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Sweet 16,000?—Weekly Market Review

Jerry Webman, Ph.D., CFA

Chief Economist

As we head toward the Thanksgiving holiday, equity investors can be grateful for quite a run so far in 2013. Last week, the Dow Jones Industrial Average crossed the 16,000 level for the first time in its 117-year history. Pundits love round numbers when it comes to index levels, although 16,000 in and of itself doesn’t signify much. It does, however, put a fine point on how strong this rally has been. Unlike some instances in which the Dow crossed a round-number milestone for the first time, the index is currently within spitting distance of its highest level ever in real terms—that is, net of inflation. The record, set on January 14, 2000, is the equivalent of 16,261.40, according to one estimate based on the Consumer Price Index (CPI).

Record or not, stocks by now have more than recovered the ground they lost in the financial crisis. The natural question is, of course, whether the markets have soared too high, too fast. After all, while the U.S. economy continues to expand, growth remains fairly lackluster. Are corporations today really worth more than virtually ever before, or is this all just a Fed-driven bubble? With millions still without jobs, arguing that the corporate sector is more valuable than it’s ever been may seem beside the point. Investors should keep in mind, however, that deleveraging has come a long way, and corporate earnings are robust as companies continue to make do with leaner workforces and ageing equipment. Eventually, I believe, animal spirits will return and drive employment and capital spending higher.

Perhaps, economically, the U.S. today is sadder but wiser, in a manner of speaking. Healing after the financial crisis has been a slow process with results spread unevenly among the economy’s participants. Though it may not seem so for everyone, we’ve come a long way since 2008, and equity prices reflect that.

As for the Fed, there is an argument to be made that low rates and large scale asset purchases have pushed stock prices higher. The relationship may not be as strong as some believe, however. I’d note that during this past summer’s “taper tantrum,” U.S. equities were among the best-performing asset classes, while most income-oriented asset classes took a beating. Clearly, many investors remained bullish despite the expectation of a September taper that never came. I don’t think that the real taper, whenever it comes, is likely to doom equities, either.

Stock prices may be breaking new ground, but the path of least resistance over the medium term is still probably up. In the shorter term, frothy investor sentiment—a bearish indicator—could presage a pullback, though the strong equity inflows we’ve been seeing for months pale in comparison to the outflows they experienced during the financial crisis. In any case, valuations are not particularly stretched by most measures, as they have been at previous market tops. 2014 should bring respectable earnings growth, re-emerging loan growth, increased housing demand, higher capital spending, more gains in domestic energy production, and reduced fiscal drag. These factors, in combination with highly accommodative monetary policy, suggest favorable conditions for additional gains whatever reversals we may see on the way.

Amid Modest Growth, Inflation Nowhere to be Seen

Last week’s economic data showed that inflation remains very low in the U.S., with the consumer prices dropping by 0.1% month over month in October. Lower energy prices were a key factor, though even core CPI, which excludes the volatile food and energy categories, rose only 0.1% month over month and is up a modest 1.7% year over year. Prices at the wholesale level show much the same trend. Meanwhile, employment costs remain understandably muted, having risen 0.4% in the third quarter for a year-over-year gain of 1.9%. Wage and salary growth has been essentially flat since 2009. Taken together, these low inflation readings do nothing to cause concern that the Fed might raise interest rates any time soon. Indeed, Fed Chairman Ben Bernanke emphasized in a speech last week that while tapering remains a relatively near-term prospect (dependent on incoming data), an interest rate hike was an entirely different animal and was likely still quite far off. I see no reason to expect his presumptive successor, Janet Yellen, to deviate from that plan.

The housing market has been a source of growth in the economy, and while the sector’s rebound continues, the pace of home sales may not be as fast in the near future as it was earlier this year. The National Association of Homebuilders’ Housing Market Index was down slightly in October (the fourth decline in as many months), but builders remain fairly confident. Meanwhile, existing home sales registered their third down month in a row, with low inventories and higher mortgage rates (relative to last spring) dampening sales activity. Those low inventories have, on the other hand, kept prices high; they’re up 12.8% year over year, a trend bound to help many homeowners who want to sell but are or were underwater on their mortgages.

On the manufacturing front, last week brought some good news, with Markit Economics’ flash Purchasing Managers Index (PMI) rising to 54.3 in November, from 51.1 the previous month (anything over 50 indicates expansion). The data echo the strong showing in the Institute for Supply Management’s gauge of the same name, which has been reasonably strong since mid-summer. The Markit PMI report showed strength in new orders—a key forward-looking component—as well as in output. Longer delivery times, and little pressure from input prices were also positive, but employment in the sector remains fairly sluggish.

Finally, last week brought us the last monthly retail sales report before Black Friday, the unofficial kick-off to the holiday shopping season, and among the biggest shopping days of the year. Despite D.C.-driven uncertainty in October, retail sales rose 0.4%; a tenth of a point lower for the retail sales reading excluding autos and gasoline. Consumers’ resiliency is notable given cratering consumer sentiment in recent months—a good sign, considering that consumer spending makes up roughly 70% of GDP.

China Data Weakens Slightly

As markets continue to digest the reforms announced after the recent Third Plenary Session of the Chinese Communist Party, HSBC’s November “flash” PMI dropped to 50.4 from its 50.9 level at the end of October. The reading was in line with a separate business survey, the Market News International (MNI) China Business Sentiment Indicator, which also polls companies in the services sector. Chinese growth continues apace (the latest annualized rate was 7.8%), and the government seems serious about moving toward more sustainable, consumption-led growth rather than continuing to rely so heavily on credit and investment. While many of the proposed reforms (highlighted in this space last week) are crucial, their implementation could be politically difficult and could mean slower growth for a time. The government’s goal for implementation of these reforms is 2020, but our vision into the future, unfortunately, is not.


U.S. Stocks: The S&P 500 Index is a market capitalization-weighted index designed to measure the performance of large cap stocks in the United States.

Core Bonds: The Barclays U.S. Aggregate Bond Index is an investment-grade domestic bond index.

Senior Loans: The Credit Suisse Leveraged Loan Index tracks the performance of senior loans.

Global Equities: The MSCI ACWI (All Country World Index) is designed to measure the performance of developed and emerging equities across the global equity landscape.

Utilities: S&P GICS Sectors – Utilities is classified by the Global Industry Classification Standard (GICS) which divides the S&P 500 index into 10 groups based on industries. It is market-capitalization-weighted and the index measures the performance of their respective industries

REITS: The FTSE National Association of Real Estate Investment Trusts (NAREIT) equity REITS Index is an index consisting of certain companies that own and operate income-producing real estate that have 75% or more of their respective gross invested assets in the equity or mortgage debt of commercial properties.

Emerging Market Equities: The MSCI Emerging Markets (EM) Index is an index designed to measure the performance of equities in the emerging market world.

Emerging Market Bonds: The JP Morgan GBI-EM Global Diversified Index tracks total returns for local-currency-denominated sovereign and corporate bonds in the emerging markets.

European, Far East and Australiasia Equities: The MSCI EAFE Index measure the performance of developed market equities excluding the U.S. and Canada.

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