Archives for September 2014

Why Do These Fed Decisions Matter? Weekly Update – September 29, 2014

Image courtesy of FreeDigitalPhotos.net/cuteimage

Image courtesy of
FreeDigitalPhotos.net/cuteimage

Markets lost ground last week, though a Friday rally on positive economic data helped trim losses. For the week, the S&P 500 lost 1.37%, the Dow dropped 0.96%, and the Nasdaq fell 1.48%.1

Last week, a lot of market focus was on the Fed. Following the Federal Open Market Committee on September 16th -17th, multiple Fed officials gave speeches outlining their opinions about how the Fed should handle raising interest rates and returning to normal monetary operations. Unsurprisingly, there are some definite differences of opinion amongst the Fed’s top experts.

The hawks: Monetary hawks generally prefer high interest rates because they fear the effects of high inflation more than they worry about weak economic growth. Prominent members of this camp, like Dallas Fed President Richard Fisher, believe that the Fed should start raising rates as early as Spring 2015.2

The doves: Doves tend to favor lower interest rates in order to boost economic growth; they believe that the negative effects of inflation are negligible in comparison with the benefit of increased economic activity. Prominent doves include Chicago Fed President Charles Evans, who favor keeping rates low until they can be certain the economy has enough momentum behind it. Folks in this camp seem to favor keeping rates low for much longer, possibly until 2016.3

Keep in mind that such disagreements are healthy, because there is a lot of room for interpretation of economic data and debate about the effects of economic policy. However, these splits mean that Fed chairwoman Janet Yellen must craft a careful compromise at the October FOMC meeting or risk making financial markets nervous.

Why do these Fed decisions matter? The Fed has held interest rates at rock bottom levels in order to encourage lending and stoke economic activity. Now that the economy is improving, the Fed is starting to think about inflation – which they like to keep below 2% (headline inflation). By slowly raising rates, the Fed plans to avoid the specter of high or unexpected inflation, which can negatively affect the economy by chipping away at buying power. If the Fed raises rates too soon, the economic recovery could falter. If rates are left low too long, inflation could spike.

For bond investors, rising interest rates will affect the market prices of the bonds in their portfolios. As interest rates rise, bond prices fall as new bonds paying higher rates come on to the market. As financial professionals, we spend a lot of time managing these issues for our clients so that they are prepared for rising rates.

Bottom line: We know higher interest rates are coming, we just don’t know when. The good news is that the economy is doing reasonably well and the signs point to continued growth this year.

The minor decline last week wasn’t unexpected. Markets have been trading at record highs and concerns about slowing growth in China and other threats to the global economy caused investors to hit pause ahead of the end of the quarter. Will the decline continue or will investors buy the dip? Hard to say. Looking ahead at the last week of the quarter, a lot of attention will be on the release of the September jobs report, which will hopefully underscore the labor markets improvements. However, a positive jobs report could be the evidence the Fed needs to move away from monetary stimulus, which could cause some market volatility. We’ll know more once we start to see a trickle of Q3 earnings reports and quarterly economic data.

 

ECONOMIC CALENDAR:

Monday: Personal Income and Outlays, Pending Home Sales Index, Dallas Fed Mfg. Survey

Tuesday: S&P Case-Shiller HPI, Chicago PMI, Consumer Confidence

Wednesday: Motor Vehicle Sales, ADP Employment Report, PMI Manufacturing Index,

ISM Mfg. Index, Construction Spending, EIA Petroleum Status Report

Thursday: Jobless Claims, Factory Orders

Friday: Employment Situation, International Trade, PMI Services Index, ISM Non-Mfg. Index

HEADLINES:

Q2 GDP estimate rises to 4.6%. The third estimate of second quarter economic growth was revised upward again, largely driven by greater business and personal consumption. These are excellent indicators for greater growth this year.4

Durable goods orders fall. After July’s surprise surge in aircraft orders, August orders for long-lasting manufactured goods fell. However, excluding the volatile transportation category, so-called core orders rebounded 0.7%, which is a healthy amount.5

Consumer sentiment measure reaches 14-month high. An index of consumer confidence reached the highest level seen since July 2013, also the second highest level in seven years. Americans feel more upbeat about economic growth and rising incomes, which could give consumer spending a needed boost.6

