Politics, Corporate Earnings and the Fed
October 17, 2016
Stocks continued their October slide last week, with the Russell 2000 declining 1.94% and the S&P 500 slipping 0.95%. The strong dollar acted as an additional headwind for overseas markets, with EAFE down 1.39% and EM declining 1.93%. The 10 year Treasury yield increased from 1.73% to 1.80% last week as a hawkish tone in September’s FOMC meeting minutes pushed rates higher.
The markets were weighed down by a strengthening dollar and increasing long term interest rates. A stronger dollar and rising rates negatively affects corporate earnings which are already expected to be languid as they are reported over the next few weeks. J. P. Morgan Chase, Citigroup and Wells Fargo reported and modestly beat earnings expectations, however, year-over-year net income declined and a possible slowdown in commercial lending activity surfaced. Wells Fargo’s profit fell 2.6% amid the fallout of the sales –tactics scandal.
With less than one month away from the U S Presidential election, the polarized political views are, and will continue to be, a drag on the financial markets. In addition, there is concern that government bond yields will continue to rise across developed markets reflecting better economic data and less accommodative monetary policy. With enough positive economic data being reported, the Fed will more than likely raise rates by 0.25% in December.
This week’s calendar will be very active, with another presidential debate set for Wednesday. A slew of corporate earnings announcements and the consumer price index, housing indices, and jobless claims will also be reported.
“I’m not an old, experienced hand at politics. But I am now seasoned enough to have learned that the hardest thing about any political campaign is how to win without proving that you are unworthy of winning.” – Adlai E. Stevenson
Employment Data Keeps the FED on Track
October 10, 2016
Most equity indices traded lower last week continuing a narrow trading range it has navigated for the last couple of months. Economic data for the week included the following: ISM Manufacturing index came in at 51.4 showing an improvement from August’s reading of 49.4; U.S. Department of Commerce reported that construction spending dipped 0.7% for the month of August … missing consensus of 0.2% increase; Labor Department reported that US economy added 156,000 jobs in September (missing of estimates of 170,000) with unemployment ticking up to 5.0% … misleading as more people have reentered the labor market and are now looking for jobs.
For the week, the DJIA closed the week at 18240 for a weekly decline of 0.31%. The broader-based S&P 500 finished at 2154 for a weekly loss of 0.60%. Smaller US companies representing the Russell 2000 finished the week lower by 1.18% while international markets were mixed with the MSCI EAFE and MSCI EM finishing (0.77%) and 1.29% respectively. Rates moved higher last week with the 10yr US Treasury closing at a yield of 1.73% … up from 1.56% the week prior.
Recent economic data would indicate a December rate hike from the FOMC is probably the base case for the markets at this point. Minutes from the last Fed meeting will be released on Wednesday and should shed some light on the Fed’s next move. Fed funds futures are pricing in roughly a 72% chance of hiking rates in December.
Be on the lookout for 3rd quarter earnings announcements which begin on Tuesday with the report from Alcoa. Many big banks are due to report on Friday with earnings releases from Citigroup, JPMorgan and Wells Fargo.
“You can never cross the ocean until you have the courage to lose sight of the shore.” – Christopher Columbus
The Market is Currently Dodging the Shoals
October 3, 2016
The markets finished the quarter on an up-note, with domestic equities advancing 20bps for the week and ~3% for the quarter. Deutsche Bank concerns [a proposed $14B fine threatened its balance sheet] produced a 6.7% decline on Thursday, but CEO assurances combined with a reduction of the fine to ~$5.5B produced a substantial Friday relief rally.
OPEC also made news last week by announcing a reduction in its output, which boosted crude prices by an additional 8% over three days [prices are up 30% YTD after briefly falling below $30 in February {a 13-yr low}]. However, remember that ~0.5M bbl/day is not that big, OPEC often fails to comply with its promised production cuts, and that OPEC is no longer the marginal producer [and its MS is down to 42%].
