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If you feel like things are more expensive, you are right. Despite a slightly weaker than expected inflation report in April, this year, prices have accelerated faster than Fed officials anticipated just a few months ago. Last week we learned that headline inflation increased to a 14-month high of 2.5 percent from a year ago in April, due in large part to rising gas prices. Excluding food and energy the core rate increased by 2.1 percent.
Wouldn’t you hate it if you were to come upon a transcript of what you said, as you navigated a difficult time in your life? Now imagine what it would be like if that transcript was released publicly -- chances are, you would wish you could rewrite history. Alas and alack, without the ability to go back in time, you would be stuck with your mate or your dear friend saying, “Well, you did the best you could during a rough patch.” Those thoughts went through my head as I poured over the 2008 FOMC transcripts and then read all of the second-guessing by the financial press and various pundits. The bottom line is that not only was the Fed slow to realize the gathering storm in 2007 (In May 2007, Ben Bernanke said “We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system”), but when the once-in-a-generation storm made landfall in 2008, the Fed was caught flat-footed and “behind the curve,” according to Chairman Bernanke in January 2008.
For much of the spring and summer, some Fed officials thought the worst was over. In August, St Louis Fed President James Bullard said, “My sense is that the level of systemic risk associated with financial turmoil has fallen dramatically” and even Janet Yellen, who was prescient about the severity of the crisis earlier in the year and predicted recession before the NBER declared it so, momentarily took her eyes off the ball and worried unnecessarily about inflation.
OK, but that’s really cherry-picking the worst quotes from the year. (For the record, it appears that Boston Fed President Eric Rosengren may have been the most spot-on with his analysis of the crisis.) In the last third of the year, circumstances demanded swift and decisive action and Fed officials rose to the occasion by slashing interest rates, buying bonds and implementing a variety of strategies to prop up the US and global economies.
Spoiler alert: The best part of reading through the transcript was to discover that some central bankers actually have a sense of humor. Frederick Mishkin invoked Monty Python’s “Look on the Bright Side of Life,” Donald Kohn quipped “Anyone who thinks he or she understands what’s going on is either a lot smarter than I am or delusional — or both” and Janet Yellen provided a bit of Halloween humor during an October meeting, when she said: “We have had a witch’s brew of news. Sorry. The downward trajectory of economic data has been hair-raising — with employment, consumer sentiment, spending and orders for capital goods, and home building all contracting — and conditions in financial and credit markets have taken a ghastly turn for the worse.”
HAHAHAHAHAHA…those crazy Fed officials!
MARKETS: The quiet, holiday-shortened week was highlighted by two technology sector deals: the maker of Candy Crush Saga is going public and Facebook is paying $19 billion for WhatsApp.
THE WEEK AHEAD: As we enter the third year of the housing recovery, two reports on real estate prices are expected to confirm that increases are slowing down from last year’s brisk pace. But the old saying “location, location, location” may still hold. According to HSH.com, housing affordability varies dramatically across the country. For instance, you need an annual salary of about $20,000 to afford a median home in Cleveland, but you have to earn a whopping $115,000 if you are seeking a median-priced home in the San Francisco area.
Mon 2/24:
8:30 Chicago Fed National Activity Index
10:30 Dallas Fed Mfg Survey
Tues 2/25:
Home Depot, Macy’s, T-Mobile
9:00 Case Schiller Home Price Index
9:00 FHFA Home Price Index
10:00 Consumer Confidence
Weds 2/26:
JC Penney, Target
10:00 New Home Sales
Thurs 2/27:
Best Buy, Kohls, Sears
8:30 Weekly Jobless Claims
8:30 Durable Goods Orders
10:00 Fed Chair Janet Yellen testifies before the Senate Banking Committee
Fri 2/28:
Berkshire Hathaway
8:30 Q4 GDP – 2nd estimate (1st estimate=3.2%)
9:45 Chicago PMI
9:55 U Michigan Sentiment Index
10:00 Pending Home Sales
All eyes will be on the Federal Reserve this week, when the central bank concludes its last policy meeting of the Ben Bernanke era. (Janet Yellen will succeed Bernanke as leader of the central bank on February 1st.) Before launching into what will happen at the upcoming meeting, it’s worth considering Ben Bernanke’s legacy during his seven years as Chairman of the Federal Reserve. Bernanke presided over one of the most turbulent periods in U.S. economic history and reviews of his performance have varied. Critics note that Bernanke has been a modern-day money printer, who missed the implication and severity of the subprime crisis in 2007. Who can forget his May 2007 comment, “We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” Woops!
