Market Insights: September 23, 2013
Economic Outlook: Most of the data continues to be positive…
- The Leading Economic Indicators posted a +0.7% increase for August, coming in better than economists predicted [The Conference Board]. This has now returned to the highest level since early 2008.
- Existing home sales last week also came in stronger than predicted: +1.7% annualized. This is a surprise to the upside, bucking the headwinds of higher mortgage rates. Admittedly, however, data for first-time homebuyers is not as positive.
- The 4 week average of initial jobless claims is down to 315,000 from 350,000 in June. The trend points to a lower expectation.
- Expect Monday’s Euro-area composite PMI for September to show an increase. This would be six month’s in a row. The August number was at 51.4, a high for the last two years, and showed particular strength in the new orders component. Even emerging economies in Europe (Poland, etc.) are participating. UK’s PMI numbers are showing the same strength.
- The consensus estimate for 2014 earnings on the Stoxx Euro 500 index for is +13.1%, a significant advance over the +1.3% estimate for 2013. We’ve written about the valuation discount for Europe before but here’s another data point: The price-to-estimated book value on the Stoxx Euro 500 Index is 1.6X, which is quite cheap compared to the 2.25X ratio for U.S. stocks.
- The German election was held on Sunday: Television projections at the close of the polls indicate Angela Merkel’s Christian Democratic bloc captured 42% of the vote compared to the 26% taken by the Social Democrats. Though Merkel must still consolidate her coalition with the other parties in the Bundestag, this is a strong show of support for her pro-euro policies.
Equities Outlook: Is there more being served up here than Kool-Aid?
- Virtually all markets rallied on the Fed’s announcement of no taper. Is this just a reaction to the continued serving of Kool-Aid by the Fed? While that may cause concern, there appear to be other discernible explanations that make more sense.
- Earnings estimates for the S&P 500 companies continue to come in strong. Earnings estimate revisions for August showed more upward revisions than downward revisions. This is a first since the early months of 2012. [Strong sectors include energy, financials, and technology].
- As we pointed out last week, if next year’s earnings for the S&P 500 come in around $120 (consensus) and forward earnings estimates 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 is a 10% to 18% increase in the S&P 500 from where we started last week.
- What are corporations doing with these earnings? Buying back shares and paying out dividends. Since 2009, S&P 500 companies have repurchased $1.5 trillion of their shares and paid out $1.1 trillion in dividends. They are still holding $1.8 trillion of liquid assets. [Edward Yardeni Research notes]
- And though the Fed’s Kool-Aid may not be the direct cause, the correlation of the S&P 500 with the Fed’s expansion of its balance sheet has been widely noted. Certainly, it is not slowing the market’s advance.
- We do not see a strong case here for becoming defensive in clients’ equity posture.
The Fed and Fixed Income Markets: Wrong with lots of company…
- Like almost all market observers, we were wrong in predicting the Fed would begin the tapering process following the September meeting. The announcement last week following the Fed meeting was “no change”.
- This was indeed surprising in that Ben Bernanke had predicted in May that the Fed would start to wind down QE over the next few meetings. And most Fed spokesmen since May have reinforced the belief that September would see the first move.
- The Fed said all along that the move would be “data dependent”, so apparently they were not sufficiently motivated with the recent economic data nor hurried by any germinating inflation seeds to take action. [Fed President James Bullard’s Friday comments on Bloomberg Radio]
- The Ten Year Treasury rallied after the announcement and closed the week at a lower yield of 2.73%, down from 2.88% a week ago. Note that this rally does not take us back down to the yields below 2.5% that characterized the first half of 2013, so “taper anticipation” is still dialed in to the equation. And after all, the difference between a $15 billion taper and no change is not actually that great.
- Though the inflation seeds are only germinating and not yet blooming, the prospect of higher inflation down the road is the main risk to bondholders if the Fed delays too long in tightening its monetary reins. [“The continued high level of monetary accommodation… could cause an increase in long-term inflation expectations.” – Kansas City Fed President Esther George]
- Likewise, it is possible that some of the bond market’s higher rate response to taper talk is related to a strengthening economy.
Once again, as we’ve emphasized over the past few weeks, the focus in bond risk has made a secular shift from credit to duration. We will continue to take this into account in managing clients’ fixed income exposures.
The Week Ahead: More economic data to clear the picture for the rest of 2013…
- Monday: Flash PMI Manufacturing Report
- Tuesday: Case-Shiller Home Price Index & Consumer Confidence Index
- Wednesday: Durable Goods Orders
- Friday: U.S. Consumer Sentiment