Recently the markets’ focus has been on the battle in Washington DC over the government shutdown. Last week a major economic report, the monthly jobs report, was postponed due to the shutdown. It is likely that more economic news will be delayed therefor shifting more importance to corporate earnings for the third quarter.
Initially, analysts were estimating a 6% increase for third quarter earnings but that has been gradually reduced to a 2% go ahead. If the shutdown continues on it will be a drag on fourth quarter earnings as well. Right now the solution seems to be to “kick the can” into next year.
Continuing the uncertainty does not bode well for consumer spending or corporate earnings in the fourth quarter.
“Do not yield to misfortunes, but advance more boldly to meet them, as your fortune permits you.”
The S&P 500 declined 0.2% last week following the partial shutdown of the U.S. government as investors try to figure out the negative implications to growth. Weakness Monday is attributable to the lack of any progress in Washington over the weekend. Most economists expect a 0.1% to 0.2% hit to GDP for every week the government is closed. Though none of us know when there will be a resolution, the markets are just 2.5% below all-time highs (the DJIA is down 4.1%) from September.
We expected uncertainty and increased volatility to continue until there is an agreement from Congress. However, monetary policy will remain accommodative, tapering is probably off the table until December or later and expectations for corporate earnings have come down to an achievable level. In addition, we see global economies improving, with better manufacturing data in the Eurozone and China. This is a positive tailwind which will be supportive of equities into year end and into 2014.
Several clients have been asking about the market implications from a government shutdown. The following chart should shed some light. Both the stock and bond markets have tended to look through past Federal government shutdowns as temporary ‘non-events’. The chart below shows that the equity market has tended to be choppy heading into and during past government shutdowns, but has strengthened markedly once they are resolved.
Click image to see larger version.
“The reason why worry kills more people than work is that more people worry than work.”
– Robert Frost
Markets were mixed last week as the Federal budget building process careened toward impasse and a partial government “shutdown”. The combatants are involved in a game of chicken which is increasing uncertainty and the size of the so-called “Washington DC discount”. The S&P fell by 1.1% last week, while the bond market continued to strengthen on the taper postponement [which was probably motivated by the Fed’s “shutdown” concerns]. The 10 year treasury yield is down to 2.62%, giving up 11 BP over the last week.
The US economy is expanding, but at a lethargic pace. Higher taxes, slower Federal spending growth due to the sequester [which, if continued, will be positive in the intermediate and long-term], and more regulations are all dragging down the GDP growth. One interesting example is the “Jobs Act” passed in 2012.
The Jumpstart Our Business Startups Act [Jobs Act] was designed to expedite startup funding. The idea was to allow these rapidly growing companies [which are big jobs creators] to more easily access expansion capital, using 21st century tools such as Kickstarter or other crowdfunding alternatives. Unfortunately, the Washington sausage mill is producing an edifice which is in many ways worse than the Depression-era original. Investor requirements, filing timetables and penalty thresholds have become more onerous. Details of this ongoing counterproductive tragedy are available in a recent WSJ oped.
The good news is that our economy is growing in spite of these accumulating impediments. Just think about how well it will do when [if?] they are removed.
“Worry is like a rocking chair – it gives you something to do but it doesn’t get you anywhere.”
Markets advanced last week on news that the Federal Reserve will delay the start of any tapering of its asset purchase program.
For the week, the Dow Jones Industrial Average finished at 15,451 to close up by 0.49%. The broader-based S&P 500 closed at 1,710 for a gain of 1.30% for the week. The Nasdaq Composite closed the week at 3,775 for an advance of 1.40%. International markets fared better than the U.S. as the Dow Jones Global (ex US) Index gained 2.62% for the week (we see international equities outpacing U.S. equities for the next few quarters). The 10-year Treasury closed the week at a yield of 2.74% … down quite a bit from last week’s 2.90% yield (thanks to comments from the Fed).
Investors seem to be cheering the Fed’s decision to delay their tapering efforts. Strong home and auto sales along with better manufacturing and overall economic activity was not enough to persuade the Fed to begin taking away the punch bowl. The Fed remains concerned (who doesn’t … except the President and Congress?) about the anemic rate of job growth and the U.S.’s tepid GDP outlook. Of course, the Fed could quickly change their decision should the data indicate stronger employment and economic growth. St. Louis Fed President, James Bullard, indicated last week that the Fed could actually begin their taper process in October … thus contributing to Friday’s sell-off.