August new home sales swell. August sales of new single-family homes surged to their highest level in six years, supporting hopes that the housing market isn’t done growing yet. However, low supply levels will likely continue to stunt sales activity.7

Coming Up! Earnings, Elections, & the End of the Year. Weekly Update – September 22, 2014

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Image courtesy of jscreationzs at FreeDigitalPhotos.net

Markets regained steam last week, pushed higher by a reassuring Federal Reserve meeting and a referendum on Scottish independence. For the week, the S&P 500 gained 1.25%, the Dow grew 1.72%, reaching a new record, and the Nasdaq rose 0.27%.1

 

As was generally expected, the Federal Reserve voted to continue to taper its quantitative easing programs by another $10 billion per month.2 Digging a little deeper, meeting notes suggest that though the Fed believes the economy is still growing at a moderate pace, economists are still concerned about meager labor participation and growing income inequality. The official statement of the Fed’s meeting shed little light on the timeline for interest rate changes, but Dallas Fed President Richard Fisher stated that the Fed should start raising rates in spring 2015, not summer, as many analysts have predicted.3 It’s too soon to know how markets will react to a sooner-than-expected interest rate increase, especially since economic conditions between now and then may change.

 

The U.S. dollar has been on a tear over the last couple of months, making this the longest winning streak since 1973, and the return of a strong dollar has its share of winners and losers.4 A rising dollar helps fight inflation by making each dollar buy more in goods and services; it also makes it cheaper for Americans to buy imported goods. Since consumer spending makes up about 70% of economic activity, when consumers pocket extra money, it’s generally a win for the economy. On the other hand, a stronger dollar is hard on exporters of U.S. goods, and multinationals who depend on foreign demand are being hit with a one-two punch of stagnant demand from major trading partners in Europe and Asia plus a rising dollar, which further cuts into their sales.

 

So, is a rising dollar ultimately good for the U.S. economy? In the short run, it’ll probably be a net positive, since consumers are benefiting and will be able to spend more money. The long-term effects won’t be known for some time; but, generally speaking, as long as currency movements remain stable, financial markets should be able to adapt.5

 

The week ahead is packed with speeches by Fed insiders, which analysts will be mining for additional details after the Fed’s official statement last week. With the end of the quarter upon us, investors are also starting to turn their attention to earnings, mid-term elections, and positioning their portfolios for the end of the year. Could we still see a correction? Absolutely. While the equity environment is looking healthy and the economy is doing well, a deteriorating economic situation in Europe and China or geopolitical issues in Ukraine or the Middle East could definitely throw a wrench into the works.

 

 

ECONOMIC CALENDAR:

 

Monday: Existing Home Sales

Tuesday: PMI Manufacturing Index Flash

Wednesday: New Home Sales, EIA Petroleum Status Report

Thursday: Durable Goods Orders, Jobless Claims

Friday: GDP, Consumer Sentiment

 

Data as of 9/19/2014 1-Week Since 1/1/14 1-Year 5-Year 10-Year
Standard & Poor’s 500 1.25% 8.77% 16.72% 17.64% 7.81%
DOW 1.72% 4.24% 10.51% 15.19% 6.80%
NASDAQ 0.27% 9.65% 20.86% 22.95% 13.98%
U.S. Corporate Bond Index 0.17% 2.50% 3.51% 1.98% 0.83%
International 0.02% -0.76% 3.07% 3.88% 3.77%
Data as 9/19/2014 1 mo. 6 mo. 1 yr. 5 yr. 10 yr.
Treasury Yields (CMT) 0.01% 0.04% 0.11% 1.83% 2.59%

Notes: All index returns exclude reinvested dividends, and the 5-year and 10-year returns are annualized. Sources: Yahoo! Finance and Treasury.gov. International performance is represented by the MSCI EAFE Index. Corporate bond performance is represented by the DJCBP. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.

