The major market indices finished the week little changed as concerns over the financial health of Europe and the potential for tighter monetary policy in China battled against signs the U.S. economy is on the mend. Investors also appeared to be generally cautious as they await the resolution on the extension of the Bush tax cuts.
Sovereign debt concerns: Déjà vu all over again
Concerns over the fate of Ireland, and in turn the eurozone, gripped the markets once again last week. After insisting for the past couple of weeks that no aide was needed, Irish officials succumbed to the growing pressure, and stated they would accept financial assistance from the European Union (EU) and International Monetary Fund (IMF).
While details of the bailout were still vague, the news of a deal led to a major rally in the global markets on Thursday. Investors remain -- although less so now -- concerned that a debt contagion could spread to other nations (Portugal, Greece, Spain) in the eurozone and put the monetary union in jeopardy.
The recent financial problems have mostly been focused on Ireland, a country that contributes less than 2% of the eurozone GDP. While the economic contribution from Ireland is minimal, the county's sovereign debt is held by many large financial institutions outside of the country, particularly in Germany, the United Kingdom and France. A default or failure of Ireland, for example, could have significant ramifications on the overall health of the global banking system and would likely shred investor confidence.
QE- 2 / Inflation concerns seem misguided
Criticism of the Federal Reserve's quantitative easing (QE) program hit a fever-pitch this past week as a growing chorus of critics remained skeptical of the program's ability to resuscitate the economy and the Fed's ability to keep inflationary pressures under wraps. Fed leaders were out in full force defending the program. New York Fed President William Dudley and Vice Chairman Janet Yellen both argued that the intention of the program was not to weaken the dollar (a major complaint by foreign officials) and that the Fed has the tools to stem an outbreak in inflation.
Chairman Ben Bernanke, who gave the keynote speech at the European Central Banks (ECB) meeting in Frankfurt, also continued to defend the actions. Mr. Bernanke noted that additional stimulus was warranted due to the feeble economic recovery and the subdued level of pricing. Mr. Bernanke assured that the Fed only wants inflation to trend to the 2% level -- no higher -- and that the Fed has the tools to tighten policy when appropriate.
Fears of a rampant rise in inflation appeared misguided following last week's reading on consumer prices. The U.S. Labor Department reported that the Consumer Price Index (CPI) during the month of October rose 0.2% while the core rate (which excludes food and energy) was flat for a third straight month. On a year-over-year basis, the CPI is up a very subdued 1.2% while the core rate has gained just 0.6%. The core rate, in fact, was at the lowest level since the beginning of 1958, when the Labor Department began keeping records.
While inflation tends to be a lagging indicator, we believe that with large amounts of slack in the economy, the high levels of unemployment, and stagnant turnover in money (velocity), inflation is likely to remain subdued for the foreseeable future.
Concerns over inflation in China are warranted
For the fifth time this year, China raised the level of reserves banks are required to keep on hand. The call for higher reserves is an effort to cool lending and in turn cap inflationary pressure. The action follows recent speculation that a rate hike by China's Central Bank is imminent after the country's inflation rose to a 4.4% annualized rate during the month of October. The 4.4% rate was well ahead of the country's goal of a 3% cap, and the highest level in more than two years.
While China's inflation rate is uncomfortably high, the make-up of the report is what really seems to be concerning Chinese officials. For example, food prices rose by a 10.1% annualized rate in October versus a 1.6% gain for non-food prices. In China, due to the low levels of household incomes, food accounts for the majority of most consumers' budgets (up to 70% in poorer regions of the country) and therefore stemming the rise in inflation will remain a top priority for the government.
The threat of tighter monetary policy in China weighed on global markets last week, as China is being looked to as the locomotive for global economic growth. A slowing of growth would likely have a ripple effect throughout world economies.
U.S. economy: The healing continues
Last week's economic statistics continued to hint that the U.S. economy remains on the mend. Highlights included the Conference Board's Index of Leading Indicators which rose for a fourth consecutive month, suggesting improving economic conditions in the months ahead.
The Philadelphia Fed Index, which is a barometer of manufacturing activity in the greater Philadelphia area, jumped to the highest level since the end of 2009. In addition to the strong headline number, the underlying components of the report -- new orders, shipments, employment -- all posted solid gains. The report likely hints at a solid uptick in the broader-based ISM Manufacturing report (due out on Dec.1).
Finally, the Labor Department reported that jobless claims for unemployment insurance continued to trend lower. The four-week moving average, which helps smooth the week-to-week volatility, fell to 443K, the lowest level in over two years. While claims are still elevated -- a dip below 400K is basically needed to help lower the overall rate of unemployment -- the trend generally remains encouraging.
Q3 earnings summary
Through Friday, 484 members of the S&P 500 have reported quarterly results, with overall earnings up 31% on a year-over-year basis. Excluding earnings from the financials sector -- which continues to benefit from easy year-over-year comparisons -- reported earnings are up a solid 25.1%. Of the companies that have reported, 70.6% have beaten analyst expectations while 20.1% have fallen short. The "beat" rate is significantly better than the historical 61% average.
Revenues are up 8.1% (9.4% when excluding financials) so far in the quarter. When all is said and done, third-quarter earnings for the S&P 500, according to Bloomberg data, are expected to rise 30.2%. If that growth rate is achieved, that would mark the fourth consecutive quarter of 20%-plus growth. Looking ahead, consensus expectations are currently forecast a 24.5% gain in fourth quarter earnings.
Looking ahead
The economic calendar is front-end loaded this week due to the Thanksgiving holiday in the United States on Thursday. Focal reports this week will be the Chicago Fed Index (Monday), the second revision to the third-quarter GDP and existing home sales (Tuesday), durable goods orders, jobless claims, personal income/spending, and new home sales (Wednesday). Third-quarter earnings reports continue to wind down as only nine members of the S&P 500 are scheduled to release results. The U.S. stock and bond markets will be closed on Thursday, and both are scheduled for an early close (1:00 ET for stocks, 2:00 ET for bonds) on Friday.