Now that the Syria situation has moved off the front pages, the next item on the worry list is the ongoing debt ceiling/budget debate in Washington. It is quite likely that the drama will continue this week, but we do not anticipate a government shut-down any time soon.
Third quarter earnings season should wind-down this week, and we expect earnings to be reasonable (as they have been for most companies who have already reported). A number of U.S. and international economic releases will take place this week … expect a lot of short-term “noise” from what will likely be conflicting news.
As always, we urge investors not to get caught up in the day-to-day noise of the markets. Instead, focus on long-term goals and enjoy the beginning of fall (yes, summer is really over).
“To conquer fear is the beginning of wisdom.”
– Bertrand Russell
We’re sure Larry Summers saw this coming. His informing President Obama that he was not interested in the Fed Chairmanship was greeted today by strong rallies in the bond and stock markets. The ten year Treasury note yield was down around 2.8%, having reached 3.0% earlier this month. This is the lowest level reached in September. The ten year note has risen substantially in recent months with the talk of tapering bond purchases by the Fed. The Dow-Jones average was also pleased, up around 125 points as we write. Summers had a reputation as a potentially hawkish chairman who would be more inclined to raise interest rates.
The leading candidate now becomes Fed vice-chair Janet Yellen who is viewed as more like Ben Bernanke and less likely to tighten monetary policy in 2014. She is described generally as a monetary policy dove who is more concerned with unemployment than inflation. Of course there is no certainty she will be the choice. One interesting possibility is Stanley Fischer, an American citizen who recently stepped down as Governor of the Bank of Israel. Several other candidates, even Tim Geithner have been mentioned.
Mr. Bernanke’s term expires in January 2014, so the waiting game should not last much longer. The Fed chair has been described by some as the second most powerful person in America. We think Mr. Bernanke has done an admirable job, and we look forward to an equally sound replacement.
“The only place where your dream becomes impossible is in your own thinking.”
– Robert H. Schuller
Last week U.S. stock markets rallied with the S&P 500 advancing 1.4% and the DJIA rising 0.8% the first positive week for the DJIA in 5 weeks. Equities were supported by recent improving economic reports on U.S. auto sales and the service sector of the economy. Also, China economic news is showing signs of a gradual improvement which would be a positive for emerging country economies.
A weaker than expected jobs report on Friday caused Treasury prices to rally for the first time in September. 10 year Treasury rates have nearly doubled from their lows of the year and are approaching 3%. August’s jobs report showed new jobs created of 169,000 vs. expectations for 175,000. In addition the prior two months were revised downward by 58,000 and 16,000. Bond investors were hopeful that this would mean that the Federal Reserve would not discontinue its bond buying program or at least any reduction in bond purchases would be moderate.
One encouraging sign for further job improvement was the four week average for initial jobless claim at 328,500, the lowest level since October 2007. With productivity also running at a low level, companies may have to higher more employees if the economy continues to improve.
The markets declined last week with U.S. stocks posting their worst month since May 2012. The S&P 500 declined 4.5% for the month but is still up nicely for the year with a 14.5% gain. International markets faired better in August with the MSCI EAFE down 2.12% while maintaining a year-to-date gain of 9.67%. Ongoing Fed taper talk continued to pressure fixed income. Our bond benchmark, the Barclay’s U.S. Aggregate, continued to struggle in August down .83%, adding to the year-to-date decline of 2.81%.
This week’s cover story in Barron’s, Fall Forecast: Sunny, highlights a growing economy and rising earnings for stocks. Their consensus is for the S&P to reach 1700 by year-end, 4% higher than Friday’s close and a 19% gain for the full year. They see earnings growth, which hovered around 5% in the first half of this year, accelerating to 8% toward year end. Their experts believe that an uptick in GDP will lead to cyclical and large capitalization stocks outperforming defensive names.
We also note the Interim Economic Assessment report out of the Organization for Economic Co-operation and Development – “the pace of recovery in the major advanced economies improved in the second quarter and growth is expected to be maintained at a similar rate in the second half of the year. Activity is expanding at encouraging rates in North America, Japan and the United Kingdom, while the euro area as a whole is no longer in recession. In several major emerging economies, however, growth has slowed.”
Finally, we are encouraged to see two major M&A deals occur over the weekend. MSFT will purchase substantially all of Nokia’s Devices & Services business, license Nokia’s patents, and license and use Nokia’s mapping services for $7.2 billion in cash. In addition, Verizon agreed to acquire Vodafone’s 45% stake in Verizon Wireless for $130B.