HEADLINES:

Factory activity falls in September. A key Federal Reserve indicator of manufacturing in the key mid-Atlantic region decelerated this month. The survey, covering factories in Delaware, eastern Pennsylvania, and southern New Jersey, is often seen as a bellwether for national trends.6

Jobless claims fall to lowest level since July. Weekly claims for new unemployment benefits unexpectedly fell to 280,000, putting the labor market back on trend for sustained improvement.7

Scotland votes “no” on independence. The E.U. weathered one of its first serious independence crises when a referendum on Scottish independence was defeated. While the vote was close and the issue may arise again, Scotland (and its valuable North Sea oilfields) will remain part of the U.K. and EU for now.8

Housing starts to drop dramatically. Groundbreaking activity on new homes dropped 14.4% in August, led by a slump in multifamily apartments and condos. As Americans have shied away from homeownership in favor of renting, builders have started work on more rental units, a more volatile category of housing growth.9

Markets Slide Before Key Fed Meeting Weekly Update – September 15, 2014

Image courtesy of FreeDigitalPhotos.net/Stuart Miles

Image courtesy of FreeDigitalPhotos.net/Stuart Miles

Markets closed last week on a down note – breaking five straight weeks of gains – as investors hedged their bets ahead of a pivotal Federal Reserve Open Market Committee Meeting. For the week, the S&P 500 lost 1.10%, the Dow dropped 0.87%, and the Nasdaq slid 0.33%.1

After weeks of great performance, markets finally hit pause as investors declined to push markets higher ahead of a big week. Fed decisions have driven a lot of market activity in recent months and the upcoming FOMC meeting is highly anticipated. Analysts are poised to leap on any hint of Fed economists’ thinking about the state of the economy and the return to normalized monetary policy.

What will the Fed be looking for? Overall, clues that the U.S. economy is still on the path to sustainable, broad-based growth. So much of what the FOMC does comes down to interpretation and reading the tea leaves; Fed economists are accustomed to delving deeply into the data and making judgments based on cloudy and uncertain data.

One of the biggest variables in the Fed’s evaluation of the economy is the labor market. So far, most indicators show that the labor economy is improving, albeit modestly.

The August jobs report was grim and showed that job creation slowed over the last three months. Worse, the labor force participation rate was a measly 62.8%, the lowest rate seen since the 1970s.2

However, fresh research by a group of Fed economists suggests that declines in labor force participation since the financial crisis – often attributed to discouraged Americans who drop their job searches – may actually be due to the natural aging of the U.S. workforce as boomers move into retirement.3 If true, this means that the Fed may be able to discard some of their concerns about discouraged workers.

Digging a little deeper, the number of job openings in the U.S. ticked down slightly in July, but is still close to a 13-year high. On the other hand, the pace of hiring hasn’t kept up with job openings, indicating that workers may be struggling to retool for new jobs or that employers may not be offering competitive wages.4 Unfortunately, these are not problems that the Fed can solve, but economists need to factor these issues into their thinking to ensure that they don’t take away the training wheels too soon.

There are a couple of decisions that could come out of the FOMC meeting. (1) The Fed could decide to continue steadily trimming back bond purchases as they have at every meeting since the taper began in December. This decision would keep us on track for an October finish. (2) If the economic oracles show that the economy is doing well, the Fed could decide to accelerate the pace of its taper, ending its quantitative easing programs ahead of schedule. While doing so would be a huge vote of confidence for the economy, markets might react badly to the news that the party is ending early. (3) If economic prospects look uncertain, the Fed could decide to pause its taper, keeping bond purchases going until the end of the year.

Whatever decision comes out of the meeting, investors can expect some volatility as markets adjust to the news. Investors will also want to gauge the expected effects of a fresh round of sanctions against Russia, which many analysts worry will dampen growth in Europe.5 All told, it’ll be an informative week and we’ll keep you posted.

