The major market indices finished higher for a fourth consecutive week on fading concerns over the durability of the global economic recovery, the announcement that the U.S. recession officially ended in June, and the growing likelihood of additional stimulus measures by the Federal Reserve.
On a month-to-date basis, the S&P has tacked on more than 9% while the NASDAQ has added over 12%. As mentioned in prior editions of the Weekly Viewpoint, the investment community has generally been positioned for a sharp slowdown in economic growth (a "double dip"). However, with the recent improvement in economic data, coupled with the pending close to the third quarter, investors appear to be rotating back into the equity markets. Anecdotally, it appears that traders now believe the bigger risk is to be out of the market versus in it.
While September has historically been the worst month of the year for market performance, the sharp decline in August may have pulled the negative performance forward. In addition, with the economy on the mend and the growing potential for a market-friendly outcome to the mid-term elections in the U.S., the risk/reward ratio may have tipped back in favour for stocks.
FOMC meeting
Last week the Federal Open Market Committee (FOMC) gathered for its sixth meeting of the year. While it was a foregone conclusion that interest rate policy would remain at a standstill, the area of interest for investors was the content and tone of the after-meeting communiqué. The statement hinted at lower forward growth assumptions (official estimates will be released at the conclusion of the November 2 and 3 meeting) and rising concerns over the muted level of pricing pressure. The Fed said that "inflation is likely to remain subdued for some time before rising to levels the committee considers consistent with its mandate."
As a refresher, the Federal Reserve operates under a dual mandate: full employment and price stability. The mention of the mandate--a rare occurrence for the Fed--likely sets the groundwork for additional stimulus efforts. The most likely scenario will be for the Fed to try and "reflate" prices by pushing liquidity into the market through the purchase of Treasury securities. This effort should also result in lower borrowing costs and eventually a pickup in borrowing/lending activity. The minutes from Tuesday's FOMC meeting will be released on Oct. 12 and should shed further light into the Fed's thinking.
Recession is over?
The National Bureau of Economic Research (NBER) officially announced that the recession in the U.S. that began in December 2007 ended during June 2009. The announcement was met with high levels of skepticism likely reflecting the 9.6% rate of unemployment. The NBER, in knowing that the current economy remains wobbly, stated that "in determining that a trough occurred in June 2009, the committee did not conclude that the economic conditions since then have been favourable or that the economy has returned to operating at normal capacity." In other words, the economy stopped shrinking last June but growth remains sub-par.
The recession numbered 18 months, the second longest in history after the 43-month contraction during the Great Depression. The timing seemed to be a little suspect and almost appeared to be a politically motivated. Interestingly, neither party embraced the announcement and instead viewed it as a political hot potato.
Housing data
Last week saw a plethora of housing-related data creating a general impression that while things in the housing sector are not getting much worse, they also don't appear to be getting any better. The housing market's sideways slog along the bottom is discouraging in light of record low mortgage rates and the downdraft in housing prices.
The fact that near-record affordability can't jumpstart the housing market underscores the notion that the real problem is one of confidence. Until the overall economy shows signs of a durable recovery and the labour markets strengthen, this traditional avenue of growth will likely remain a headwind.
Tax cuts on hold
Last week, the debate over whether to extend the Bush tax cuts was pushed to the back burner by the Democratic Party and a vote will not likely occur until after the mid-term elections. With that said there is growing speculation that politicians are becoming more open to extending the tax cuts for all wage earners for at least one year with a rising probability that the middle-class brackets (under $200K for single filers and $250K for families) could see a permanent extension.
The growing risk is that Congress fails to reach an agreement after the Nov. 2 elections which would result in an across-the-board tax increase come Jan. 1, 2011. This is likely an outcome neither political party would want to deal with; therefore, we believe an agreement will likely be reached before year-end.
Economic data: Less bad, but still not great
Last week, several economic reports showed the U.S. economy remains in recovery mode, albeit at a snail's pace. Despite the lack of economic vigour, the level of growth continues to be just enough to dampen concerns over the economy falling back (double dip) into recession. For example, The Conference Board's Leading Indicators report--which is structured to gauge economic activity in the upcoming three- to six-month period--rose 0.3%, suggesting muted economic growth.
On a more upbeat note was the Durable Goods Order report for August. The headline number declined on the month (-1.3%) as a result of a sharp contraction in the transportation sector. However, orders jumped 2.0% when the volatile transportation component was excluded. Importantly, the non-defence capital goods ex-aircraft (i.e. "core" orders)--a proxy for business-related spending--rose a very strong 4.1%, the third gain in four months. Core orders are up 22.2% on a year-over-year basis. Offsetting the positive data points were the higher-than-expected uptick in weekly jobless claims and the lacklustre housing data.
Quarterly confessionals
From a seasonal perspective, we are in the midst of what is often referred to as the quarterly confessional period. This occurs in the weeks ahead of the official kick-off to earnings season and is typically a time when companies indicate how earnings are tracking relative to analysts' expectations. Since the beginning of September, Bloomberg data indicates that 26 companies have issued upside guidance while 23 have lowered guidance--an inconclusive tally at this stage, although lower guidance by a handful of high-profile companies has created a slightly negative tone. Overall S&P 500 earnings in the quarter are forecast to grow 23.5% on a year-over-year basis. This would mark the third consecutive quarter of 20%-plus growth.
Looking ahead
With the kick-off to third-quarter earnings season still a couple weeks away the focus will remain on the economic calendar and earnings guidance. On the economic front, the calendar will be back-loaded with Friday carrying the bulk of the load. Investors will keep a close eye on the personal income and spending data as well as the ISM Manufacturing report and construction spending.
Also of interest will be Tuesday's update on consumer confidence from The Conference Board. Trading this week may be choppy as Thursday marks the end of the third quarter.