“I know that you believe you understand what you think I said, but I’m not sure you realize that what you heard is not what I meant.”
– Robert McCloskey
An erratic and tentative market ended the week higher, thus avoiding a third weekly decline. The S&P advanced 46BP on the week to 1663.50, while the 10 year treasury yielding 2.816%.
The stock market’s NT direction is muddy. One noted commentator is warning investors in Saturday’s WSJ that stocks might fall by ~30%. But, only three days earlier [in Wed’s “Smart Money”] he had pointed out that market timers with the best LT performance are steadfastly bullish, while those timers with the worst record are the ones who are turning bearish. As a result of observing those actions, he concluded that stocks are headed higher!
Economic numbers are also mixed. Midweek unemployment claims were lackluster, but existing-home sales [5.4M] were better than the 5.1M forecast. Wed’s Fed minutes focused on the low participation rate, and high incidence of part-time workers [new health care insurance regs?]. Manufacturing PMI from both China and the Eurozone were positive, supporting cyclical equities. But new home sales hit an air-pocket in July, falling 13% to 394K from a downwardly revised 455K in June. This was the largest drop since May 2010.
As a result, investors are becoming stock pickers, emphasizing company-specific news. [“Correlations are declining”]. Hewlett-Packard fell 12.5% [its largest daily decline in two years!] after reporting a disappointing quarter, while Microsoft advanced by 7.3% on the news that Steve Ballmer would “resigning” as soon as a replacement could be found.
PS: the volatility continued Monday afternoon with a ~56BP decline following John Kerry’s impassioned condemnation of Syria’s chemical-weapons usage.
“By prevailing over all obstacles and distractions, one may unfailingly arrive at his chosen goal or destination.”
– Christopher Columbus
1966 Sir Francis Chichester begins 1st solo ocean voyage around the world
While economic data is always subject to differing interpretation, we find much of this week’s data to be positive. The front page story today in the WSJ notes the progress in the U.S. manufacturing sector. Our newfound manufacturing competitiveness is producing a shrinking manufacturing trade deficit. Lower energy costs and sluggish wages contributed to our competitiveness. The Boston consulting group thinks that 2.5-5.0 million jobs could be created by 2020. In some cases we may actually become the low-cost global manufacturer.
Note that there is still plenty of room for improvement. From 2000 to 2011 our share of global exports shrank from 19% to 11%. During that period, our exports to China grew 19%, though still accounting for only 1/5 of China’s imports. China no longer relies solely on its labor-cost advantages. It is rapidly improving its effectiveness to manufacture higher-tech items. We will need more skilled workers to compete in that scenario.
Finally, we note that this is the peak of our summer vacation season.. Take advantage of the peaceful surroundings and enjoy.
“I will prepare and some day my chance will come.”
– Abraham Lincoln
Markets retreated last week from their recent all-time highs to finish the week down roughly 1%. Investors reacted to comments from the Fed that the central bank was closer to tapering their bond buying than previously thought … or maybe most investors were simply on vacation.
For the week, the Dow Jones Industrial Average finished at 15,425 to close down by 1.35%. The broader-based S&P 500 closed at 1,691 for a loss of 0.98% for the week. The Nasdaq Composite closed the week at 3,660 for a decline of 0.70%. International markets fared better than the U.S. as the Dow Jones Global (ex US) Index gained 0.22% for the week (we see international equities outpacing U.S. equities for the next few quarters). The 10-year Treasury closed the week at a yield of 2.58% … down from last week’s 2.61% yield (bonds could rally temporarily should the equity markets take a breather over the next month or so).
Europe and China reported decent economic news last week. Europe’s purchasing manager’s index and retail sales were better-than-expected, and Germany’s factory orders surprised on the upside … perhaps Europe is at the beginning of a long bottoming process. News out of China was equally impressive as industrial production, fixed investment and trade data were encouraging. Cyclical stocks finished the week nicely higher on the news out of China and Europe.
We expect a quite week ahead as the earnings season winds-down. It looks like S&P 500 2nd quarter earnings will finalize around +4.5%. Unfortunately, non-financial earnings may be negative for the first time since 2009. Bottom line – expect a bit of a pullback in the markets on light volume … this is very normal for the late summer.
“Rome was not built in one day.”
– John Heywood