Market Insights: September 9, 2013
Economic Outlook: We are not on the edge of a cliff..
- August manufacturing numbers are stronger. Index rises to 55.7, led by the New Orders component, rising to 63.2 (highest in 2-1/2 years) [ISM Manufacturing Index]
- Non-manufacturing index also rises for August to 58.6, up from 56 in July. [ISM]
- These kind of ISM numbers are very encouraging, suggesting acceleration in GDP growth.
- U.S. auto sales rose almost 2% in August from the previous month and are at an annualized rate of 16.1 million [This number was at 14.5 million a year ago]. We have not been at these numbers since 2007, reflecting pent-up demand.
- Gallup’s most recent index of American consumers is at 95, after several consecutive months below 90. This puts consumer spending at the best pace since September 2008. There continue to be early signs that consumer deleveraging may be coming to an end. This could be a headwind shifting to a tailwind.
- “Reports indicated that consumer spending rose in most Districts… back-to-school sales contributed to overall consumer spending growth.” [Most recent release of the Fed’s Beige Book]
- Construction numbers for July rose 0.6%, which makes the three-month average about 12%, annualized.
- Eurozone Composite PMI comes in at 51.5. This is a 26-month high. China’s August PMI number for August came in at 51.8, the highest for the year. The UK’s Economic sentiment indicator hit 108.5 in August (highest since October of 2007).
- Bottom line: This is not a global economy on the edge of a cliff…
Equities Outlook: Competing influences are evident, but don’t panic…
- PLUS: Evidence is mounting that Europe is coming out of an extended recession. And as noted above, the U.S. stats continue sending a pretty positive message.
- MINUS: We have seen bond yields back up about 100 basis points in the past 3 months. Rising interest rates, even those that are still low, will put some limit on market valuation. So near term, a market breakout is not likely.
- PLUS: Earnings estimates for 2014 for the MSCI World Stock universe predict a 10.9% advance in earnings for 2014. This would represent faster growth than the 8% number likely to post as final for 2013.
- MINUS: Sequestration and debt-ceiling debates are lying ahead of us with a divided government. We are also facing a resolution vote on the situation in Syria. All of this creates the uncertainty markets dislike.
- PLUS: But the improving global growth picture portends possibilities for year-end rallies and further advance in 2014.
- Where does all that leave us? The S&P 500 is down about 4.5% from the high in early August. Most of this is nervousness over taper talk by the Federal Reserve. Of late, the Syria jitters have added some fuel. Nothing here however suggests that equities do not remain attractive for the longer term. All investors other than traders should hold steady.
The Fed and Fixed Income Markets: It’s all about duration…
- Monetary policy by the Fed is now dedicated to the idea of higher inflation. The Fed has said 2.5% inflation is tolerable. Higher inflation makes the bond market a sell (all other things equal).
- With the signs of strengthening in the economy, the futures market has begun pricing some likely Fed tightening in 2015, sooner than what we saw some months back (2017).
- The Fed’s holdings of U.S. Treasury securities longer than 10 years has expanded from $100 billion in 2009 to more than $500 billion today, the result of QE. In addition, their holdings of 5-10 year paper has expanded from $200 billion to more than $800 billion.
- The Fed now owns 60% of the U.S. government’s long-dated bonds. When they start slowing down on purchases, expect pressure on the bond prices and rising yields.
- Commercial banks have reduced their holdings of U.S. Treasury securities at a rate of 20% plus over the past several months, apparently anticipating higher interest rates and some inflationary pressures.
- The 10-year Treasury got very close to the magic 3.0% level during the week, but closed at 2.93% on Friday.
- Our view: The main issue facing bond investors is duration risk. Credit risk is secondary.