But Bernanke fans see him as the savior of the financial system. After recognizing the magnitude of the crisis, he rose to the occasion, according to Martin Wolf of the Financial Times. “Bernanke acted decisively and effectively, slashing interest rates and sustaining credit.” Once the worst of the crisis passed, Bernanke realized that political fighting in DC had made the Federal Reserve the economy’s best hope for recovery. He resorted to extreme measures to prod growth: maintaining short term interest rates at zero and purchasing bonds for the Federal Reserve’s portfolio.
The naysayers contend that although these actions have not yet created inflation, they will down the road. They also say that unwinding these policies under Janet Yellen will lead to destabilizing events across the globe-just take a look at the emerging markets in the last week alone!
How history judges Bernanke will depend in large part on what happens in the next group of years. As the legacy of the Bernanke era develops, there is no doubt that the man will be seen as one of the most important Fed Chairmen in the 100-year history of the central bank.
And now, the week ahead!
At the December FOMC meeting, Fed officials began the process of unwinding their bond-buying program by reducing purchases by $10 billion dollars to $75 billion. Many believe that with economic activity picking up, the Fed may announce another $10 billion dollar cut to $65 billion at this week’s meeting. Others say that the weaker than expected December jobs report may encourage the Fed to hold off until the March meeting.
In addition to the FOMC, the first estimate of fourth quarter growth is expected to show that the economy grew by an annualized pace of 3.3 percent, despite the government shutdown and unusually bad weather. If the consensus comes in on target, the result would be slower than the previous quarter’s 4.1 percent, stronger than the 2013 real (inflation-adjusted) growth of 2-2.25 percent; and equal to the 60-year average.
Just a few weeks ago, economists predicted that US growth in 2014 would finally match the historic norm. The boost would come from an accelerating jobs recovery, waning household debt burdens and the fading of sequestration’s fiscal drag. The combination would encourage consumers and businesses to spend more freely, creating a virtuous economic cycle. That line of thought came under scrutiny last week, after disappointing Chinese manufacturing data prompted a sharp sell off in global equities and emerging market currencies.
As the rosy growth picture dimmed, some worried that companies might err on the side of caution and restrain spending. According to Factset, total capital expenditure by the non-financial companies in the S&P 500 index is forecast to rise by just 1.2 per cent in the 12 months to October, despite the fact that those companies are sitting atop $2.8 trillion in cash. Of course, corporate plans can shift quickly. If sales and growth pick up more than expected, businesses may go on a mini-spending spree.
MARKETS: Just a week and a half ago, the S&P 500 reached a new all-time high. Last week, worries about slowing growth in China, an emerging market melt down (led by a potential currency crisis in Argentina and exacerbated by the eventual withdrawal of Fed stimulus), and weakness in some blue chip earnings, sent stocks lower. Investors may have forgotten the word volatility, but before we get too nutty, the S&P 500 is now off 3.1 percent from its all-time high on Jan 15th. The classic definition of a correction is a drop of 10 percent or more from the peak. Meanwhile, risk-averse investors piled into highly rated government bonds (US and Japanese).
