Market Insights: October 7, 2013
Economy: There are headlines, and then there’s data…
- Things may not be great, but they are steadily getting better with time. The facts speak for themselves. There is a lot of data that suggests the economy is gradually getting better, but it is completely drowned by the news of the Washington squabbling.
- Drill down on the most recent Consumer Spending report. Spending on big ticket items was up again and is running at +7% on an annual rate for the past three months.
- Another drill-down: Advances in wages and salaries in what some called the “horrible” August payroll report are running +3.5% year-over-year. This is real, inflation-adjusted growth in wage income, a positive sign in the midst of what is admittedly a slow jobs recovery. The ADP payroll report this past week showed 166,000 new jobs, a bit below expectations, but still within the normal range of variation for the intermediate trend.
- Average weekly overtime hours in U.S. Durable Goods industries have returned to the levels prevalent in 2006-2007, prior to the recession. Here’s a headline from last week: “GM Plants at Full Tilt to Feed U.S. Car Demand” [Financial Times]. Average price paid for auto transactions is up 5% over a year ago [New York Times report – last week].
- Fact check: Are we only creating “low-wage, below-average” jobs? The industries that pay their workers more than the national industry average include Utilities, Mining, Information Services, Financial Activities, Wholesale Trade, Business Services, Construction, and Manufacturing. More than one-half of the job creation in this economic recovery has been in these industries. [David Rosenberg, Gluskin-Shelf Advisers].
- Continued positive data from Europe. German retail sales were +0.5% in August, erasing the slight dip in July. The ECRI Leading Economic Indicators index moved ahead to 132.9, the highest level in over a year.
- In Japan, the most recent CPI statistic is +0.9% year-over-year. This is the fastest rate of inflation in Japan for the past 5 years. Perhaps “Abenomics” is working.
Equities Outlook: This too shall pass…
- What does one do in the face of such negativity in the headlines? To paraphrase Benjamin Graham: “The investor’s chief problem is not the market and not low interest rates. The investor’s chief problem, and even his own worst enemy, is likely to be himself.”
- We’ve had 17 government shutdowns since 1976. The market performance during shutdowns has been positive 47% of the time and negative 53% of the time. The median change has been an insignificant -0.1%. Apparently, the market does not care.
- The headlines from Washington highlight political dysfunction. Likely, it will resolve itself in the classic American political way – a few minutes before or after the “11th hour” of the debt ceiling deadline. Once it is behind us, the U.S. will then continue its low-inflation, slow-growth recovery. We continue to believe the intermediate term outlook for equities is attractive. The bull market is not over.
- We comment below on the yield curve’s predictions about recession and bear market. Bottom line: almost no likelihood. Corrections (10% declines) can happen anytime, and usually do. Bear markets (20%+ declines) are almost always related to recessions.
- We wrote 2 weeks ago about the possibility for an S&P 500 level of 1850-2000 by the end of 2014, which, at the midpoint, would be a +14% move from current levels. This was based upon our back-of-the envelope earnings projections for S&P 500 companies of $132 per share in 2015. The current analysts’ consensus for earnings in 2015 is actually better than that: $135.40.
- Earnings announcements for the third quarter start this week. Analysts’ estimates now call for an average gain of +4.2% versus a year ago. The key in watching the results come in: how will the revenue growth look? Can we break out of low single-digit revenue growth?
- Will we have earnings surprises when Q3 earnings are announced? When the dust actually settled for Q2, the earnings announcements were +4.9% over the previous year, considerably better than the final analysts’ predictions of +2.9%. The market responded with a significant advance during earnings season. We will have our answer for Q3 in about 4-6 weeks.
The Fed and Fixed Income Markets: Confirmation from one of the doves…
- FOMC voting member Eric Rosengren spoke on Wednesday. He confirmed three concerns that influenced the vote against tapering in September. Incoming data was disappointing. Washington’s fiscal deadlock represented a potential economic drag. Rising bond yields and mortgage rates were reaching levels that might threaten the recovery.
- None of these comments were a big surprise, but confirm the thinking that currently influences the still future taper decision.
- How great is risk of a recession? All 6 recessions of the past 40 years have been preceded by an inverted yield curve (short-term rates exceeding long-term rates). And there has been no case where the yield curve was inverted which was not followed by a recession. We are certainly not inverted today. The 10-year yield finished around 2.65% last week, and the 3-month yield is still practically zero. Hard to call that inverted.
- Longer run, the headwinds for fixed income investors are likely to be stronger inflation and rising rates. But we are talking longer run, not the next 12 months.
- In the current fiscal squabbling, nothing is being said about the cost of servicing the government’s debt over the next 5 years. As the Fed tapers and reduces its balance sheet, interest costs for the U.S. Treasury will rise (as they will for everyone else). In addition, the profit earned by the Federal Reserve and transferred to the Treasury will decline with the shrinkage of the Fed’s balance sheet. Together, these two changes in financing cost are estimated at $750 billion per year — pretty significant pressure for the deficit. We are not out of the woods yet. The hard decisions for the government sector remain ahead.
The Week Ahead: More Data, if the government is open for business…
- Monday: China PMI Composite
- Wednesday: Release of Fed Minutes
- Thursday: Initial Jobless Claims
- Friday: U.S. Consumer Sentiment [University of Michigan]