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
The monthly jobs report too center stage last week, with expectations were for an increase of 183,000 jobs. However, the economy added only 162,000 jobs, and average hourly earnings were slightly lower.
On the plus side the unemployment rate fell to 7.4% from 7.6% but part of that was due to a drop in the number of people in the labor force. This report was just weak enough so that investors were hopeful that the Fed might consider not scaling back on their bond buying program tentatively scheduled to begin in September.
Most economic forecasts call for a pickup of growth in the second half. But if the economy continues to be sluggish, and consumer spending is also disappointing, the Fed may feel obliged to postpone its tentative taper.
“Just remember – when you think all is lost, the future remains.”
– Dr. Robert H. Goddard
Last week the S&P 500 essentially went sideways after gaining nearly 9.0% over the preceding four weeks. The Dow Jones Industrial Average eked out a 0.1% gain for the week while the Nasdaq added 0.7%.
We saw a deluge of company earnings reports with 157 S&P 500 companies and eight Dow components reported their quarterly results. U.S. earnings have beaten estimates by 65%, however, revenue growth is still challenged. According to Thomson Reuters, revenue growth for S&P 500 companies is expected to creep up by just 1.1% in the second quarter from a year earlier. Even still, profit margins are close to record highs at 9.7%. Analysts are projecting a slight climb in profit margins in the second half of this year (see chart below). “Restructuring is just a way of life in corporate America,” says Gregory Hayes the Chief Financial Officer of United Technologies.
The week ahead is filled with several market-moving items, such as advanced estimates for Q2 GDP, the FOMC meeting, and the July employment report. To add to the action, over 100 S&P 500 companies will be reporting their results.
“The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.”
– Alexis de Tocqueville
Markets continued to edge higher last week, with the S&P registering a 0.7% advance.
Earnings reports were mostly positive. Early-week reports from Citigroup, Goldman Sachs and Johnson and Johnson were all positive. General Electric produced only a modest beat, but expectations were modest, producing a 4%+ relief rally. The “Debbie Downers” this past week were Google and Microsoft. Both are challenged by market shifts to mobile. Finally Schlumberger’s positive report reflects continued strength in crude oil pricing [Brent has averaged above $100 since the beginning of 2011].
Bernanke’s congressional testimony indicated that fed actions are data dependent, and he even broached the possibility of increasing purchases if financial conditions were to tighten. The concurrent housing data [starts were 836,000 units vs. 958,000 estimated] suggested that fed asset purchases remain unchanged, which appeased fixed-income markets. So, the Fed’s “trial-balloon” has been withdrawn for the moment. Thus, the transition from ease to relative tightening will occur next year [or later?] under the supervision of a new Fed chief. Will the next chairman be in the mold of G. William Miller or Paul A. Volker? [We’re praying for the latter].
“Bon ton roulette”
– cajun musician Lawrence Walker
Many analysts have been spending their time agonizing over the slowdown in the Chinese economy. The second quarter GDP numbers are out and now perhaps the analysts will move on to something else.
China reported 7.5% growth for the quarter, which was right on the estimates. This is a slowdown from China’s previous 10-11% reported growth, but is a much more sustainable pace. It also helps with worldwide inflation caused by the excess demand from China. Big exporters to China can adapt to the changed level of activity.
Alcoa kicked off the quarterly earnings reporting season, but the major banks tell us more about U.S. economic conditions. So far these reports have made for pleasant reading. Wells Fargo kicked off the proceedings by reporting a $.98 quarter versus the $.93 consensus. Estimates will go up for 2013-15 as a result. Their balance sheet is the strongest of the big banks. Its capital strength stands out as its most impressive characteristic and provides the freedom to increase dividends and/or buy back shares.
J.P. Morgan came up next, reporting $1.60 for the quarter, ahead by 32% from a year ago. Improvement was boosted by refinancing levels, lower credit losses and very strong investment banking.
Finally, Citicorp reported today and kept pace with its brethren. $1.34 handily beat the forecasted number of $1.18. The bank showed continued improvement on bad loans and improved expense control, which has been a focus of new CEO Michael Corbat. Citi’s most unique aspect is that it sells right around tangible book value, best of the big banks. Personnel expenses were down 4.35%, total expenses decreased by 2.1%.
“Remember, my son, that any man who is a bear on the future of this country will go broke.”
– John Pierpont Morgan