Finally, although it gives us no pleasure to throw cold water on a popular, bipartisan campaign promise, Phil Gramm’s warning about “The Subprime Superhighway” is a needed dose of reality. He points out that most developed economies are fully leveraged [debt at 85% to 100% of GDP] and that the rate of return on public infrastructure spending is much lower than previously promised. In the past, politicians have raided private savings [recall the Community Reinvestment Act] to fulfill their grandiose promises. The EU is starting to repeat this wrong-headed funding approach, and the US seems to be not far behind. Let’s hope that cooler heads prevail.
“No really great man ever thought himself so” – William Hazlitt
Fed Stays on Hold
September 26, 2016
Financial markets rallied on the news that the Fed decided to leave rates on hold at last week’s policy meeting … at least for the time being. Any chance of a rate increase won’t come until the FOMC gathers for their December policy meeting with the decision of course being data dependent. Equities ultimately finished the week higher with the DJIA and the S&P 500 up 0.76% and 1.2% respectively. International stocks responded positively with the MSCI EAFE index rising 3.15% while emerging markets finished higher by 3.65%. Fixed income also finished the week positive as the yield on the 10 year U. S. Treasury dropped from 1.7% to 1.62%.
This week look for economic reports on durable goods and the 3rd revision to second quarter GDP which is expected to come in at 1.3%. Interestingly, the Fed now only sees long term rates reaching 2.88% vs a prior estimate of 3.0%. This lower projection indicates that the Fed likely believes that the growth rate for the economy is lower than previously thought.
Next month, corporations will begin reporting earnings for the 3rd quarter and expectations are for a decline of 2.3% according to FactSet, which would mark the 6th consecutive quarterly decline. The 3rd quarter was supposed to be when earnings growth returned … lets hope the analysts are wrong. The energy sector will likely be the largest culprit with an expected drop of 66%. On the positive side, revenue growth is expected to be positive.
“Education is the most powerful weapon which can use to change the world.” – Nelson Mandela
Commentary (9/19/16) – Volatility Returns
September 19, 2016
After trading for nearly 50 days without a move of +/- 1%, the S&P 500 saw moves of greater than 1% four times in the past six days. Seasonality (August/September/October tend to be more volatile than other months) along with chatter from various Fed Governors contributed to the market volatility. Weak retail sales numbers (first decline in five months) combined with tepid industrial production numbers (-0.4% m/m) more-or-less cemented the feeling among investors that the Fed would remain on hold for their September meeting.
For the week, the DJIA finished higher by 0.25% while the broader-based S&P500 gained 0.59%. Interestingly, the S&P 500 is at roughly the same level that it reached in July 2015 (i.e., little overall movement in the S&P 500 average in over 14 months). International markets were weaker as the EAFE Index lost 2.48% for the week while emerging markets gave up 2.59%. Fixed income, represented by the Barclays Aggregate, finished the week slightly lower by 0.11%. As a result, the 10 YR US Treasury closed at a yield of 1.70% (up 3 bps from the previous week’s closing yield of 1.67%). Gold fell by $24.50 to close at $1,306.20/oz. Oil prices trended a bit lower on the week to close at $43.03/bbl … the International Energy Agency released their September report highlighting a slowdown in the growth of global demand (we see oil prices between $40 – $50 per barrel until at least year-end).
We expect volatility to remain high as investors digest conflicting economic and political news in the week ahead. All eyes will be on the Federal Reserve’s Wednesday meeting and rate announcement. We expect the Fed to remain on hold, but Fed comments will likely point to a December rate hike (of course, being data dependent). As always, we plan to look through the day-to-day news and focus on longer-term objectives.
How ‘bout those Sox!