 

ECONOMIC CALENDAR:

Monday: Empire State Mfg. Survey, Industrial Production

Tuesday: PPI-FD, Treasury International Capital

Wednesday: Consumer Price Index, Housing Market Index, EIA Petroleum Status Report, FOMC Meeting Announcement, FOMC Forecasts, Chair Press Conference 2:30 PM ET

Thursday: Housing Starts, Jobless Claims, Philadelphia Fed Survey

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HEADLINES:

Factory output in China drops. Chinese factory production growth fell to the lowest level in six years, stoking fears that the world’s second-largest economy might be cooling off. Weak readings in several other sectors increase the probability that China’s central bank may undertake additional stimulus.6

U.S. retail sales rise in August. Retail sales, which account for about one third of consumer spending, rose broadly last month. While retail sales levels are still below pre-recession numbers, this increase bodes well for future spending and economic growth.7

Consumer sentiment hits 14-month high. Friday’s report showed that U.S. consumer sentiment rose to the highest level in more than a year, as Americans felt more upbeat about economic conditions. Though Americans still worry about a labor slowdown, they are more optimistic about the future.8

Import prices decline. The cost of imports into the U.S. fell by the largest amount in nine months, largely due to a sudden decrease in petroleum prices. While this drop may be short-lived, lower import prices will help keep inflation down and cut Americans a break on imported products.9

Why Another Uptick in Spite of Bad News? Weekly Update – September 8, 2014

Image courtesy of FreeDigitalPhotos.net/Stuart Miles

Image courtesy of
FreeDigitalPhotos.net/Stuart Miles

Markets chalked up another win last week, pushing the S&P 500 to another record close. After several days of cautious trading, Friday’s August jobs report finally gave investors the push they needed to extend gains for a fifth week. For the week, the S&P 500 grew 0.22%, the Dow gained 0.23%, and the Nasdaq added 0.06%.1

Investors reacted with surprising relief to a disappointing August employment report that showed jobs growth braked to an eight month low. The data shows that payrolls increased by just 142,000, after expanding by over 200,000 in July. Data from June and July was also revised downward, tempering optimism about the labor market recovery. However, even though growth slowed, underlying trends show that slack in the labor market is still slowly being taken up.2 Another positive bit of news is that what jobs were created came from areas like business services, health care, and construction – areas where job seekers can potentially find high-paying, career-oriented jobs.3

Why the positive reaction to disappointing news? This is a case of bad news being treated like good news; investors have been chewing their nails in recent weeks over the possibility that the Federal Reserve could end quantitative easing and hike interest rates sooner than expected. A poor labor market showing takes away some of that risk, giving relieved investors some stimulus to rally.

In Europe, the European Central Bank (ECB) cut interest rates to the bone and announced a new plan to boost lending, neatly avoiding the discussion of whether to engage in a full-scale Fed-style quantitative easing program. If “QE-light” fails, the ECB may be forced to take on the debt of struggling states like Portugal and Spain to boost economic growth. Right now, the bank is counting on constituent governments to do their part by cutting taxes and engaging in economic reform.4 Will this be enough to boost Europe’s stagnant economy in the face of waning demand and economic sanctions against Russia? We won’t really know until next year.

The crisis in Ukraine continued last week, with Russians achieving control over the eastern half of the country, and Western leaders debating whether or not to take a more active military role in constraining Russian ambitions. While U.S. leaders are willing to show their displeasure through further sanctions, the European bloc, sensitive to their dependence on Russian energy, are more reluctant to act.5

The week ahead is slow on economic data until Friday, when analysts will get a look at retails sales, consumer sentiment, and business inventories, all important indicators of economic health. With investor sentiment so high, it’s quite possible that a bump in the road may cause stocks to temporarily turn downward in coming weeks as investors hit pause and take stock of their surroundings.

 

ECONOMIC CALENDAR:

 

Tuesday: JOLTS

Wednesday: EIA Petroleum Status Report

Thursday: Jobless Claims, Treasury Budget

Friday: Retail Sales, Import and Export Prices, Consumer Sentiment, Business Inventories

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HEADLINES:

Factory orders post record gains. Orders for goods from U.S. factories jumped 10.5% in July, driven by strong demand for aircraft and automobiles. Excluding the volatile transportation category, orders for manufactured goods are still on a modest upward trend.6

Fed Beige Book shows pickup in economic growth. The Federal Reserve’s anecdotal snapshot showed that the U.S. economy expanded at a moderate pace over the last six weeks, though its tone was more tempered than other government reports. Overall, the Fed believes economic growth is expanding at a moderate pace.7

