The major market indices finished mostly lower for the first time in five weeks. The losses were mild and likely reflected profit taking in light of the strong gains in September, as well as portfolio jockeying associated with the ending of the third quarter.
Q3 review:
Thursday marked the end of the third quarter. After a disastrous second quarter, the major market indices snapped backed and posted strong gains. The rally in the quarter appeared to be a reflection of fading concerns over the durability of the U.S. economic recovery accompanied by a pledge from the Federal Reserve (the "Fed") to commit more stimulus if the recovery were to falter.
The S&P 500 Index gained 10.7% during the quarter, with the bulk of the performance coming from the 8.8% rally in September. September's performance was the best since 1939, when the S&P added over 14%. The rally in the quarter was global in nature with the MSCI World Index gaining 13.8%. Sector performance was dominated by the Telecom sector (+19.1%), which likely benefited from its rich dividend yield and attractive valuation.
U.S. stock gains during the third quarter accounted for a $1.34 trillion increase in shareholder wealth. Globally, shareholder wealth increased by $6.5 trillion in the quarter. Historically, there has been a high correlation between stock price performance and holiday sales. The recent gains in the market coupled with the growing likelihood of additional quantitative easing and an outside chance the Bush tax cuts will be extended after the midterm elections may set the stage for a solid holiday season.
Seasonal trends turning positive
While the near-record gains in September may lead to questions over historic seasonal patterns (i.e. September is typically the worst-performing month of the year), seasonality is likely to remain in focus, as fourth-quarter performance has historically been the best quarter of the year. According to research provider Strategas, since 1928, the S&P 500 has advanced by an average 2.4%, besting the 2.2% second-quarter average.
Fed officials telegraphing lower growth assumptions
Several Federal Reserve officials were on the speaking circuit last week, and the common theme among them was lower GDP growth expectations for 2011. While the estimates varied among the different Fed officials, the projections generally centered around the 3% range. The Federal Reserve releases its official central tendency forecasts on a quarterly basis, with the next update due at the two-day (Nov. 2 and 3) FOMC meeting. The last update was presented at the July FOMC meeting and projected 2011 GDP in a range of 3.5% to 4.2%.
While most private forecasters deemed the July forecasts as very aggressive, the general lack of progress in the broader economy seems to be resulting in the regional Fed presidents "telegraphing" to investors that lower assumptions are forthcoming. To wit, Minneapolis Fed President Narayana Kocherlakota--speaking in London--lowered his forecast for 2011 GDP growth to 2.5% from 3%. Meanwhile, Boston Fed President Eric Rosengren said 2011 growth is likely to come in at 3% to 3.5%, but downside risks exist.
What was also interesting in recent Fed rhetoric was the general lack of consensus about the need/effectiveness of additional quantitative easing. Regardless of the posturing, there is a very high likelihood that the Fed will initiate additional quantitative easing before year end, with a high probability of a move at the Nov. 3 FOMC meeting.
The mention of the Fed's mandate--full employment and stable prices--at the most recent FOMC meeting coupled with the expected downward revisions to the central tendency forecast, likely set the groundwork for these additional stimulus efforts. The mostly likely scenario will be for the Fed to try and "reflate" the economy by pushing liquidity into the market through the purchase of Treasury securities. This effort should result in lower borrowing costs and eventually a pickup in borrowing and mortgage refinancing activity. The minutes from the Sept. 21 FOMC meeting will be released on Oct. 12 and should shed further light into the Fed's thinking.
As an aside, the Street's heavy focus on further quantitative easing (QE) is becoming somewhat worrisome, as investors may be setting themselves up for disappointment. It almost appears that most investors feel that QE will be the silver bullet to jumpstart the flagging economy whereas, in contrast, Fed officials have been hesitant to opine on the effectiveness of further stimulus. In addition, if we take QE for what it is, in other words the Fed providing additional stimulus to try and prop up a weak/deteriorating economy, then at least in my eyes, the action at best is bittersweet and provides further confirmation of just how bad things are. We also have to keep in mind that the first round of quantitative easing, while likely limiting the level of damage, arguably did little to prime the economic pump.
Economic data remains skewed toward "less bad"
Last week's batch of economic data had a mildly positive tone, if for nothing more than the data being less bad than in recent months. The recent stabilization of the economic data has for the most part ended concerns of the economy falling back into a recession (a double dip).
Jobless claims, one of the timeliest reports on the health of the labour markets, declined to 453K in the week ended Sept. 25. The four-week moving average--which helps smooth the week-to-week volatility--fell to 458K, marking the fifth straight weekly decline and the lowest level since late-July. While the progress is encouraging, claims still need to fall to the sub-400K area to bring down the unemployment rate.
Meanwhile, the Commerce Department reported that the final revision to the second-quarter GDP came in at 1.7%. The results were slightly better than the 1.6% gain expected by economists.
Importantly, personal consumption was revised to 2.2% from the earlier estimate of 2.0%. This was followed by better-than-expected readings on Friday for August personal spending and personal income.
The health of the U.S. manufacturing sector, however, remains in flux. While the broad Institute for Supply Management (ISM) Manufacturing Index came in at 54.4 in September (readings above 50 signal expansion), recent regional manufacturing reports have been spotty and may be a precursor to lower future readings on the ISM Index.
On the global front, a report on Friday showing a better-than-expected reading on China's manufacturing sector bolstered confidence in regards to the global economy. China continues to be looked at as the engine of global growth and this report helped soothe recent worries over the state of the Chinese economy.
Looking ahead
The focal point in the week ahead will be Friday's employment situation report for September. Consensus expectations, according to Bloomberg, are for the unemployment rate to rise to 9.7% (from 9.6%) while nonfarm payrolls are expected to be unchanged. Private payrolls, which filter out the distortions from government hiring/firing, are expected to expand by 78K. Since the beginning of the year, private payrolls have expanded by roughly 75K per month. Other highlights during the week will be the ISM Services Index, pending home sales, and the kick-off to third quarter earnings season on Thursday when Dow-component Alcoa reports. Overall S&P 500 earnings in the quarter are forecast to grow 23.4% on a year-over-year basis. This would mark the third consecutive quarter of 20%-plus growth.