THE WEEK AHEAD:
Mon 1/27:
AAPL, Caterpillar
10:00 New Home Sales
Tues 1/28:
AT&T, Ford, Pfizer, Yahoo
8:30 Durable Goods Orders
9:00 Case-Schiller Home Price Index
10:00 Consumer Confidence
Weds 1/29:
Boeing, Facebook
2:00 Fed Meeting announcement (no press conference)
Thurs 1/30:
3M, Altria, Amazon, Colgate, Exxon Mobil, Google, UPS, Visa
8:30 Weekly Jobless Claims
8:30 Q4 GDP (1st estimate)
10:00 Pending Home Sales
Fri 1/31:
Chevron, Master Card, Mattel
8:30 Personal Income and Spending
9:45 Chicago PMI
9:55 Consumer Sentiment
Sat 2/1:
Janet Yellen becomes Fed Chair, the first woman to do so
Sun 2/2:
A football game will be played in NJ
Ben Bernanke told Congress that despite a gradual improvement in the labor market, “the jobs situation is far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high.” Because the labor market is still so difficult, employers have been able to keep a lid on wage growth. According to the latest Mercer compensation survey, despite a strengthening economy, base salaries are expected to rise by only 2.9 percent in 2014, which is just a touch better than last year’s 2.8 percent and the previous two year’s 2.7 percent. Sure, that’s an improvement since the recession levels, when increases were averaging 2.1 percent, but it still lags the mid-2000s when annual increases averaged around 3.5 percent.
There is a bit of good news, though. If you are a top-performing employee (about 7 percent of the workforce), you may see a bigger increase. In 2013, the highest-performing employees received average base pay increases of 4.6 percent compared to 2.6 percent for average performers and 0.2 percent for the lowest performers.
Obviously, employers want to keep their top performers, so it may take some creativity on your part to get the much-needed boost in your paycheck. Here are some tips for how you can make your case -- I have used all of these at various times as both a boss and as an employee!
For the 26th time this year, the Dow finished at an all-time nominal closing record and the broader S&P 500 saw it’s 20th record close of the year. This year, stocks are up about 18 percent – an amazing performance, but (buzz-kill alert) we there is still quite a ways to go to reclaim new highs, when adjusted for inflation: the Dow has to rise above to 15,730 and the S&P 500 has an even steeper climb to over 2,000. Don’t even start to calculate the NASDAQ, which needs to add another 1425 points to get back to the nominal closing high. We all know that Ben Bernanke’s Federal Reserve is responsible for the lion’s share of the stock market’s move higher. Without low short-term interest rates (0 to 0.25 percent since December 2008) and $85 billion worth of monthly bond buying, it’s hard to build a case where stocks would be at these levels. That’s why all eyes have been on Bernanke over the past 8 weeks, as he has tried to explain under what circumstances the central bank would taper its bond purchases.
There will be another chance for a taper-tantrum this week, when Bernanke provides his semi-annual testimony to the House and Senate. That means you have a couple of days to force yourself to rebalance your investment accounts.
Remember that just because stock are up, does not make them safe. If you are the kind of person who simply cannot handle the ups and downs of the stock market, then your inclination is probably to avoid stocks at all costs. But what if you kept your stock allocation to a level where they gyrations didn’t cause you to lose sleep? Maybe a stock allocation of 10 to 20 percent of your portfolio would allow you partially participate over time, but not get your hat handed to you if/when the bottom falls out.
Even if new records don’t really mean too much, I am happy to use them as an opportunity to remind you to review where you stand, create a target allocation and force yourself to rebalance according to your goals.
Here's what smart money has known forever--the quicker you learn these rules, the better:
Don’t let your emotions rule your financial choices. There are two emotions that tend to overly influence our financial lives: fear and greed. At market tops, greed kicks in and we tend to assume too much risk. Conversely, when the bottom falls out, fear takes over and makes us want to sell everything and hide under the bed.
Maintain a diversified portfolio. One of the best ways to prevent the emotional swings that every investor faces is to create and adhere to a diversified portfolio that spreads out your risk across different asset classes, such as stocks, bonds, cash and commodities. (Owning 5 different stock funds does not qualify as a diversified portfolio!)