Motor vehicle sales grew 6% in August. A strong Labor Day showing helped sales of light vehicles to grow significantly year-over-year, indicating that American consumers are feeling confident enough about their prospects to make big-ticket purchases. Overall, sales are expected to increase in coming months due to pent-up demand and improving employment conditions.8

Chain stores reported solid August sales growth, indicating that the back-to-school shopping season was solid. Though chain stores make up only 10% of retail sales, they are an important indicator of overall consumer spending trends.9

September 2014 Monthly Video Update

S&P 500 Tops 2,000-May Slow Down Weekly Update – September 2, 2014

Image courtesy of FreeDigitalPhotos.net/pakorn

Image courtesy of
FreeDigitalPhotos.net/pakorn

Despite volatility around geopolitical concerns and sluggish growth in Europe, U.S. stocks had a phenomenal week, lifting the S&P 500 to a new record close, and giving the index its best August performance since 2000.1 For the week, the S&P 500 picked up 0.75%, the Dow grew 0.57%, and the Nasdaq gained 0.92%.2

The Ukrainian crisis ratcheted up to a new level of tension as reports emerged that Russian forces have actively invaded eastern Ukraine and are engaging local forces. Although Russian and Ukrainian leaders met last week, the two sides appear more fiercely opposed than ever. It’s hard to know how Russia’s ambitions in the region will affect markets, but interruptions in gas supplies will not be good for Europe’s economy.3

Investors got their second look at Q2 Gross Domestic Product (GDP) numbers and cheered at the news that the economy grew 4.2% (upgraded from 4.0% in the initial estimate). Even better, growth appears to be broad-based and spread among multiple sectors of the economy.4 This result indicates that the economic recovery is entering a sustainable cycle of growth, where improvement in one area of the economy feeds growth in another. Let’s hope so.

Looking ahead, the first week of September is packed with important data. Friday’s August jobs report is especially critical because it could shed some light on the timing of the Federal Reserve’s interest rate hikes. Investors will also have their eyes glued to Thursday’s European Central Bank meeting, seeking a response to the EU’s stalled recovery and dwindling economic hopes.

Geopolitical concerns around Ukraine, Syria, and Iraq will also likely continue to dominate headlines, and volatility is to be expected. European leaders are considering a fresh round of sanctions against Russia, which may cause volatility as investors think about how sanctions may affect global growth.

All told, new record highs and low summer trading volume may transform into additional volatility and more activity in coming weeks. Depending on how these variables play out, a short-term pullback is also possible as investors take profits off the table. This is simply the nature of the investor sentiment pendulum that swings between optimism and pessimism, driving overall buying and selling activity. While we believe that additional upside may be possible this year, we caution our clients to expect periods of volatility as major events shift investor sentiment.

 

ECONOMIC CALENDAR:

 

Monday: U.S. Markets Closed for Labor Day Holiday

Tuesday: PMI Manufacturing Index, ISM Mfg. Index, Construction Spending

Wednesday: Motor Vehicle Sales, ADP Employment Report, Factory Orders, Beige Book

Thursday: International Trade, Jobless Claims, Productivity and Costs, ISM Non-Mfg. Index, EIA Petroleum Status Report

Friday: Personal Income and Outlays, Chicago PMI, Consumer Sentiment

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HEADLINES:

Personal income rises, but household spending falls. Personal income – defined as income from wages, investments, and other taxable sources – grew in July, following an increase in June. Despite the increase, Americans pared back their spending, preferring to bank their extra cash rather than go shopping. This reluctance could indicate a lack of confidence in their prospects.5

Consumer sentiment ticks upward. An August survey of consumer sentiment grew on the back of increased optimism about jobs and increasing wealth. However, most of the positivity was in the upper income segments, indicating that lower-income Americans may still be struggling.6

New home sales drop, again. July sales of newly built homes dropped for the third month in a row. On the other hand, new home sales were 12.3% higher than in July of 2013, indicating that momentum is still up over last year, which means that a turnaround is still possible.7

Durable goods orders soar. Orders for long-lasting manufactured goods skyrocketed by 22.6% in July. Though this is good news for the manufacturing sector, the surge was largely driven by a spike in volatile aircraft orders, meaning the underlying trend may soften next month.8