As summer wraps up, the kids head back to school, and the weather becomes crisp, I can’t help but remember the ice storm that hit Portland earlier this year during one of the coldest weeks.
High Hurdle
More Gas, Same Brakes
This past week’s plethora of economic and market-moving data, especially regarding interest rates, has served to highlight the sometimes-conflicting forces at work in the U.S. economy. While the Federal Reserve maintained their interest rate policy at 22-year highs on Wednesday, we also learned the U.S. government’s budget deficit grew to nearly $2 trillion in their most recent fiscal year.
Legends of the Fall
We have consistently messaged our belief the Fed would accomplish its goal to bring inflation down to 2%, and this week’s latest reading on its preferred measure of the price level supports our thesis. The core version of the personal consumption deflator moderated again in the August reading, rising 3.9% from last year’s level, in line with expectations and moderating from the 4.2% increase registered in July.
Give Me Fuel, Give Me Fire
Equities continue their grind harder and higher this week as optimism for economic growth remains. The S&P 500 finished the week up three quarters of a percent resulting in year-to-date gains of over 14 percent. Yields also ticked up resulting in the 10-year Treasury yielding 2.32 percent.
Notably Accomplished
by Shawn Narancich, CFA
Executive Vice President of Research
Onward and Upward
As the sun sets on another round of quarterly earnings that again proved the ability of companies to stay ahead of expectations, investors are left to observe that the “mini-correction” stocks experienced a month ago proved to be a fleeting buying opportunity. With just a small handful of retailers left to report, blue-chip stocks at record levels are in part a reflection of corporate America’s winning scorecard for the quarter, one in which S&P 500 companies produced sales growth of 4 percent that combined with better margins and share buybacks to generate high single-digit earnings gains. Not bad for a quarter where many feared that a suddenly stronger dollar would wreak havoc with so many blue-chip companies doing business overseas.
Puts and Takes
Topping the list of key themes we've observed over the past month’s reporting season is a stronger U.S. economy that companies are seeing juxtaposed against incrementally weaker economic conditions in Europe and slower growth from China. The stronger dollar is a by-product of a globally decoupled economy. But while it creates challenges for multinationals translating earnings from countries using the weaker euro and yen, it has had a silver lining for the American consumer. The comparative strength of the U.S. dollar has coincided with lower commodity prices in general and oil prices in particular. Each one-cent-decline in fuel prices at the pump boosts consumers’ disposable income by $1 billion, providing a major boost to household budgets ahead of the holiday selling season.
Ka-Ching!
Investors got their first glimpse into how this dynamic might play out with Macy’s kicking off the third quarter reporting season for retailers with mixed results. The company delivered earnings above expectations, but on disappointing same-store sales that fell in the period. Despite management lowering earnings expectations, investors bid the stock higher, perhaps acknowledging Macy’s solid track record of expense controls, capital returns and the stock’s undemanding valuation. Whether the twin tailwinds of lower energy prices and a strengthening job market will fuel better holiday sales of the apparel, accessories and footwear that Macy’s sells is open to debate, but our bet is that Americans will spend their newfound income; it might just be that what they’re after turns out to be new gaming consoles, smartphones and SUVs!
Rocket Science
Finally, we would be remiss to deny recognition of Europe’s impressive accomplishment of a space mission this week that, for the first time ever, landed a space probe on a comet. If only a continent with the bright minds required to pull off such a feat could realize and act upon the knowledge that its stagnant economy and accompanying 12 percent unemployment rate aren’t fixable by monetary policy alone. ECB leader Mario Draghi knows that newly enacted European style QE by itself won’t pull Europe out of its funk—only labor market reforms, a more competitive tax system, and lower power prices can pull off that deft landing.
Our Takeaways from the Week
- With all but the last few retailers yet to report, corporate America has delivered another solid quarter of earnings that have helped push stocks to record highs
- Tailwinds for the American consumer should result in healthy levels of holiday spending
Let's Make a Deal
by Jason Norris, CFA
Senior Vice President of Research
Let’s Make a Deal
After two weeks of a partial government shutdown and on the eve hitting the debt ceiling, the Senate cobbled together a short-term fix to reopen the Federal government and kicked the debt ceiling “can” down the road for a couple months. Despite all the hysterics in the media that included dire warnings and countdown clocks, the U.S. economy, as well as the equity markets, held up fine. While we expect a short-term hit to economic growth due to the shutdown, we do not believe it will have a lasting effect. Though equity markets have been volatile during this period, stocks actually traded higher in October, resulting in an all-time high for the S&P 500. We believe that consumer confidence will pick back up through the remainder of the year. The wildcard in Washington is whether or not there will be a “grand bargain” before we hit the debt ceiling again or will the short-term band aids be more common, thus creating more uncertainty.
While interest rates fell a bit over this time, it was another story for the U.S. dollar as the major European currencies are close to 52-week highs relative to the greenback. While this may not positively impact a planned European vacation, it will benefit major exporters because their goods will be relatively cheaper in the world market.
Blackened Big Blue
IBM reported a disappointing and sloppy quarter earlier this week. While once a bellwether for the technology space, the company has struggled in recent years, and have been unable to post revenue growth on a year-over-year basis for eight quarters. However, IBM has been able to hit profit targets due to reduced costs, lower tax rates and share buybacks. The key metric we have been watching is free cashflow and this has not been compelling enough for us to step in at current levels, even though the stock is 20 percent off its high.
Earnings Redux
Third quarter earnings have been coming in mixed across the market. Semiconductor stocks are seeing a slower fourth quarter while Google’s growth continues to exhibit strength. The regional banks are experiencing sluggish loan growth and some compression in net interest margin. However, they are hitting profit targets due to cost cutting. Although the big industrials, such as GE and Honeywell, have delivered healthy reports this week, they are showing a bit of caution in their outlooks over the next few quarters. Looking toward 2014, overall corporate earnings are still forecasted to grow close to 10 percent. While this may prove to be too optimistic, we remain bullish on equities due to continued earnings growth and low inflation, which should translate into further P/E expansion.
Out Takeaways from the Week
- Even at current levels, equities are still attractive on growth and value metrics
- While Washington tried its best to slow down the U.S. economy, we believe overall growth with continue as consumer confidence picks up