Avoid timing the market. Repeat after me: “Nobody can time the market. Nobody can time the market.” One of the big challenges of market timing is that requires you to make not one, but two lucky decisions: when to sell and when to buy back in.
Stop paying more fees than necessary. Why do investors consistently put themselves at a disadvantage by purchasing investments that carry hefty fees? Those who stick to no-commission index mutual funds start each year with a 1-2 percent advantage over those who invest in actively managed funds that carry a sales charge.
Limit big risks. If you are going to make a risky investment, such as purchasing a large position in a single stock or making an investment in a tiny company, only allocate the amount of money you are willing to lose, that is, an amount that will not really affect your financial life over the long term. Yes, there are people who invest in the next Google, but just in case things don’t work out, limit your exposure to a reasonable percentage (single digits!) of your net worth.
Ask for help. There are plenty of people who can manage their own financial lives, but there are also many cases where hiring a pro makes sense. Make sure that you know what services you are paying for and how your advisor is compensated. It’s best to hire a fee-only or fee-based advisor who adheres to the fiduciary standard, meaning he is required to act in your best interest. To find a fee-only advisor near you, go to NAPFA.org.
For those who want to protect their portfolios against the eventual rise in interest rates, you may be tempted to sell all of your bonds. But of course that would be market timing and you are not going to fall for that, are you? Here are alternatives to a wholesale dismissal of the fixed income asset class:
Lower your duration. This can be as easy as moving from a longer-term bond into a shorter one. Of course, when you go shorter, you will give up yield. It may be worth it for you to make a little less current income in exchange for diminished volatility in your portfolio.
Use corporate bonds. Corporate bonds are less sensitive to interest-rate risk than government bonds. This does not mean that corporate bonds will avoid losses in a rising interest rate environment, but the declines are usually less than those for Treasuries.
Explore floating rate notes. Floating rate loan funds invest in non-investment-grade bank loans whose coupons “float” based on the prevailing interest rate market, which allows them to reduce duration risk.
Keep extra cash on hand. Cash, the ultimate fixed asset, can provide you with a unique opportunity in a rising interest rate market: the ability to purchase higher yielding securities on your own timetable.
Let's start at the very beginningA very good place to start When you read you begin with A-B-C When you sing you begin with do-re-mi
- The Sound of Music (1959, music by Richard Rodgers, lyrics by Oscar Hammerstein II)
Investors used to think that starting at the very beginning meant examining corporate earnings. After all, buying stock in a company (or through a stock mutual fund) is a bet that the company will increase its ability to earn money over time. Yet there is ample proof that companies are having a harder time making money by selling more goods and services and have instead been relying more on cost containment and financial engineering to meet their earnings objectives.
S&P 500 corporate profits are expected to rise 2.9 percent in Q1 vs. a year earlier, according to analysts polled by Thomson Reuters, which would be a slowdown from 5.4 percent in Q1 and 6.2 percent in Q4. But those diminished earnings are coming on projected revenue growth of only 1.6 percent. “If companies are having a harder time making money, then why is the stock market rising?” asked a caller to my radio show recently. The answer to that question requires that we start at another beginning…or with Ben Bernanke.
In January, I jotted down 7 reasons why the stock market rally could extend well into 2013:
(1) (2) (3) The Federal Reserve is maintaining its low interest-rate policies (including the monthly purchase of $85 billion worth of bonds) until employment improves substantially
(4) Japanese officials have started to address the country’s multi-decade economic stagnation
(5) Europe is no longer on the precipice of disaster
(6) The much-feared hard landing in China never came to fruition
(7) U.S. housing is finally contributing to economic growth
You get the joke…Ben Bernanke’s Federal Reserve is responsible for the lion’s share of the stock market move. Without easy monetary policy in place, all of the other factors would not have boosted stocks to the levels that we are seeing now. Last September, the Fed launched its current round of bond buying (QE3) and also said that it would maintain low short-term interest rates until mid-2015. The announcement and the subsequent December pledge to keep the program open-ended sparked a rally in global equities.
