Look Past the D.C. Drama— Weekly Market Review
Last Friday, Google celebrated its 15th birthday. As part of its celebrations, the internet juggernaut offered users a chance to use the site as it appeared back in 1998 (ages ago in Internet time), when it was just an unknown search engine with a funny name. What famously started off as a project by two Stanford grad students in a Menlo Park garage has gone on, of course, to become a great American success story, and a potent reminder of the kind of amazing innovation the U.S. is still capable of producing. If you need another reminder, take a look at some of the fascinating projects in the arts and sciences that this year’s MacArthur “genius” Fellowship winners—also announced last week—are working on.
What a contrast with the shenanigans we’re seeing in Washington, D.C. these days. If our private sector is still exceptionally fertile ground for creativity and productivity, high profile parts of our public sector certainly seem to be wanting in those qualities. Events in Congress are now moving quickly, and a detailed recap in this space would be out of date within hours. For a basic outline of the issues at hand, I would direct you to my blog post from last week instead.
Here, I’d simply note that policymaking in the U.S. is rarely elegant, and despite all the bluster over the past few years, Congress has made some incremental but substantial progress in addressing key questions over taxation, spending and the budget deficit in recent years. Together, the Budget Control Act, the American Taxpayer Relief Act and the sequester purport to deliver close to $4 trillion in deficit reduction and stabilize the debt-to-GDP ratio over the next 10 years.
I’d also reiterate that dismay with one’s government is not an investment strategy. While it’s too early to say exactly how the current showdowns in Congress over federal spending and the debt ceiling will play out, I fully expect that, ultimately, a new spending bill will pass and that Congress will raise the debt ceiling. The biggest question in my mind is how much uncertainty markets will have to endure before the final act of this drama. We’ve seen U.S. Treasury credit default swap (CDS) spreads—in effect, the cost of insuring against a default—rise sharply as the showdown has gathered pace, but they remain far below the levels seen at the peak of the 2011 debt ceiling crisis and even farther below those seen in September 2008, when Lehman Brothers collapsed.
Incidentally, in 2011, the S&P 500 Index lost about 17% of its value during the debt ceiling standoff, including almost 7% on Monday, August 8, following the credit rating downgrade.1 In the end, Congress raised the debt ceiling, and the U.S. did not default. And investors had one of the great buying opportunities of their lifetimes. Be prepared for some degree of volatility this go round, and keep in mind that there may be upside potential once the current storm passes. As Messieurs Page and Brin demonstrate, wealth creation in America depends on the effort, insight, and creativity of the private sector, and it repeatedly survives the gyrations of politics.
Mixed U.S. Data Ahead of Jobs Report
This Friday, all eyes will focus, for at least a few minutes, on a spot part way between the Capitol and the White House. There, the Labor Department (depending on how shutdown priorities may play out) releases the monthly employment report for September, in which we’re expecting to see further signs of improvement in the labor market. Another month of adding a net of 175,000 to 200,000 jobs would reinforce last week’s heavy serving of data on manufacturing, the consumer and housing, painting an overall picture of modest expansion.
On the manufacturing front, durable goods orders came in above expectations for August, but July’s reading was revised lower, indicating spotty demand for items such as machinery and computers. Non-defense capital goods orders excluding the volatile aircraft category, a proxy for capital spending, rebounded 1.5% in August after dropping 3.3% the month before.
Markit’s Purchasing Managers Index (PMI) for manufacturing edged down slightly but remained, at 52.8 in September, well within expansion territory. The forward-looking new orders component was the softest since April however, signaling modest demand for manufactured goods. Regional manufacturing surveys from the Richmond and Kansas City Federal Reserve Banks indicated similar softness. Overall, while the manufacturing sector continues to expand, it’s doing so at only a modest pace.
Things look a bit better among consumers, whose spending makes up over 70% of GDP. Spending rose 0.3% overall in August, a slight improvement over July’s 0.2% growth rate, while personal incomes rose 0.4% vs. July’s 0.2% rate. In the labor market, initial claims for unemployment benefits continue to plummet, with the four-week average hitting a new low point for the recovery. If the good news is that fewer people are losing jobs than at any point since the financial crisis, the flip side is that companies are still not hiring en masse. Net U.S. payroll gains have averaged 184,000 over the past 12 months, but that’s barely enough to keep up with the natural increase in the size of the working-age population.
The housing sector, meanwhile, continues to add to growth, though there are signs that higher mortgage rates since last spring have begun to change potential buyers’ calculus. The S&P/Case-Shiller Home Price Index has been increasing at a steadily slower pace over the past few readings, the latest of which is for July. In that month, home prices rose 0.6%, versus gains of 0.9% in June and May, and readings of 1.7% and 1.9% in April and March, respectively. Year over year, however, home prices have risen the most since the recovery began. Keep in mind that over the long haul, home prices rise at about the rate of overall inflation so a cooling of earlier hot markets is part of a return to normality. Other reports released last week show that inventories of new homes on the market have ticked higher after seeing very tight conditions earlier this year, and that pending home sales as of August are the lowest since last spring. While we may not see mortgage rates as low as they were last April and May again, it’s worth remembering that they remain very low by historical standards, which should continue to help support the housing market going forward.
1. Source: Bloomberg, 9/24/13. The S&P 500 Index is a broad-based measure of domestic stock market performance. The index is unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results.
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