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. http://goo.gl/Ylu4k9]
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. http://www.investing.com/analysis/what-the-worst-jobs-report-of-the-year-really-tells-us-225722]
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. http://www.reuters.com/article/2014/09/12/us-usa-fed-workforce-idUSKBN0H62NF20140912] 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. http://abcnews.go.com/Business/wireStory/us-job-openings-13-year-high-hiring-rises-25376006] 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. http://www.cnbc.com/id/101997089] All told, it’ll be an informative week and we’ll keep you posted.
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
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. http://www.cnbc.com/id/101994640]
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. http://www.reuters.com/article/2014/09/12/us-retail-sales-idUSKBN0H71DF20140912]
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. http://www.reuters.com/article/2014/09/12/us-usa-economy-consumersentiment-idUSKBN0H71LR20140912]
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. http://www.reuters.com/article/2014/09/12/us-usa-economy-importprices-idUSKBN0H71EQ20140912]
Markets rallied strongly last week and closed at new records for the S&P 500 and Dow. Though stocks ran in circles early in the week, they picked up the pace after Wednesday’s reassuring Federal Open Market Committee (FOMC) meeting announcement. For the week, the S&P 500 gained 1.38%, the Dow grew 1.02%, and the Nasdaq added 1.33%.[1. http://goo.gl/UVAvcx]
There were no surprises from the Fed’s June Open Market Committee meeting. The FOMC announced another $10 billion cut to quantitative easing, lowering monthly bond purchases to $35 billion, and emphasized its commitment to data-driven decision-making with respect to future interest rate hikes. The Fed also released economic projections for the rest of the year, forecasting an unemployment rate of 6.0%-6.1% at the end of the year. On the down side, the Fed lowered expectations for annual Gross Domestic Product (GDP) growth, projecting that the economy will grow just 2.1%-2.2% this year.[2. http://wsj-us.econoday.com/byshoweventfull.asp?fid=464104&cust=wsj-us&year=2014&lid=0&prev=/byweek.asp#top] Investors counted the meeting as a win, reassured that the Fed is still willing to support markets.
Stocks jogged past more milestones last week, producing record highs for the S&P 500 and the Dow on Friday. Such performance naturally leads to the question: Is the bull market ending? By the calendar, you might think so. The average bull market lasts 62 months,[3. http://www.zacks.com/stock/news/125505/What-Comes-Next-as-the-Bull-Market-Turns-Five] and we passed that mark earlier this year, but there are several good reasons for why we aren’t looking for the end just yet:[4. Hat tip to Steve Reitmeister]
1) Economic growth is still moderate. Bull markets often end when the economy gets overheated and investors start worrying about the next recession. GDP growth is still below-trend, and current forecasts show that it probably won’t crack 3.0% until 2015.[5. http://wsj-us.econoday.com/byshoweventfull.asp?fid=464104&cust=wsj-us&year=2014&lid=0&prev=/byweek.asp#top] Future economic growth potential may give this bull market a second wind.
2) There’s still money on the sidelines. Many investors and corporations have piles of cash sitting around uninvested. When these stragglers finally start buying into the trend, the inflow of cash may send markets higher.
3) Plenty of bull markets last longer than 62 months. The one between 1987 and 2000 lasted roughly 150 months, and the rally between 1949 and 1956 lasted about 87 months.[6. http://www.bespokeinvest.com/thinkbig/2014/3/4/longest-and-strongest-bull-markets-updated.html]
Now, we can’t assume that markets will continue their upward progress indefinitely. As we discovered in the first few months of the year, declines do happen. One of the benefits of an active management strategy is that we can use these interruptions in the overall trend to cherry pick solid investments at attractive prices. Overall, we’re still cautiously optimistic about market performance going into the latter half of the year. We’ll know more about future prospects as Q2 economic data and earnings reports trickle in over the coming weeks.
Monday: PMI Manufacturing Index Flash, Existing Home Sales
Tuesday: S&P Case-Shiller HPI, New Home Sales, Consumer Confidence
Wednesday: Durable Goods Orders, GDP, EIA Petroleum Status Report
Thursday: Jobless Claims, Personal Income and Outlays
Friday: Consumer Sentiment
U.S. exports slump. America’s current account deficit – the difference between imports and exports – widened in the first quarter largely because the cold weather caused exports to pile up in port. Hopefully, stronger overseas demand will cause exports to pick up in the second quarter.[7. http://www.cnbc.com/id/101769170]
Weekly jobless claims fall. The number of Americans filing new claims for unemployment benefits fell more than expected last week, suggesting that labor market conditions continue to improve.[8. http://www.cnbc.com/id/101772587]
U.S. manufacturing production rises. Factory production rose significantly in May, supporting the belief that the sector is rebounding strongly after the first quarter slowdown. Since manufacturing contributes 12.5% to GDP growth, we can hope for a strong showing this quarter.[9. http://www.nam.org/Statistics-And-Data/Facts-About-Manufacturing/Landing.aspx , http://www.cnbc.com/id/101762241]
Oil prices rise on Iraq fears. The price of Brent crude oil rose above $113/barrel as the fighting in Iraq intensified and shut down the country’s biggest refinery. Though exports have not yet been affected, it’s likely that prices will continue to be affected as investors respond to disruption fears.[10. http://www.cnbc.com/id/101768270]