This latest stock market pullback has provided an unwelcome reminder that stocks do not always go up in a straight line. Even within powerful bull markets such as this one, pullbacks of 5 – 10% have been quite common and
do not mean the bull market is nearing an end. In this week’s commentary,
we attempt to put the pullback into perspective. We look beyond this latest
bout of volatility and share our thoughts on the current bull market, compare
it with prior bull markets at this stage, and discuss why we do not think it’s
coming to an end.
Pullbacks Don’t Mean the End of the Bull Market
Pullbacks such as this one, which has reached 5%, have been normal.
Sometimes stocks get ahead of themselves. When they do, investor concerns
can be magnified and profit taking might take stocks down more than might be
justified by the fundamental news. We see this latest pullback as normal within
the context of an ongoing and powerful bull market and do not see its causes
(European and Chinese growth concerns, the rise of Islamic State militants,
Ebola, the Russia-Ukraine conflict, etc.) as justifying something much bigger.
The S&P 500 has now experienced 19 pullbacks during this 5.5-year-old bull
market, during which the index has risen by 182% (cumulative return of 217%
including dividends). The 1990s bull market included 13 pullbacks; there were
12 during the 2002 – 2007 bull market. At an average of three to four pullbacks
per year, we are in-line with history [Figure 1]. We understand the nervousness
out there, but what we have just experienced looks pretty normal at this point.
When volatility has been so low for so long, normal volatility does not feel..
Read Full Report here Weekly Market Commentary 10132014
Grading on a Curve (the Yield Curve, That Is)
Kids are back in school and have started taking tests. Some of those tests
are graded on a curve, meaning that students are graded based on their
score relative to the rest of the class. In terms of stock market indicators,
one that gets an A+ and ranks at the top of its class is another type of
curve — the yield curve. In fact, this indicator receives a perfect score (seven
for seven) in signaling recessions over the past 50 years.
The goal for all investors is to find indicators to help anticipate big down
moves, and the yield curve has been about as good as it gets on that
score. One of the Five Forecasters featured in our Mid-Year Outlook 2014:
The Investor’s Almanac Field Notes, the yield curve passes the test as
an indicator that has consistently signaled increasing fragility of the U.S.
economy and a transition to the late stage of the economic cycle, an
oncoming recession, and ensuing market downturn.
Many market participants have become worried (if not obsessed) about
Read Full Report here Weekly Market Commentary 09292014
The most recent figures on gross domestic product (GDP) — the broadest
measure of economic activity — revealed that residential investment (a.k.a.
housing) grew at an 8.8% annualized pace between the first and second
quarters of 2014. As a result, housing contributed 0.3 percentage points to the
overall 4.6% gain in GDP in Q2. It was the first time since Q3 2013 that housing
added to GDP growth; but it marked the 12th quarter of the last 15, dating back
to late 2010, that housing has made a positive contribution to GDP. Prior to
that, between late 2005 and late 2010, housing had been a drag on the overall
economy in 17 of the 20 quarters (or five years), as the economy endured the
housing-induced Great Recession and its aftermath [Figure 1]…
Read Full Report here Weekly Economic Commentary 09292014
MIND THE GAP
On September 17, 2014, the Federal Reserve’s (Fed) policymaking arm, the Federal Open Market Committee (FOMC), met for the sixth time this year. On the one hand, the FOMC surprised markets by announcing “how” it would exit from quantitative easing (QE) and reduce the size of its balance sheet in the coming years. On the other hand, the FOMC calmed markets by not making any substantive changes to its forward guidance to the public and financial markets on when it would begin raising rates.
The statement released after the meeting once again said that the FOMC
would keep rates low for a “considerable time” after QE ends. However,
the new set of economic and rate forecasts by FOMC members indicated
an earlier start to rate hikes than the forecasts made at the conclusion of
the June 2014 FOMC meeting and a slightly steeper path for the fed funds
rate once rate hikes commenced. Some market participants — ourselves
included — thought that perhaps the FOMC would switch to a more
explicitly data-dependent approach (how quickly the economy is growing,
where the unemployment rate is, what the inflation rate is, etc.). The FOMC,
however, decided to strike a more balanced tone, and Fed Chair Janet Yellen
repeatedly stressed in her post-FOMC meeting press conference that…
Read Full Report here Weekly Economic Commentary 09222014
Don’t Fight the Fed ECB? (Part 2 of 2) There have been a lot of bad movie sequels. Remember Ghostbusters II? Grease 2? Blues Brothers 2000? In the case of this Weekly Market Commentary, “Don’t Fight the Fed ECB? (Part 2 of 2),” we hope you find the sequel at least as good as the original, perhaps something closer to The Godfather: Part II than The Godfather: Part III.
Last week we answered the question of whether the latest bold stimulus measures by the European Central Bank (ECB) are a buy signal for European equities. We highlighted key differences between buying Europe now and the United States several years ago during the start of the Federal Reserve’s (Fed) quantitative easing (QE) programs. The different pictures for growth, valuations, and corporate profits in Europe versus the United States lead us to conclude that we should take a broader view to evaluate the investment opportunity in Europe. To that end, this week we take a deeper dive into the investment opportunity in Europe and evaluate fundamentals, valuations, and technicals — none of which we find particularly compelling at this time.
