Market Insights: September 16, 2013
Economy: Peeling back the onion…
The consensus headline view is that Thursday’s widely-watched jobs report was “just good enough” and the Fed will likely proceed with very modest tapering – a cut-back of $10-15 billion per month in purchases of bonds and MBS securities. That long-discussed decision awaits us this week.
- Most of the decline in last Thursday’s jobless rate (now 7.3%) can be attributed to people dropping out of the workforce. We are at a 63.2% labor force participation rate. We have not been this low in 30 years. A number of factors are at work here. But underneath the hood of the report, we can still find some good news in answering the question: “How many people are working and how much are they making?”
- Four-week average for initial jobless claims stands at 328,000 on August 31. We have not been that low since 2007. [Bureau of Labor Statistics Monthly Report]
- We talked last week about the ISM indexes and their strength. The sub-data on employment in those indexes is also showing strength. [ISM]
- Average workweek numbers are increasing. Average hours worked for all workers increased in August to 34.5 hours. In manufacturing jobs (which pay more), it increased to 40.8 hours, a level rarely exceeded since these statistics started in the mid-2000’s.
- Wage gains for workers are also improving, which should follow through and help retail sales. Average hourly earnings for all workers, excluding government employees, rose 2.2% in August over the same period for 2012. Manufacturing jobs increased more than service jobs, but all increased.Probably a blip, but the European factory production report for July pulled back some, reversing some of the recent gains we’ve talked about.
Equities Outlook:Do the Math…
- The pick-up in global growth that we have been talking about in recent weeks bodes well as to the outlook for earnings and valuation.
- Many write that corporate profit margins, near all-time highs, must revert to the mean. This may be true, but consider that significant productivity gains ushered in after the 2008-2009 downturn might be a game-changer. Thanks to technology, the “band” for corporate profit margins may have been raised.
- This economy may not qualify as “great” but do the math: If next year’s earnings for the S&P 500 come in around $120 (consensus) and forward earnings for 2015 are $132 (a 6% increase), the S&P 500 could be at 1850-2000 by the end of 2014 [A 14x to 15x multiple of $132]
- This would represent a 10% to 18% increase in the S&P 500 from last Friday’s close of 1,688. How quickly might such a move begin to materialize?
- Hard to say since several wild cards are still facing us in coming months. Some of the uncertainty we spoke about last week, however, diminished with the news that there will be no immediate military response to the Syria situation. [The VIX volatility index has dropped over the past 2 weeks]
The Fed and Fixed Income Markets: Higher rates draw more bids…
- The tapering decision is finally here this coming week. Look for the Fed to go lighter on MBS reductions and heavier on Treasury bond reductions in their cutbacks. They are likely to be concerned not to choke off the housing recovery, given the back-up in mortgage rates. [New mortgage applications dropped 13.5% in the data from the week of September 6th. The decline is now more than 50% since mortgage rates began to rise.]
- We’ve written about sparse demand for Treasury securities at recent auctions. The back-up in interest rates appears to be an antidote. At last week’s auction, institutional demand rose significantly compared to the previous 6 months. [The bid-cover ratio hit 2.86x, compared to 1.7x, over the past 10 auctions]
- Not making a headline: The re-pricing of the bond market since Bernanke cracked the taper egg in late May amounts to the fifth worse bond sell-off in the last 55 years. Your total return on Treasury bonds has been -10% (10 year Treasury note) to -16% (30 year Treasury bond). If this was happening in the stock market, everyone would be talking about it.
- The Ten Year Treasury closed the week at a slightly lower yield of 2.88%, down from 2.93% a week ago. So far, we’ve stayed below the 3.0% psychological barrier.
- We believe the focus in bond risk has made a secular shift from credit to duration. We are taking this into account in managing clients’ fixed income exposures.
The Week Ahead: Some pretty important data…
- Monday: Industrial Production Report [Federal Reserve]
- Tuesday: Consumer Price Index Report [Bureau of Labor Statistics]
- Wednesday: Housing Starts [U.S. Department of Commerce]
- Friday: Existing Housing Sales [National Association of Realtors]