Everything was honky dory until May 22nd, when during Congressional testimony, Bernanke raised the prospect that the central bank could downshift from its accommodative policies, if economic data were to improve. The subsequent 7½ weeks were volatile for every asset class, with most (bonds, gold, emerging stocks) heading lower. The exception has been the U.S. stock market -- the S&P 500 and Dow Jones Industrial Average tumbled about 7 percent from their intraday record highs in June, before recouping all of those losses and recording a new nominal closing high by the close of trading on Friday.
If the boomerang stock market started its journey with Bernanke’s comments, it makes sense that markets would return home after another Bernanke speech. In it, the Chairman underscored that the central bank would continue to pursue highly accommodative policies for the “foreseeable future,” due to a weak labor market and low inflation. This time, investors took Bernanke at his word.
This week’s key event puts Ben Bernanke back on the hot seat for his semi-annual testimony to the House on Wednesday and to the Senate on Thursday. It is expected that the Chairman will draw a distinction between tapering bond buying, which is likely to begin at either the September or December Fed meeting, if all goes well in the economy; and raising interest rates, which is not likely to occur until 2015. Bernanke and company will have a lot more data to chew on between now and the September 17-18 FOMC meeting, including two more employment reports.
Markets: The risk-on trade was ON…at least for another week. For the 25th time this year, the Dow closed at an all-time closing record. The S&P 500 hit its 19th record close of the year, and the NASDAQ hit its highest closing price since September 2000.
THE WEEK AHEAD: Bernanke’s testimony and earnings season will dominate. Readings on Retail Sales are likely to show an increase, due to a spike in energy prices and consumer inflation at the core level should remain tame.
Mon 7/15:
Citigroup
China GDP
The trial of former Goldman Sachs employee Fabrice “Fab” Tourre begins. He is charged with misleading investors in a mortgage deal begins
8:30 Retail Sales
8:30 Empire State Manufacturing Survey
10:00 Business Inventories
Tues 7/16:
Goldman Sachs, Coca-Cola, Yahoo
8:30 CPI
9:15 Industrial Production
10:00 Housing Market Index
Weds 7/17:
American Express, Bank of America, BNY/Mellon, eBay, IBM, Intel
8:30 Housing Starts
10:00 Ben Bernanke testifies before House
2:00 Fed Beige Book
Thurs 7/18
Capital One, Google, Morgan Stanley, Verizon, Microsoft
8:30 Weekly Jobless Claims
10:00 Ben Bernanke testifies before Senate
10:00 Philadelphia Fed Survey
10:00 Leading Indicators
Fri 7/19:
GE, Honeywell, Schlumberger
The Labor Department said the U.S. economy created 195,000 jobs in June and the unemployment rate remained at 7.6 percent. There was something for everyone in the report. Optimists focused on the fact that employment is trending higher. The previous two months were revised up, bringing total monthly job creation to just over 200,000 this year, ahead of last year’s pace of 175,000. And although the unemployment rate remained steady, it did so by absorbing 177,000 new workers into the workforce. Pessimists will underscore that there are still 11.8 million Americans out of work and the quality of many of the jobs was weak, with 75,000 new positions coming from low paying jobs in the leisure and hospitality industry. As far as the rate holding steady, pessimists note that a slew of part-time workers (360,000), many of whom would likely prefer full-time employment, boosted the workforce. As a result, the broad unemployment rate (unemployed, disgruntled and part time workers who would prefer full-time) jumped from 13.8 percent to 14.3 percent in June.
On a low-volume day, the optimists won the day, interpreting the report as proof that the economy was improving, but not by so much that the Fed would alter policy before its September meeting. Stocks gained ground, but the bond market was less convinced as 10-year treasury prices slumped and yields increased to 2.72 percent, the highest level in almost two years.
