Market Insights: October 20,2014
Economic Outlook: A Few Things to Worry About
- Last week was a week of further “headline” risk and volatile markets. We are not really worried about the headlines that are getting the media play. There were however, a few surprising soft spots in some U.S. economic data that was released. This is not cause for panic, but it bears watching.
- The NFIB Small Business Optimism Index retreated slightly to 95.3, putting it now at a level consistent with its pre-recession average.
- The Producer Price Index (PPI) unexpectedly declined slightly (-0.1%) for September. It remains solidly up 1.6% on a year-over-year basis. (Bureau of Labor Statistics)
- Retail Sales also surprised with a decline of 0.3% in September. If you remove the volatile impact of falling gasoline prices, however, the measure was only down 0.1%.
- These data points may be aberrations. Other data continues to be strongly positive. Initial Jobless Claims dropped to 264,000 this week, which represents the lowest level since April of 2000 (and no, that “2000” is not a typo).
- U.S. Industrial Production jumped an impressive 1% in September, reversing the small decline in August. It is encouraging to see this production confirm some of the positive survey data that has come in recently.
- Housing Starts have been volatile, as we’ve noted in the past two months. They rebounded 6.3% in September from the decline of 12.8% in August. Some of this is probably monthly “noise” in the data. On a year-over-year basis, housing starts are up 17.8%.
- It is no secret that the consumer is almost 70% of the U.S. economy. The University of Michigan’s Consumer Sentiment indicator reached a new recovery high of 86.4, reflecting lower gas prices, improved employment and income prospects, and better expectations for the future.
- The foreign data is considerably weaker. European Union Industrial Production is weak, declining 1.8% in August according to Eurostat. The weakness was led noted most in capital goods sectors.
- The German ZEW Survey was significantly weaker than expected in both current and expected conditions, reflecting this general malaise in Europe.
- All of this means (no surprise) that inflationary pressures remain low in Europe, making more aggressive stimulus almost certain. Year-over-year inflation rates are hovering in the zero range. France is at +0.3%, German at +0.8%. Italy is -0.2%. The U.K. economy was only slightly higher at +1.2%.
Equities Outlook: Divergence and Opportunities…
- As we take a breath and reflect, it was a super-volatile week last week. The poor European data, further Ebola news, and weak commodity prices all contributed to the fear trade.
- The S&P 500 Stock Index was down over 2% for the week through Thursday’s close but made up about half of that ground on Friday with a 24 point rebound. Maybe some of that cash on the sidelines is finally shaking loose.
- Surprising to some, smaller cap stocks had a better week, strongly up through Thursday, and giving back only a slight bit on Friday. As we wrote last week mid-cap and small-cap stocks had a full 10%+ correction after hitting record highs earlier in March of this year. This reduced correlation between large-cap and smaller stocks suggests investors are paying close attention to valuation.
- Is there a silver lining in this pullback for the blue chips? The fear of global slowdown and softer oil prices are not good news for major integrated oil producers. Hence, stocks like Exxon-Mobil and Chevron have backed off considerably more than the indexes. This looks like attractive buying territory for patient long-term investors.
- At current prices, Chevron produces a 4% dividend yield with considerable room for this dividend to rise in the future. The company is paying out barely 35% of earnings. A Price-Earnings Ratio that is now around 10 suggests a valuation that is favorable for price appreciation ahead.
- The opportunities are not confined to energy names. Other stocks we like that produce dividend yields above 3.5% include General Electric, McDonald’s and Lockheed-Martin.
Fixed Income Markets: How Low Can You Go?
- The interest rate on the Ten-Year U.S. Treasury Note dropped to 2.19% on Friday. This is further “flight to safety” reaction to last week’s market volatility and fear. A week ago, we were at a yield of 2.31% and just two weeks ago, closer to 2.50%.
- At one extreme point during the volatility for equity prices, the 10-year U.S. Treasury dipped all the way down to a yield almost as low as 1.8%. This was clearly overbought and lasted only briefly, followed by a rebound.
- On a price-appreciation basis, investment grade corporate, government, and municipal bonds have all done well for most of 2014, serving as a reminder of the benefits of balance in portfolio allocation.
The Week Ahead
- Existing Home Sales (National Association of Realtors)
- Consumer Price Index (BLS)
- Euro-zone PMI “Flash” Release (Markit)
- Consumer Confidence (European Commission)
- U.S. Conference Board Leading Indicators
- U.S. New Home Sales (Census, Commerce Dept, HUD)