Negative pressure continued for global markets last week following the recent hawkish tone coming out of the U.S. Federal Reserve. Equities, fixed income and commodities sold off for the week with the Dow Jones down 1.8%, the U.S. 10 year treasury rising to 2.54% (its highest levels since 2011), and Gold down 6.9%.
We have been discussing a correction for some time in our weekly pieces. This week, we thought it would be useful to reiterate some points we have discussed in previous commentaries. On May 6th we showed the following chart which shows June as the second worst performing month of the year for the S&P 500:
The S&P 500 is still up 12.8% for the year but we have given back over 4% in the past 4 weeks.
On June 3rd we published “Fed Shift?” which highlights the changing tone of the Fed: “Stocks retreated on the day because investors viewed these reports as signs the Fed could taper sooner rather than later. Regardless, this may be the start to a much discussed equity market correction.”
On June 11th “QE’s Inevitable End?” we continued with: “Mentions of QE’s inevitable end have been one of the primary reasons for recent market downdrafts, and it is becoming clearer that the transition back to sound money policies will cause further bond and equity angst.”
Markets are digesting the Fed’s outlook and the recent surge in interest rates. However, our long term view on stocks and the economy is positive. As said on June 17th: “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 nice weather!”
“Follow effective action with quiet reflection. From the quiet reflection will come even more effective action.”
- Peter F. Drucker
Markets gyrated quite a bit last week as increased uncertainty about the economy and the direction of the Federal Reserve unnerved investors.
For the week, the Dow Jones Industrial Average finished at 15,070.2 to close down by 1.2%. The S&P 500 closed at 1,626.7 for a decline of 1.0% for the week. The Nasdaq Composite closed the week at 3,423.6 for a decline of 1.3%. Most international markets fared similarly as the EAFE (Europe, Australia and Far East) Index gave back 1.1% for the week. Bonds were relatively unchanged for the week with the benchmark 10-yr treasury closing the week with a yield of 2.12% (from 2.14% the previous week).
Economic news last week was largely mixed. U.S retail sales and initial jobless claims were better-than- expected, yet manufacturing and industrial production news were less-than-expected. The World Bank (who?) lowered global growth expectations to 2.2% in 2013 and 3% in 2014, yet they see smoother growth ahead (wouldn’t that be nice?).
Investors will be keeping close tabs on comments from this week’s Federal Open Market Committee meeting scheduled for Tuesday and Wednesday. Other notable items this week include the consumer price index, producer price index and Home Builders survey. We expect more volatility this week as Fed comments and economic news will likely fail to provide clarity to investors. 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 nice weather!
“Well done is better than well said.”
- Benjamin Franklin
The Market ended the week with respectable ~0.8% gains, albeit with a lot of volatility. Monday’s positive cancer research developments were offset by Tuesday’s intra-day reversal. The Dow broke its string of 20 consecutive positive Tuesdays. Midweek dollar weakness coupled with abrupt strength in the yen further roiled equities, but Friday’s payroll numbers boosted the S&P 500 by 1.3% for the day.
Quantitative Easing by the US, the European Union and more recently Japan has been a big boost for both the bond and stock markets. However, it appears that its usefulness is coming to an end [some would argue that unlimited money printing was never a net positive]. Mentions of QE’s inevitable end have been one of the primary reasons for recent market downdrafts, and it is becoming clearer that the transition back to sound money policies will cause further bond and equity angst.
Finally, it should be noted that the federal budget deficit has improved dramatically. The Sequester and [perhaps only temporary] slower Medicare spending growth has reduced the obscene $1 trillion-plus annual deficit to “only” ~$640B for this year. An annual deficit of four percent of GDP is still too large, but it is a step in the right direction.
“The measure of who we are is what we do with what we have.”
- Vince Lombardi
Last week equity markets finished lower with the S&P 500 down 1.1%. However, the S&P 500 was up 2.1% for the month and 14.3% year-to-date. Bonds, most notably long duration U.S. treasuries, have been under pressure as interest rates have moved up from their historic lows. The Barclays US Aggregate Bond was -0.69% for the week, -1.78% for the month and -0.91% year-to-date.
The recent market pressure is related to uncertainty around the Fed’s expected tapering of quantitative easing. Investors are now focusing a sharp eye on economic reports that may dictate future Fed moves. For example, on Friday consumer sentiment (shown below) and Chicago PMI were stronger than expected.
Stocks retreated on the day because investors viewed these reports as signs the Fed could taper sooner rather than later. Regardless, this may be the start to a much discussed equity market correction. As we have stated recently, market corrections will most likely be sallow.
“Uncertainty will always be part of the taking charge process.”
- Harold S. Geneen
Rarely have we had such a pleasant way to begin a work week after a three day weekend than today. Consider the good news: consumer confidence jumped up on the Conference Board Report from 69 to 76. This is well above the experts’ forecast of 71-72. The real superstar number was home prices jumping 10.9% versus a year ago. (Of course if you are a first time buyer you‘re not thrilled by the news.)
Separately we learned that Texas home prices hit a new all-time high. Many cities do still have a ways to go to get back to their old highs. Prices nationally are about 29% below the July 2006 peak.
Two of the factors influencing the improvement are job gains and near-record low mortgage rates. Important to the supply-demand equation is a slower pace of homeowners putting their house on the market. The supply of available homes did jump in April, but remains 14% below its year ago level. The reemergence of “flippers” in the market is also having an impact. We have heard of real buyers being outbid by these flippers.
In sum, the housing improvement is having a significant effect on the economy and the stock market. Today will be the twentieth consecutive up Tuesday for stocks. Enjoy it, but remain vigilant when the news is all good.