Is this what the rest of the year is going to be like? Since May 22nd, after Fed Chairman Ben Bernanke testified before Congress and raised the prospect that the central bank could downshift from its accommodative policies if economic data were to improve, investors have been throwing a “Taper Tizzy.” Every day is highlighted by the question, “When and by how much will the central bank taper its bond buying?”
This week, the Fed-funk is likely to continue, after the release of the minutes from the last policy meeting. You might recall that was the meeting after which Chairman Ben Bernanke attempted to soothe investors with more details about the conditions under which the Fed would take its foot off the gas. Instead of the intended calming effect, Bernanke inflamed the situation and volatility spiked across all asset classes.
Taking the Fed at its word, we know that the exit strategy is a work in progress, which will be driven by economic data. Capital Economics sees five stages of the Fed’s exit plans. From an investor perspective, these stages might seem to match Elisabeth Kübler-Ross’ “Five Stages of Grief”:
(1) Taper monthly asset purchases this fall (DENIAL)
(2) End bond purchases completely by mid-year 2014 (ANGER)
(3) Modify forward guidance language included in FOMC policy statement (BARGAINING)
(4) Raise short-term interest rates in 2015 (DEPRESSION)
(5) Begin to sell Fed’s holdings of Treasuries starting in 2017 (ACCEPTANCE)
Regardless of the exact timing and staging, these steps will occur and the quicker investors adapt and accept them, the better off they will be.
For those who were getting sick and tired of the constant Federal Reserve naval-gazing, there is something new to agitate raw nerves: geopolitical risk. In the two years since the Arab Spring, there hasn’t been much discussion of geopolitical risk, which is loosely defined as the risk that an investment's returns could suffer as a result of instability in a country, due to a change in government, legislative bodies, other foreign policy makers, or military control. The situation in Egypt has all of the components necessary to qualify and has already pushed up crude oil prices -- NYMEX crude breached $100 per barrel for the first time in over a year. Thankfully, those increases have not translated to higher prices at the pump yet.
As a reminder, Egypt is not a major oil producer and has been a net oil consumer of oil since 2008. However, its control of the Suez Canal and its proximity to large Middle East oil exporters puts investors on alert whenever there is political unrest. Approximately 2.5 million of barrels of crude oil pass through the Suez Canal or the Suez-Mediterranean (SUMED) pipeline each day. Any disruption to the flow of oil could have ripple effects throughout the region.
Markets: In a holiday-shortened week, stocks benefited from a surprise announcement from across the pond. For the first time, both the Bank of England and the European Central Bank provided investors with forward guidance. Both central banks will maintain their aggressive policies for an extended period.
THE WEEK AHEAD: Q2 earnings season kicks off this week. S&P Capital IQ predicts earnings to increase by 2.9 percent from the same period a year ago and for the full year to rise by 6.3 percent from 2012.
Mon 7/8:
Alcoa
3:00 Consumer Credit
Tues 7/9:
7:30 NFIB Small Business Optimism Index
Weds 7/10:
2:00 FOMC Minutes
4:10 Ben Bernanke delivers speech commemorating 100th anniversary of the Federal Reserve
Thurs 7/11
Bank of Japan rate decision
8:30 Weekly Jobless Claims
8:30 Import/Export Prices
Fri 7/12:
JP Morgan Chase, Wells Fargo
8:30 Producer Price Index
9:55 Consumer Sentiment
The first 6 months of the year is in the books, so it’s a perfect time to check in on the U.S. economy’s progress thus far, and to look ahead to the second-half of 2013. Economic growth: Recovery from the Great Recession has been sub-par (the post World War II growth rate for the U.S. is 3-3.5 percent), with growth averaging about 2 percent since 2010. Q1 growth was revised down to 1.8 percent from 2.4 percent and Q2 is expected to be similar to Q1, due to the lingering effects of sequestration. But economists believe that activity should pick up towards the end of the year and that total growth for 2013 will be between 2 and 2.5 percent. The pace of growth is due to accelerate to 3 percent next year, but this seems like a long way off.