Read Full Report here Weekly Market Commentary 09222014
Don’t Fight the Fed ECB? (Part 1 of 2)
The European Central Bank (ECB) announced bold stimulus measures,
including further cuts to key interest rates and an asset-backed securities
(ABS) purchase plan, on September 4, 2014. The moves are an
acknowledgment of the recent deterioration in the Eurozone economy and
increased deflation risk. This decision follows the historic move to negative
deposit rates initiated back in June of 2014. These measures are geared
toward spurring economic growth through easier access to cheaper credit
for businesses and households and toward driving prices higher to avoid
deflation. These moves may also continue to pressure the euro currency and
help boost European exports.
Is this move by the ECB a buy signal for European equities? To help
answer that question, we look back at how U.S. stocks reacted to our own
monetary stimulus through quantitative easing (QE). Although Europe
has not engaged in outright QE (where the ECB buys government bonds
directly), it may in the future. With essentially zero interest rates (or lower),
and the addition of bond purchases, these ECB moves are similar to the
Federal Reserve’s (Fed) moves.
Buying stocks after the various QE programs were announced by the
Federal Reserve was generally a profitable decision for investors, although
Read full report here Weekly Market Commentary 09152014
Fall FOMC Watch
On Tuesday, September 16 and Wednesday, September 17, 2014, the
Federal Reserve (Fed) will hold the sixth of its eight Federal Open Market Committee (FOMC) meetings of the year. This meeting will include a press conference by Fed Chair Janet Yellen and FOMC members’ forecasts for the economy, the timing of the first fed funds rate hike, and the level of the fed funds rate at the end of 2014, 2015, 2016, 2017, and in the long run. In recent years, markets have been conditioned to expect a greater possibility of policy changes at meetings accompanied by press conferences and new forecasts and, as a result, market participants have increased their odds that
the Fed will change “something” at this meeting.
Although we continue to expect the Fed will again cut the pace of its bond
purchase program (quantitative easing or QE) and remain on pace to exit QE
by the fourth quarter of 2014, the odds have increased in recent weeks that
the Fed will take some additional action. Arranged from most likely to least
likely (in our view), at this week’s meeting the Fed could:
Read full report here Weekly Economic Commentary 09152014
Is Congress Contemplating QE4?
This past Sunday marked the 45th anniversary of the Apollo 11 moon landing, when American astronauts Neil Armstrong and Buzz Aldrin became the first to set foot on the moon. If they had stayed there, what would their tax rate have been?
The number of U.S. corporations seeking a “tax inversion” seems to be soaring to the moon. An inversion is when a U.S. company acquires another based in a country that has a lower corporate tax rate and moves its tax jurisdiction to that country in order to pay a lower corporate tax rate on profits made outside the United States — profits made inside the United States are still taxed normally.
Read the Full Article…
Beige Book: Window on Main Street
Modest-to-Moderate Economic Growth Continues
The Beige Book is a qualitative assessment of the U.S. economy and each of the 12 Federal Reserve (Fed) Districts. We believe the Beige Book is best interpreted quantitatively by measuring how the descriptors change over time. The latest edition of the Fed Beige Book, released last Wednesday, July 16, 2014, ahead of the July 29 – 30, 2014 Federal Open Market Committee (FOMC) meeting, once again described the economy as increasing at either a “modest” or “moderate” pace, noting that “labor market conditions improved” but that “several Districts continued to report some difficulty finding workers for skilled positions.” Aside from higher wages to attract talent for these skilled positions, the Beige Book noted that “wage pressures remained modest in most Districts” and that “price pressures were generally contained.” The modest-to-moderate description of the overall economy has now been used in the last 10 Beige Books, and in 11 of the past 12 dating back to March 2013.
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Counting Down the Months
After five-and-a-half years of keeping short-term rates in a range of 0 – 0.25%, many market participants believe the Federal Reserve (Fed) is now about 12 months away from hiking interest rates. This may affect markets in the months and quarters ahead as investors begin to brace for a change in policy.
Over the five-and-a-half years since the Fed took the federal funds rate down to a range of 0 – 0.25% on December 16, 2008, participants in the fed funds futures market have had varying views on when the Fed may begin to raise rates for the first time. Figure 1 shows the number of months until the fed funds futures yield will move above the 0 – 0.25% range priced into the futures market at the end of each month. Figure 1 also shows the 10-year Treasury yield (shown with an inverted scale), revealing how in sync long-term bond yields have been with the outlook for short-term rate moves by the Fed.
With the participants in the futures market pricing in the first rate hike at 12 months away, 10-year Treasury yields should be between 2.5% and 3.0%, based on the past five-and-a-half year relationship between them. The 10-year yield is at the low end of that range now. However, if this relationship persists and the year ends with market participants still thinking the Fed will hike rates in July 2015, the 10-year yield may end this year in a range of 3.0 – 3.5%. Of course, the markets have been wrong repeatedly over the past five years on how soon the Fed may hike rates.
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