic default. But no one has tried this before, so no one knows if the Treasury’s systems would cope.” [Recent issue of The Economist].
- The relevant longer-run question for investors continues to be “Are stocks a reasonable investment at these levels?” One important measure: “What kind of job companies are doing returning cash to shareholders?” The total dollar volume of dividend payouts in the third quarter rose 14% over the year-ago quarter. That is a lot of money returned.
The Fed and Fixed Income Markets: The rest of the story…
- It is safe to assume that one result of the debt ceiling fighting is that uncertainty, the great enemy of confidence, will continue to overhang the economy. This is likely to mean that the Fed, under Janet Yellen, will maintain a policy of gradualism when it comes to tapering decisions. Continued accommodation is likely. But do not mistake Janet Yellen as a permanent dove. She has voted for more rate hikes than rate cuts in her tenure at the Fed. She will start the taper soon enough.
- The Fed Minutes released last week indicate the debate at the September meeting on the go/no-go decision for tapering was quite spirited and could have gone either way.
- The stock market and bond markets have been remarkably calm during the government shutdown and debt ceiling stand-off. The real volatility has been in the market most investors pay no attention to — the short-term paper market (T-bills, Commercial Paper, etc.). The one-month T-bill rose at one point last week to 35 basis points. While this does not sound high, it is nearly a ten-fold increase in yield in a matter of days.
- At 35 basis points, the one-month T-bill yield rose above the LIBOR rate, which has not happened in over a decade. We reached a point briefly where investors were more willing to loan money to major banks than to the U.S. government.
- While this may not be making the headlines, it shows the serious importance of Congress attaining an agreement that avoids the prospect of a technical default on the country’s debt. The consequences of even a technical default are unpredictable and disruptive.
- So why are most Treasury Securities other than the short-term paper relatively stable in light of all this? Probably because investors still perceive them a safe haven in light of uncertainty over economic growth that might be precipitated by an extended shutdown and continuing debt stalemate. The industry grapevine reports that Bill Gross of PIMCO is aggressively adding bond exposure, expecting a rally [Bill Gross is the portfolio manager of the industry’s largest bond mutual fund].
The Week Ahead: Foreign and private sources…
Monday: EU Industrial Production
Wednesday: U.S. Housing Market Index [NAHB]
Thursday: China GDP and Retail Sales
Friday: U.S. Leading Indicators [Conference Board]