Jobs: 5 months into the year job growth has been good, not great. The economy has added an average of 192,000 non-farm positions per month in 2013, ahead of the 175,000 monthly pace seen in the previous two years; and the unemployment rate has edged lower to 7.6 percent from 7.8 percent in December. Still, there are 11.8 million Americans out of work, 4.4 million of whom have been unemployed for more than 6 months. So while layoffs have tapered off, economic growth has been too weak to spur widespread hiring. Most economists predict that June job creation will be approximately 150,000 – 160,000, due to recent softness in manufacturing data.
Housing: Housing is finally recovering from the abyss. Sales have increased and prices have made great advances, though from low levels. The recent Case-Schiller house price index showed increases of 12 percent from a year ago, but housing experts note that double-digit advances are not sustainable, especially as mortgage rates have spiked and sellers will likely to return to the market in greater numbers. The slow down should not be read as another leg down in the housing market, but a new phase in which growth is normalized.
Consumers: The first half of the year has been pretty good for consumers. Americans' debt obligations have eased as a percentage of their disposable income, household net worth has surpassed its 2007 peak and consumer confidence shot up to the highest level since 2008. Still, incomes have remained mired at similar levels to where they were 10 years ago. But for tame inflation, stagnant wage growth would be a bigger concern.
Federal Reserve: We can divide Q2 into two periods: before May 22nd, which I propose we call “BB” or “Before Bernanke” and after May 22nd, which can be referred to “AB”, or “After Bernanke”.
More on bonds: Historically, the yield of the 10-year runs 1.5 to 2 percentage points higher than the inflation rate, which would suggest yields should be closer to 3 percent, even higher than the current 2.5 percent. While the move in bonds has probably been more violent than the Fed would have expected, the central bank would like to see both stocks and bonds return to more normal pricing. For those worried that the recent rise in long-term interest rates will derail the recovery, it is worth remembering that when the bond market plummeted in 1994 and yields surged, the subsequent five years saw unusually strong economic growth and large gains in stock markets.
What to expect in the second half of the year: Market volatility is likely to remain elevated, as each economic report will be parsed through the lens of “What will the Fed think about this report?” Global markets have become dependent on the Fed's unprecedented accommodative policy, including its monthly purchase of $85 billion worth of bonds (QE3). Due to the unusual nature of the Fed’s stimulus plans, it is difficult to draw on previous periods to help predict how the change in policy will impact the economy and markets. The very fact that we have not been here before is creating investor uncertainty, which is why the anticipated shift in Fed policy will likely remain the chief investment concern for the balance of the year.
Markets: June was the first losing month of the year for stocks, but all three major averages logged their third winning quarter in four and remain solidly ahead for the year. The Dow has seen its strongest first half of the year since 1999 and the S&P 500’s first half performance is its best since 1998. Volumes could be light this week due to the Independence Day holiday, but there will be plenty of action on the calendar, including policy committee meetings by the Bank of England and the European Central Bank, and the monthly jobs report in the U.S.
THE WEEK AHEAD:
Mon 7/1:
8:58 PMI Manufacturing Index
10:00 ISM Mfg Index
10:00 Construction Spending
Tues 7/2:
Motor Vehicle Sales
10:00 Factory Orders
Weds 7/3:
7:30 Challenger Job-Cut Report
8:15 ADP Employment Report
8:30 International Trade
1:00 US markets close early for Independence Day
Thurs 7/4: US MARKETS CLOSED FOR INDEPENDENCE DAY
Bank of England and ECB rate decisions
Fri 7/5:
8:30 Employment Report
8:30 Weekly Jobless Claims
I thought about this 2003 Roz Chast cartoon “Worry Tank,” as global markets collapsed in the aftermath of the Federal Reserve policy meeting and the Chairman’s subsequent news conference. It’s as if we are all worried that the economy is actually stronger than we thought - gasp! As a result, the Fed should be able to stop spiking the punchbowl later this year and eventually, it will remove the punchbowl altogether, and we will somehow learn to muddle through on our own. Poor Bernanke: Even when he’s trying to tell everyone that the economy is improving and Fed stimulus will eventually not be necessary to boost growth, asset values crater.