Enjoy the last few days summer …
“Don’t watch the clock; do what it does. Keep going.” – Sam Levenson
The Bear Growls
September 12, 2016
The S&P 500 closed out the week on a sour note as it fell 2.45% on Friday, mostly a result of hawkish comments by Fed officials. For the week, the DJIA fell 2.15% while the broader-based S&P 500 closed down 2.38%. International equities were mixed with the MSCI EAFE off slightly (-0.13%) for the week while the MSCI EM closed higher by 1.12%. Bonds closed the week in the red as yields backed up across the board on “Fed talk”. The 10Yr Treasury closed the week at a yield of 1.67%, 20 bps higher than the week before.
Eric Rosengren, the Boston Fed President and a voting member on the Fed’s interest rate setting board, said that low interest rates are increasing the chance of overheating the U S economy. Gradual tightening monetary policy is appropriate to maintaining full employment, he added. Fed officials will meet on Sept 20-21 to decide on interest rates, and the quiet period when the Fed will not speak begins tomorrow.
One of the tell-tale signs of a bullish stock market is sector rotation where money-flows move from one industry sector to another, but not out of the market itself. Last week money flowed out of stocks and into money market funds. The sectors most hit were the so called defensive stocks – utilities, telecoms, and consumer staples, which are a little disconcerting, and energy shares amid a decline in crude oil futures. We expect a bouncy ride until the Fed meeting and let reasonable asset allocations and global diversification carry the day.
“Better to keep quiet and only let people think you’re an idiot than to speak up and confirm it.” – Rodney Dangerfield
Rate Hike Likely on Hold
September 6, 2016
Equity indices moved higher last week as the calendar turned to fall. For the week, the S&P 500 and DJIA finished higher by 0.56% and 0.61% respectively, with financial stocks leading the charge. Smaller US companies representing the Russell 2000 finished the week up 1.15%. International equities were mixed with the MSCI EAFE up 0.48% and MSCI EM down 0.10%. Although yields gravitated higher earlier in the week on hawkish statements from FOMC chair Janet Yellen, they ultimately finished the week roughly where they started after a lighter-than-expected jobs report on Friday.
On Monday, the Commerce Department reported personal consumption expenditures (PCE) rose 0.3% in July, marking the 4th straight month of increases. Consumer spending continues to show signs of strength, otherwise offsetting the weak manufacturing sector. Consumer spending remains the most important aspect of economic strength with roughly 2/3 of US economic activity directly related to it. Perhaps industries will begin to try and build inventories to meet demand, which would in turn help manufacturing and continue to support job growth. Also in the report, the PCE price index was (Fed’s preferred inflation measure) was flat in July and only up 0.8% compared to 12 months prior. This is well under the Fed’s desired target of 2% and has been for more than four years.
On Friday, the Department of Labor reported that U.S. employers added 151,000 jobs in August, below expectations of an 181,000 increase. Revisions for June and July were negligible as an increase in June’s number was offset by a reduction in July’s. For the past three months, the US has added a very solid 232,000 jobs per month. The jobless rate held steady at 4.9%, while the U6, a broader measure commonly referred to as “underemployment” is also holding steady at 9.7%.
The jobs report is notable in that it is the last significant report before the FOMC is scheduled to hold their September meeting. While the numbers weren’t bad, the report didn’t have the blowout numbers needed to nudge the doves off the fence and raise rates. The decision to do that was likely pushed back to December when they will have additional data to help support that decision.
Enjoy the Fall and Go Pats!
“A dream doesn’t become reality through magic; it takes sweat, determination and hard work.” – Colin Powell
Spending Restraint Evaporates
August 29, 2016
The large-cap markets took a breather last week, with the S&P 500 declining 0.67%, while the smaller-cap Nasdaq 100 only fell 0.37% and the Russell 2000 was able to advance by 0.11%. The Jackson Hole monetary commentary produced some late-week market volatility. Futures markets increased the probability of September [36% chance of an increase] and December [64%] Fed Funds increases, but the Fed won’t increase rates ahead of the presidential election. It has become clear that global economic conditions are key to Fed decisions, not US economic data reports.
