Market Insights: September 3, 2013
Economic Outlook: On the one hand; on the other hand…
- We’ve had an extended period of households drawing down debt (i.e. de-leveraging). We appear to be turning the corner to where we could have households beginning to take on debt. This would be positive for growth.
- Oil hit an 18-month high on Tuesday last week (mid-East fears). This might be a hiccup, but if it sustains itself, the effect on the consumer (70% of GDP) will be negative.
- Consumer spending is chugging along at a 2% growth pace. Not great, but steady. In a word, the recovery continues to be “OK” but you cannot call it “Great.” GDP growth, measured in real “final sales” was +1.9% for Q2. This does not portend increasing growth in GDP in the third and fourth quarters. Consumer is just holding. Key will be what happens to business investment.
- Details from the recent Durable Goods Report – Capital goods excluding the volatile transportation sector and defense spending – down 3%. First negative report in a number of months. Businesses may be pulling in their horns.
- The Fed minutes from the meeting at the end of July “noted that employment growth had been stronger than would have been expected given the recent pace of output growth.” [Fed minutes: Meeting of July 30-31]
- The July data on new single family home sales was down 13.4%, suggesting that the increase in mortgage rates is having some effect on the pace of the housing recovery [Most recent Housing data release]. Strong pent up demand, however, is likely to keep the housing trend from turning negative.
- We have had negative real interest rates, thanks to Fed policies. Historically, when you’ve had negative real interest rates on the 10-year Treasury, the economy has been weak. So this sub-par recovery is not surprising. Positive real rates would signal that the economy and corporate earnings are growing. This is good for the markets.
Equities Outlook: Down 5%, is there another 5% to go?
- At this writing, the S&P 500 is 4% to 5% off its high. We have not had a true correction (a decline of at least 10%) since June of 2012. We are a bit overdue.
- Even this modest pullback has dropped the forward Price/Earnings multiple on the S&P 500 to below 14, which is not a number that suggests “over-valued”.
- The mixed data on the economy may induce some caution by the Fed with respect to tapering. This would be favorable for the equity market.
- The percentage of Investment Advisors expecting a pull-back of 10% has increased to 38% (from 28% in mid-July). That increase is actually a bullish contra-signal of sorts that the downside exposure is not great. [Investors Intelligence]
- Despite some recent weakness in the economic indicators and despite a rather fast adjustment upward in bond yields, investors are not panicking. There is no serious talk of recession in the U.S. If growth remains tepid, then Fed policy will likely continue as is, so this lack of panic makes perfect sense.
- There are clearly geopolitical risks to the market (Syria most prominent). However, typically a sell-off does not occur until events actually reveal a tangible threat to corporate earnings, and that has not yet happened. If it does happen, it could represent a buying opportunity.
- The most recent consensus for corporate earnings in 2014 has edged down. However it continues to represent a gain of more than 10% from the current estimate for 2013. This kind of growth in earnings is supportive to the equity market.
- We’ve talked about the emergence of some positive economic data in Europe (finally!). The Wall Street Journal ran an article last week [“Stock Investors Embark on a European Tour”] highlighting some of this trend and noting the attractive valuations for some companies compared to their U.S. counterparts.
- The European Stock Index is up double the S&P 500 since the last week of June. [MSCI Europe Index +10.6% since 6/24 versus the S&P 500 +5.3%]
The Fed and Fixed Income Markets: A declining appetite for bonds
- Bernanke admitted recently that QE purchases have been unconventional, a “process of learning by doing.”
- The talk of tapering by the Fed has punctured what might have been a bubble of sorts in the bond market.
- As we’ve wrote two weeks ago, the most recent Treasury auction of 30-year bonds witnessed total bids of 2.11 times the bonds sold, down from the traditional average (above 2.5X). This confirms the appetite for bonds by investors has declined, confirming the likelihood of increasing rates over time.
- U.S. commercial banks have reduced their holdings of Treasury and Agency securities in recent weeks. Bond funds have had net outflows virtually every week, except one, for the last 3 months. [Investment Company Institute estimates]
- Based on the mixed economic signals, if the Fed does indeed decide to begin the tapering process at the September meeting, it is likely to be a very slight lessening of bond purchases.
- A bright spot: Issuance of municipal bonds in August fell 38% from the same period in 2012. This is due to the large amount of refundings in 2012, when issuers took advantage of lower rates. These refunding reduced total debt obligations of municipalities, strengthening their budgets and improving credit position. This does not make the headlines but enhances the credit-worthiness of municipal debt.