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American Hustle: U.S. Data Strengthen, Markets Remain Flat—Weekly Market Review

Jerry Webman, Ph.D., CFA

Chief Economist

Following a gangbuster 2013, U.S. stocks have not carried their exuberance forward thus far in 2014. The muted tone comes despite a steady influx of solid economic data, with a few notable exceptions, such as the December jobs report of two weeks ago. Last week brought strong reports on industrial production, retail sales, manufacturing, housing, employment and the federal deficit, but investors seemed unmoved. While it’s certainly possible that markets could be approaching a “pause that refreshes,” I believe the secular bull market is far from over.

Investors confront fears

The believers in the so-called “January effect” have thus far been disappointed, as the beginning of the year rush to buy equities has been muted. As for me, I put as much credence into the predictive power of the calendar as I do in the adage that the conference that wins the Super Bowl is able to forecast the year’s equity returns. To be honest, I can’t remember if as equity investors we want the AFC or the NFC to win the big game but I, for one, will be pulling for the Broncos if only for the morale of our Denver office. While a big January rally hasn’t transpired, neither has a big January sell off. Jason Trennert of Strategas Research Partners noted this week that, “an eerie calm has descended upon the canyons of Wall Street.” Year to date, the major U.S. indices have either posted modestly negative returns (S&P 500 Index) to less negative returns (Dow Jones Industrial Average) to even slightly positive returns (Nasdaq Composite Index). The CBOE Volatility Index (VIX) remains very low by historical standards while the CBOE Put/Call ratio suggests few are hedging their long equity positions.

Most prognosticators remain bullish on developed market (especially U.S.) stocks for 2014, but many are expecting a meaningful pullback, followed by additional gains. Commonly heard concerns include the fear that stocks have come too far without a 20% correction (the last one was in 2011); the fear that with the Fed in tapering mode, good economic news could actually be bad news if it led the Central Bank to become more hawkish; the related worry that interest rates could spike, hurting profits; and widespread angst over structural issues across many emerging markets.

A pullback at some point is certainly possible, and it may even prove helpful. I would note, however, that most valuation measures are not especially far above long-term average levels, and bull markets rarely end at average valuations. Indeed, signs of excess are few these days. Certainly, inflation is not yet a concern. And while we may not see a full-bore “great rotation” into equities from fixed income, many market participants have even begun to wade back into risk assets, after having retreated to cash and high quality bonds in the wake of the financial crisis.

The Fed, for its part, is highly likely to keep benchmark interest rates low for a long time, despite having pegged 6.5% unemployment as a threshold below which it could begin to consider tightening monetary policy (we’re now at 6.7%). Given the extent to which workers leaving the labor force have contributed to the fall in unemployment, I would expect the Fed to remain highly accommodative for a very long time. Clearly, there is a risk that U.S. Treasury yields will spike if markets come to believe that the economy is healing fast enough for the Fed to alter its stance, but I believe a self-correcting mechanism would come into play: Higher yields would slow growth, ultimately bringing yields back down.

U.S. data strengthen

Fourth-quarter growth was likely stronger than many thought, based on a litany of incoming data releases. Most of last week’s reports were quite positive. Small business optimism is back near its best levels of the recovery on better sales expectations, according to the National Federation of Independent Business. December earnings, planned capital expenditures, and hiring were also up. The news on consumers was more mixed, with retail sales excluding the volatile auto and gasoline categories rising a strong 0.6% in the last month of 2013—an important development given that consumer spending makes up roughly 70% of GDP. Unfortunately, consumer sentiment dropped between the end of December and the middle of January, according to a Reuter’s/University of Michigan survey. Very cold weather across much of the country may have played a role. On the employment front, initial claims for unemployment, data for which have been very “noisy” since the government shutdown (and because of the holidays), indicate moderate improvement. Separately, the Labor Department's Job Openings and Labor Turnover Survey (JOLTS) showed just over 4 million job openings at the end of November, continuing a steady upward trend that’s been in place since the summer of 2009.

Manufacturing has been humming along recently, and the trend continues. Industrial production saw another positive month in December, rising 0.3% (manufacturing alone rose 0.4%)—down from November’s unusually robust levels, but still positive. Two regional reports, the Empire State Manufacturing Survey and the Philadelphia Fed were also quite strong. Turning to the housing market, the Mortgage Bankers’ Association reports that falling mortgage rates have driven a surge in applications, including an 11.9% rise in the week ended January 10. Home builder confidence, meanwhile, has leveled off at an elevated pace, according to the National Association of Home Builders. Data on housing starts and permits to begin construction indicate a similar trend of continued improvement, but at a slower pace.

Earnings season kicks off

Fourth-quarter earnings season is underway, although it is still too early to come to any conclusions about how the numbers will shape up. 52 S&P 500 constituents have reported so far, with financial firms making up the greatest proportion of the reporting group. Among those, 74% have surpassed revenue expectations, and 68% have beaten earnings estimates. One of the largest companies in the index, Citigroup, disappointed investors, despite a 21% jump in earnings; poor results in fixed income, currency and commodity trading dented results, as did legal costs. Other financial giants echoed those themes, but, like Citigroup, several reported strong revenue from deal-making. As has been the case for many quarters now, companies across all industries face the challenge of growing revenue. Many companies quickly cut costs in the wake of the financial crisis, allowing them to preserve earnings growth to varying degrees. Now lean, they must find a way to grow earnings through increased sales. Modestly strong economic growth may provide a slight tailwind, but the biggest winners likely will be those that can build sales without crushing their profit margins





The S&P 500 Index is a market-capitalization weighted broad-based measure of domestic stock market performance.

The Dow Jones Industrial Average (DOW) is a price-weighted index of 30 large blue-chip stocks in the United States.

The NASDAQ Composite Index is a market-capitalization weighted index of 3,000 U.S. equities listed on the NASDAQ Stock exchange.

The CBOE Volatility index is designed to measure the volatility of the U.S. stock market by measuring implied volatility from outstanding puts and calls.

The CBOE Put/Call Ratio measures the outstanding ratio of puts to calls in the options market to imply hedging positions.

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