Economic Outlook: Finding Strength in Weakness
- There is some consternation over what appears to be weakness in retail sales. Last week’s Retail Sales Report showed an increase of a scant 0.1% in September. It’s not that hard to explain the weakness if you give it some thought the next time you are filling your gas tank and watching the digital screen tick up your total purchase.
- Lower gasoline prices, which we all like, are depressing the figures posted in total retail sales. The result is to make the totals look weak. If you remove lower gasoline prices from the September report, total retail sales for everything else advanced a steady +0.4% for the month.
- When you actually mine the detail of the data in the report, the picture painted is one of a consumer feeling more confident. Vehicle sales advanced more than 1.5% for the month, and we saw strong gains in clothing store sales. Moreover, restaurant sales were up far above average, showing strength in an important area of discretionary spending.
- Initial Jobless Claims came in once again at pretty low levels of 255,000. When you compare this number to the total number of workers in the economy, we are at ratios not seen in almost 50 years.
- We are seeing some of the same patterns overseas. Unemployment in the U.K. has dropped beneath 6 percent.
- Euro-zone September CPI is negative on a 12-month basis, but this includes the effect of lower energy prices. Core CPI, without food and energy, is +0.9%, a number that monetary authorities in the ECB undoubtedly are feeling better about.
- Bottom line – not a lot to find out there worth wringing one’s hands over.
Equity Markets: Remembering Black Monday, 1987?
- It has received surprisingly little attention in the financial press, but October 19th is the 28th anniversary of the largest one-day stock market crash in U.S. history – Black Monday on October 19, 1987.
- On that Monday, the Dow Jones Industrial Average declined 22.8% in a single day, on what was, at the time, a record volume of shares traded.
- The following day’s Wall Street Journal described the day as one of “panic selling”. And perhaps even more unsettling was the way the market opened on the next day, declining an additional 7.0% before finding a low and reversing around mid-session.
- Headlines in what was then a much more limited supply of financial news heralded a great deal of gloom and doom. The Financial Times of London called it “Wall Street’s blackest hours.” Time Magazine’s cover declared, “After a wild week on Wall Street the world is different.”
- Even a group of 33 eminent economists from various nations met in Washington, D.C. in December 1987, and collectively predicted that “the next few years could be the most troubled since the 1930s”. Despite their academic credentials, they totally missed the call. The economy was barely affected and growth actually increased throughout 1987 and 1988, with the market regaining its pre-crash closing high by early 1989.
- 3 of the L&W Investment Committee members – Chairman Walter Christopherson, Harold Williams, and George Williams – reflected this week on that particular memorable day in market history.
- Ironically, there was little bad news to which to react. The U.S. economy at the time was actually growing at a 6.0% annual rate and corporate revenues were expanding at double-digit rates, numbers for which we would salivate today. The fundamental economic underpinnings were strong and did not signal problems.
- Rather, the market reaction seemed much more rooted in conditions of overvaluation and excessive positive sentiment. The decline was liquidity-driven and fueled by investor emotion. Non-market professionals like President Reagan commented that investors seemed to be ignoring the economic fundamentals and he was, of course, proven correct in the following months.
- What stands in sharp contrast to the present day is how disconnected most of our clients were with the moves of the market on that Monday. Many were not even aware of the market drop until they got home from work and watched the evening news on network television or even read their newspaper the following morning. No internet access or cell phone alarms were sounding as portfolio warnings.
- A “big down day” in today’s climate might be a 2.0% – 3.0% decline, about one-tenth of what we saw that day. Despite the magnitude of that decline in percentage terms, we got far fewer calls (and no e-mails in 1987) from clients than is typical on today’s “big down days”. Admittedly, of course, we had fewer clients in 1987!
- It was interesting to observe that many clients felt an urgent desire not to get out of the market, but rather, to add available cash to their portfolios in a desire to capitalize on the suddenly cheap prices for quality companies. Those instincts proved well founded, as the market bottom was realized on the following day and the market advanced over the next 3 years, providing a very attractive profit from those levels.
- Are there lessons for investors today from that now long-ago day? It actually appears straight-forward. Pay attention to the economic fundamentals. Invest in quality companies that are growing cash flow available at reasonable valuations. Maintain a long-term focus related to the client’s goals. Ignore the propaganda that characterizes most of the financial media.
- Although 2015 bears little resemblance to 1987, we’ve seen a few bumps on the road this year. We finally got a somewhat overdue market correction in late August. We’ve seen a pretty good recovery from that low point and the market is presently within 5.0% of its previous highs. On a total return basis the S&P 500 is now slightly positive for the year, after last Friday’s close. Valuations do not give any sign of being stretched and sentiment is certainly not excessively positive.
- Corporate earnings have been mixed so far this year, but decently positive. U.S. economic data is a far cry from the 6.0% GDP growth rates of 1987, but is solidly positive nonetheless. Unlike the early months of 1987, the Federal Reserve is actually maintaining an accommodative stance. In short, U.S. conditions for equity investors continue to look attractive.
- The story overseas is also generally positive. The MSCI EAFE Index of foreign markets is up 2.0% year to date, ahead of the S&P 500. Valuations overseas are by-and-large more favorable for stocks and economic growth appears to be accelerating from previous low levels, which should drive earnings growth.
Fixed Income Markets & the Fed: Waiting Until 2016?
- Last week, the yield on the 10 Year Treasury note closed at 2.04%. This is down a bit from the previous week’s close at 2.09%.
- The futures market is now forecasting very low odds of a Fed rate hike before year-end. The market suggests about 50/50 chance of Fed rate hike in March, 2016.
- There are actually some prognosticators predicting we could go all the way through 2016 without an increase in the Fed Funds rate.
The Week Ahead
- U.S., Housing Starts
- Initial Jobless Claims
- U.S., Leading Economic Indicators