There is an irony in the timing of the market’s first 2013 convulsion and the Fed’s upgraded view: It comes on the four-year anniversary of the end of the recession. The Business Cycle Dating Committee of the National Bureau of Economic Research “Determined that a trough in business activity occurred in the U.S. economy in June 2009.” The 18-month recession that began in December 2007 was the longest of any recession since World War II.
Of course it wasn’t really the end: The ensuing four years have been highlighted by a slow and painful recovery, during which job losses continued, housing prices kept dropping and every step forward was met with at least two steps back. Even today, it’s hard to feel upbeat about an economy that will likely grow by about 2.5 percent this year and still has 11.8 million people out of work.
The Fed acknowledges that things aren’t all rosy, but four years into the recovery, the FOMC “sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.” Progress, right? Not exactly, according to the reaction of global markets. After learning more details about how the central bank would taper its bond buying and the conditions under which a change in policy might occur, investors freaked out by selling stocks, bonds, commodities and just about anything else where a bid existed.
Was the sell-off an overreaction? Maybe not; after all, but for the Fed’s open-ended bond buying program launched last September, risk assets like stocks likely would not have soared to their recent highs and 10-year bond yields, which dropped to 1.62 percent in early May, would likely have been higher, according Scott Minerd, global chief investment officer at Guggenheim Partners. He recently noted that Fed buying had badly distorted the bond market and that “The yield on 10-year Treasuries would be roughly 150 basis points higher than it is today” without the Fed’s actions. (This comment was made prior to last week's pop in yields.) An improving economy plus the eventual exit of the Fed from the market may mean that the sell-off in bonds this week (the steepest weekly selloff in price and jump in yields in a decade) was warranted. As noted last week, a healthy economy should be able to manage a steady and expected rise in yields, versus a steep and a surprise one.
Mark Spindel founder and Chief Investment Officer of Potomac River Capital LLC in Washington, DC says without QE3, “The economy would be in worse shape than it is today. Unemployment would be higher - and inflation, which was already low and falling, would have been even lower and we may have even seen deflation.” That would obviously be an ugly backdrop for stocks, so in Spindel’s mind “QE3 has been responsible for almost the entire move higher in the equities market since last fall.” If he is correct, then the Fed’s policies may have delivered what was promised and we should quit complaining about a 5 percent drop from the recent highs.
Going forward, the ability of the stocks to recoup whatever is lost during this period will hinge on growth. If the economy can manage to power ahead, despite the lingering effects of sequestration and higher bond yields, then companies will make money and stocks will rise. If the economy slows, it may mean that the Fed keeps policy as is, which may not provide stocks with the same boost that we just saw, due to investor fear over “the Fed’s next move.”
Markets:
THE WEEK AHEAD: It will be a fairly active week on the economic calendar, highlighted by regional manufacturing surveys, durable goods orders, personal income/spending and updates on housing. The third and final reading of first-quarter growth is expected to remain at 2.4 percent.
Mon 6/24:
8:30 Chicago Fed Manufacturing Survey
10:30 Dallas Fed Manufacturing Survey
Tues 6/25:
8:30 Durable Goods Orders
9:00 FHFA House Price Index
9:00 S&P Case-Shiller House Price Index
10:00 New Home Sales
10:00 Consumer Confidence
10:00 Richmond Fed Manufacturing Survey
Weds 6/26:
8:30 Q1 GDP
8:30 Corporate Profits
Thurs 6/27:
8:30 Weekly Jobless Claims
8:30 Personal Income and Spending
10:00 Pending Home Sales Index
10:00 Kansas City Fed Manufacturing Survey
Fri 6/28:
8:30 Chicago PMI
9:55 Consumer Sentiment