“Happy days are here again
The skies above are clear again
Let us sing a song of cheer again
Happy days are here again”
Last week stocks continued their advance with the DJIA gaining 1.6% and the S&P 500 2.1% supported by better than expected consumer confidence readings on Friday. Since consumer spending represents about 70% of U.S. GDP this is a key indicator for continued economic growth. Also, last week CPI numbers were released and inflation continues to be tame with prices up from a year earlier by 1.1% well under the Fed’s target of 2%.
However, rates on the 10 year Treasury hit 1.95% on Friday as some Fed officials publicly start to question when and how to end the Fed’s program of quantitative easing. The Fed’s program of purchasing $85 billion a month in mortgages has helped the housing industry and home prices. The timing and the speed of any reduction in easing by the Fed will be crucial in its impact on stock and bond prices. Hopefully the fed will time it perfectly just as the economy is on a sustainable growth path.
Today’s history – 1932 Amelia Earhart leaves Newfoundland as the 1st woman to fly solo across the Atlantic.
“Never interrupt someone doing what you said couldn’t be done.”
- Amelia Earhart
Discussions have been increasing about stocks being overvalued. It is true that last week the U.S. equity markets hit another record high, but that was not on an inflation adjusted basis. We see this as encouraging given stocks tend to beat inflation by a wide margin over time, especially when you reinvest dividends. According to Yale University finance professor Robert Shiller, the S&P 500 hit its all-time high in early 2000. To surpass this previous peak on an inflation adjusted basis, the S&P 500 would have to appreciate another 20+ percent to 2,000 versus Friday’s closing price of 1,634 (See chart below).
From another perspective, rising stock prices seem to be thawing out the initial public offering market. Year-to-date 64 companies have become publicly traded enabling them to raise $16.8 billion. This is an increase over last year-to-date but is well below the peak in the 1990s. More IPOs show investor confidence in the equity markets and the economy. This in turn gives companies the funding access required to grow their businesses, and, in turn, their stock prices.
“No matter how good you get you can always get better and that’s the exciting part.”
- Tiger Woods
The S&P 500 hit yet another all-time high last week on better-than-expected U.S. jobs data and global monetary news.
The S&P 500 closed higher by 2% last week to close at 1,614.42. Likewise, the Dow Jones Industrial Average gained 1.8% for the week to close at a record high of 14,973.96. The NASDAQ, far from its record high, moved ahead 3.1% for the week to finish at 3,378.63. The push higher last week was prompted by better-than-expected U.S.jobs data as April non-farm payrolls came in at 165k with expectations of 140k. The European Central Bank provided further good news as the ECB cut interest rates by 0.25% along with commentary indicating a willingness to provide more stimulus, if needed.
Bonds traded lower last week as yields rose in response to U.S. jobs data and ECB monetary actions. The benchmark 10-year treasury closed the week at a yield of 1.73%. The Barclays Aggregate Bond Index is now up 0.62% for the year-to-date period.
Market valuations are no longer a bargain at 15.4x trailing EPS of $105 (2Q12-1Q13). We see the markets as more-or-less fairly valued. Despite valuations, we continue to favor equities as we do not see any other assets that we like better than equities. We would not be surprised to see the market trade sideways or lower for the next few months as is typical for this time of year (see chart below).
“In the business world, the rearview mirror is always clearer than the windshield.”
- Warren Buffett
Investors remain puzzled by the buoyancy of the stock market in the face of a sluggish economy. After a very weak fourth quarter, consensus for Q1 2013 had bounced up to 3 percent growth, so that the first go around release of 2.5% disappointed economists. As a result focus moved to all the negatives that have been noted-weak southern Europe, slower France and Germany, questionable China, uncertain U.S. consumer spending and on and on.
What has been impressive is the U.S. companies’ ability to handle the sluggish revenue picture by delivering good bottom line results. Bellwether General Electric for example reported profit improvement of around 16% as against a very modest revenue increase. 52% of companies reporting so far have exceeded expectations. The explanation – cost cutting. Companies have done this by keeping their head count down and controlling capital spending. Of course this does little to help the effort to reduce unemployment. Dividend increases have been meaningful, as witnessed last week by Apple’s fifteen percent dividend boost.
We would proffer two other explanations for this good stock market – the extremely loose monetary policy by Mr. Bernanke, “don’t fight the Fed,” and the other adage, “don’t fight the tape.” One more explanation – rates on money markets and bonds offer little competition at their current levels. In this light climbing the wall of worry is more manageable.
“Expect the best. Prepare for the worst. Capitalize on what comes.”
- Zig Ziglar
Global growth concerns pressured the market last week. China reported that its first quarter GDP grew 7.7%, which was less than its expected growth of 8%. Coca-Cola and Johnson & Johnson provided some mid-week earnings support, but energy, homebuilding and commodity-related companies slumped. Lower precious metals and energy prices dragged down their respective industries, but did lay the groundwork for lower inflation and a longer-lived domestic industrial revival.
We are in the thick of earnings season, and the market is reacting in its typical schizophrenic fashion. Just over 100 of the S&P500 companies have reported. Although there have been several prominent misses [such as IBM], ~70% of reporting companies have “beaten” forecast results. Reported revenue is lagging, due to pressure on bank’s net-interest-margin, lower commodities prices and foreign exchange pressure from a stronger dollar.
In addition to earnings, economics and energy, the markets’ tone last week was impacted by the terrorist bombing during the Patriots-Day running of the Boston Marathon. Describing the personal tragedies is beyond the scope of this update, but our emergency response and investigative response was exemplary. The support of the citizenry was [and is] inspiring. Let’s observe a moment of silence and relive the scene in the Garden Wednesday evening as Rene Rancourt led the sold out audience in a unifying rendition of our National Anthem.
“America was not built on fear. America was built on courage, on imagination, and unbeatable determination to do the job at hand.”
-Harry S Truman