On the fiscal front, the Federal government is ramping up spending far faster than tax revenues, producing the inevitable increase in the deficit. The Congressional Budget Office now forecasts that Fiscal 2016 federal spending will increase by $178 B while tax revenue [due to lackluster GDP growth] will increase by only $26 B, thus increasing the deficit to $590B [from $438B last year].
Putting this in perspective, debt held by the public will be back up to 76.6% of GDP, the highest since 1950, when the US was repaying the enormous cost of World War 2! Even more disturbing, as the following chart shows, current projections call for this burden to exceed 80% by ~2022. This is a lot, even for a reserve-currency country.
Past needn’t be prologue, but it will take uncommon resolve by the next administration to improve these trends.
“History is a gallery of pictures in which there are few originals and many copies” – Alexis de Tocqueville
Fed Watch
August 23, 2016
Last week most equity markets advanced modestly as the S&P 500, the DJIA, and the NASDAQ were up .06%, .02%, and .16%, respectively. The utility and telecom sectors were the worst performers for the week as investors took profits in the two sectors which have been the best performers YTD. Interest rates rose slightly for the week with the yield on the 10 year U.S. Treasury going from 1.51% to 1.58%. International stocks were mixed, the EAFE declined by .58% but emerging markets rose .08%.
This week is a quiet one on the earnings and the economic front with reports on durable goods , existing home sales, and the second revision to the 2nd quarter GDP number. The second quarter earnings season is basically wrapped up and earnings for the S&P 500 index are expected to fall 2.1% compared to a year ago. This would mark the fourth quarterly earnings drop in a row. Much of the drop is due to the energy sector and lower oil prices, however, 5 of the 10 sectors in the S&P 500 will post declines as companies have struggled to increase sales in the face of slow global growth. The big news this week may be Fed chair Janet Yellen’s speech from the meeting in Jackson Hole as investors hope to get a reading on when the Fed will raise interest rates.
“I learned that courage was not the absence of fear, but the triumph over it. The brave man is not he who does not feel afraid, but he who conquers that fear.” – Nelson Mandela
Election Anxiety … almost over!
October 24, 2016
The presidential campaign (among two of the most unpopular candidates in modern politics) remains ugly and nasty. The good news is that the election is just over two weeks away. Markets and recent polling seem to agree that Hillary Clinton will be the next president. The country’s currently polarized political backdrop will likely continue as the White House and at least one house of Congress will be divided. The good news – history shows that markets can do quite well during divided governments. Both parties will be incented to move forward with fiscal policies that are somewhat incremental and not sweeping (markets despise absolute power and uncertainty). No matter who wins the White House, workers around the world will show up for work the next day with a singular focus to do the very best that they can for their companies and shareholders.
For the week, the DJIA finished higher by 0.09% while the broader-based S&P500 gained 0.41%. International markets were stronger as the EAFE Index advanced 0.49% for the week while emerging markets jumped 1.59%. Fixed income, represented by the Barclays Aggregate, finished the week slightly higher by 0.33%. As a result, the 10 YR US Treasury closed at a yield of 1.74% (down 6 bps from the previous week’s closing yield of 1.80%). Gold gained $12.80 to close at $1,265.90/oz. Oil prices were relatively flat (up $0.10) on the week to close at $50.85/bbl.
Expect a slew of earnings this week from S&P 500 companies. So far, earnings are beating expectations by 7% with just over 25% of companies reporting. Revenues are up by 1% … a nice uptick from recent negative sales trends. Perhaps this quarter will mark the end of the earnings recession … just maybe. Along with earnings, economic releases this week include new home sales, durable goods, jobless claims and GDP.
As always, we plan to look through the day-to-day news and focus on longer-term objectives.
Enjoy the fall season …
“If opportunity doesn’t knock, build a door.” – Milton Berle