Market Insights: September 8, 2014
Economic Outlook: All the domestic readings are aligned
- The final reading for the August PMI Manufacturing Index finished at a strong level of 57.9 last week. Of particular note in the report was strength in new orders, an increase in exports, and strong readings for both production and employment.
- The ISM Manufacturing Index confirmed the PMI reading with a similar strong posting of 59. The strongest individual component in the ISM report was New Orders.
- The final July number for construction spending showed an increase of 1.80%. This metric is up 8.20% over the trailing 12 months with contributions from both private and public construction spending.
- The ADP Employment Report for last week estimated that private payrolls grew by 204,000 in August.
- Auto sales reached a level of 17.5 million units in August. This represents the highest reading for new car sales since January 2006, and exceeded Wall Street expectations.
- The Beige Book Report from the Federal Reserve concluded that economic activity continues to expand in recent weeks. The report noted that manufacturing was growing broadly and auto production is boosting demand for steel and related products.
- The comparable gauges associated with the international economy continue to send a more conservative and contrasting picture of economic momentum outside the U.S.
- The European Union, PMI Composite Index slowed further in August and now stands at 52.5. A similar index for Japan is just barely holding in an expansion mode at 50.8.
- Retail sales in the Eurozone area shrunk further in August, by -0.4%, disappointing forecasts.
- The European Central Bank surprised analysts with a further cut in interest rates last week, intended to deflect the threat of inflation and spur economic growth. The ECB’s 24 member governing counsel reduced all three of its bench mark interest rates by 10 basis points.
- These rate cuts come just a few weeks after Mario Draghi signaled to the markets that he was prepared to act again if necessary. These cuts occurred despite the fact that Draghi had said in June, “for all practical purposes, we have reached the lower bound” on interest rate cuts. We will see if the effect of these moves is enough to arrest current concerns over geopolitical tensions which are weighing on the economy.
Equities Outlook: S&P 500 at 3,000 by 2020?
- As the various economic statistics sited above demonstrate, the U.S. economy’s momentum stands in contrast to the rest of the globe at the current time. This, more than anything else, accounts for this continued strong equity market in the United States.
- U.S. pre-tax corporate profits rebounded more than 10% in the second quarter of 2014, making up for the decrease in Q1.
- As we have written in recent weeks, valuation multiples for the U.S. equity markets are moderate to high, but not in a range that would be considered grossly over-valued. To some degree, these firmer valuations may simply reflect that investors increasingly find the potential returns in the equity simply make more sense to them than the prospect of putting money to work in the bond market.
- Adam Parker, a stock market strategist with Morgan Stanley, attracted media comment last week with the release of a report which predicted the S&P 500 index will hit the 3,000 level around the year 2020. This, of course, is a 50% increase from current levels, which he predicts will occur over the next six years.
- Parker characterizes the U.S. economy as still in the “very early stages of expansion”. He believes we could therefore be in the midst of a current bull market, which could prove to be the longest on record.
- This prediction by Parker is actually not as extraordinary as the financial media attention would suggest. If U.S. S&P 500 companies continue experiencing modest revenue growth, and maintain current attractive profit margins, the natural progression of earnings between now and the year 2020 would in fact put the market at a level of 3,000 at that time. If there is not a significant economic recession that interrupts earnings, one might call the forecast conservative.
Fixed Income Markets: A Declining Deficit
- The interest rate on the Ten-year U.S. Treasury Note rose to 2.46% on Friday. While this is an increase from the previous level of 2.40%, it nonetheless remains below the key trading level of 2.5%.
- As we have noted several times in recent weeks, the exceptionally low yields for government bonds in the Eurozone seems to account for the very constrained U.S. yields in spite of good economic growth domestically.
- This continues in current weeks, as the German Ten-Year government yield has dropped below 1.0% and currently stands at 0.89%. Despite the fact that the Federal Reserve has been tapering its QE program, the ultra-easy monetary policy of European central banks, as well as the Bank of Japan, provides global sources of capital at extremely low interest rates. This competition has acted to keep U.S. interest rates lower than they otherwise would be.
- It is also worth noting that contemporaneous with the Federal Reserve tapering its bond purchases, the U.S. fiscal budget deficit has continued to narrow over the last year. Therefore, the need for the Treasury to issue new bonds has declined. In the most recent 12 months, the budget deficit has run $533 billion. This compares with the year earlier cumulative number of $723 billion.
The Week Ahead
- NFIB Small Business Optimism Index
- JOLTS Survey
- Retail Sales (Census, Dept of Commerce)
- University of Michigan Consumer Sentiment
- European Union, Industrial Production (Eurostat)