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U.S. Drifts as Europe "Dis-inflates"--Weekly Market Review

Jerry Webman, Ph.D., CFA

Chief Economist

Financial markets took a breather last week to close what was a positive October for shareholders. The global economy continues to drift along, showing few clear-cut trends—especially in the U.S. Growth in many areas of the world seems to have cooled, or failed to improve, this fall, although U.S., European and Asian (ex-Japan) equity indices have added to their 2013 gains. While emerging markets continue to lag, developed markets have delivered slow, non-inflationary growth, and investors seem satisfied with that, at least for now.  

U.S. Manufacturing Data a Bright Spot
In the U.S., market participants seemed to revisit the possibility of a late-2013 tapering of the Fed’s large-scale asset purchase program, driven by an expectation of improving economic conditions as we head toward the New Year. Of course, the Fed has made clear that any such move will be “data dependent,” and it would be hard to point to much data that look better today than they did in September, when the Fed took a pass on tapering. 

Last week did, however, bring two notably solid economic reports: The Chicago Purchasing Managers Index (PMI), which correlates well with national manufacturing conditions, showed its strongest monthly gain in more than 30 years in October, driven by the biggest jump in new orders (a key forward-looking component) in nine years. Similarly, the Institute for Supply Management’s (ISM) Manufacturing Index continued a four-month uptrend, reaching the highest level since 2011. New orders, once again, were very strong and will need to continue to be so to offset a recent increase in supplier and customer inventories.  

Not all indicators were so robust, however. Retail sales for September were fairly soft, though they looked better excluding the volatile food and energy categories. Housing data were mixed, with a sagging September reading for the Pending Home Sales Index somewhat overshadowing a solid August reading for the S&P/Case-Shiller Home Price Index. Consumer confidence, meanwhile, took a nosedive in October as the government shutdown and debt ceiling standoff grabbed headlines nationwide. Now that the crisis has been resolved (for the time being), and with gasoline prices near their lowest point since 2010, I would expect consumers’ outlooks to rebound somewhat. 

In all, the data point to what the Fed, in a post-meeting statement released last week, described as a “moderate” pace of growth for the U.S. economy.  With inflation well below the Fed’s 2.5% target, reduced fiscal drag in 2014, a 37% drop in the federal budget deficit in fiscal 2013, monetary policy continuing to push long-term bond yields lower, and valuations reasonable, equity markets appear likely to remain sanguine. A return to strong growth and job market improvement still seem like fairly far-off prospects, however. 

Third Quarter Earnings: More of the Same
On the U.S. earnings front, 368, or 74%, of the companies in the S&P 500 Index have reported third-quarter results. Within that group, the sales and earnings trends remain much as they have been the last few weeks, with 53% meeting or exceeding sales expectations and 77% meeting or exceeding earnings expectations. Although this has been another classic revise-down-and-beat type of quarter, we’ve seen high rates of upside earnings surprises in the materials, financials, consumer discretionary and IT sectors (few sectors have surprised meaningfully either way in terms of revenues). Companies continue to find ways to earn money even in a moribund revenue environment, but sustainable growth will depend on increased revenues—a tall order unless the economy improves meaningfully.

Europe Stumbles as Asia Eyes a Pick-up
Last week saw a fairly steep decline in the euro, which endured its biggest monthly drop against the U.S. dollar in about nine months. Driving investors’ concerns were a report that consumer inflation in the currency bloc was the slowest since November 2009, at just 0.7% year over year in October—well below the European Central Bank’s (ECB’s) target of just under 2%. While we’ve seen some signs of “green shoots” in the Eurozone, a strong euro has made its exports less competitive (and my current trip to Spain expensive), unemployment is at a record high of 12.2%, and banks continue, on balance, to tighten lending standards. Though banks report improvement in the conditions of their balance sheets and foresee increased lending in the months ahead, according to an ECB survey, the Eurozone has not seen as much progress as the U.S. in clearing bad debt out of the financial system. All of this points to the fragility of the Continent’s nascent recovery. Although the euro has weakened slightly from its recent highs, its 6% rise since early July spells pain, not only for tourists, but for export-oriented firms that depend on faster growth outside the continent to drive their earnings. 

On the other side of the globe, there was some good news for Asian economies. China’s official Manufacturing PMI rose to an 18-month high to 51.4, with 50 being the dividing line between contraction and expansion. A similar measure from HSBC beat analysts’ forecasts, rising from 50.2 to 50.9 in October. October PMIs for Japan and South Korea also rose last week, while manufacturing output in Vietnam remained at 51.5. Manufacturing PMIs have historically captured pivots in the future direction of growth fairly well, and has offered a reasonable indicator of stock market performance. For example, since 1998 when the index began, when the JP Morgan Global PMI has been above 50 and rising, the Morgan Stanley All Country World Index has delivered double-digit gains. As of the end of September, the JP Morgan Global PMI was at 51.8, and in an uptrend that began in late 2012. Though we note that past performance does not guarantee future results.

While plenty of challenges remain to be addressed almost anywhere you look in the world today, macro conditions in most regions, combined with generally sane valuations, create an environment in which competitive companies can still deliver growth to their shareholders. Markets may be optimistic for the moment, but as we move into 2014, investors will be looking for the clear signs of a strengthening economic backdrop that has yet to materialize.

 

 

WM001.001.1104 

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

The JPMorgan Global Purchasing Managers’ Index (PMI) is an aggregate of national PMI surveys. 

The MSCI All Country World Index is designed to measure the equity markets performance of developed and emerging markets.

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