Cole discusses how fiscal cliff negotiations affect confidence

In a recent Bend Bulletin article, reporter Elon Glucklich covers the risk Oregonians face if lawmakers allow the U.S. to go over the fiscal cliff. In addition to spending cuts, and tax increases, Ferguson Wellman’s Ralph Cole, CFA, states that when investors seek the government struggling to make a decision, it becomes a capital markets event. The full article can be read on Ferguson Wellman’s website.

Disclosures

Housing High and the Government Cliffhanger

By Ralph W. Cole Senior Vice President of Research

There’s No Place Like Home

Good news came this week when Standard & Poor’s Case-Shiller Home Price Index reported that national home prices increased 4.3 percent on average through October. 2012 is on track to be the first year of positive home price appreciation since 2006. Housing has been in bear-market territory since that time—this increase in prices is certainly a long-awaited, welcome development.

In 2012 we found a new equilibrium on supply and demand for housing. New household formations (demand) has risen from its lows to exceed new home construction (supply), resulting in a modest bump in house prices. In addition to supply and demand shifting, the housing market is benefitting from a 65-year low in mortgage rates. This week, 30-year conforming loans were quoted at 3.125 percent, prompting borrowers to ask, “How low can you go?”

We expect housing to remain one of the bright spots in the U.S. economy as we inch toward 2013. Housing starts are forecast to surpass 1 million next year, up from 475,000 in 2008, but still a long way to go from the high of 2 million we saw in 2005. Job creation from new home formation is significant for construction but also for manufacturers of goods and services associated with a new household—think carpeting, furniture, appliances, lawncare, etc. The lack of homebuilding the last five years has been a significant driver of unemployment. We expect improvements in employment in 2013 will be directly correlated to growth in housing starts.

Cliffhanger!

The unfortunate part of this “Kabuki-theater drama” is that it was so predictable. As we have noted in past publications, markets stop panicking when politicians start panicking.  It appears on the eve of the “fiscal cliff” that politicians are indeed starting to panic. The House of Representatives will be hosting a special session on a Sunday night, December 30, to hopefully vote on a deal. Outcomes range from a 30-to-90-day extension of current policy (really?) to extension of Bush-era tax cuts for all with the exception of individuals earning more than $500,000 annually.

As a firm we view the entire situation as truly unfortunate. At this moment, the U.S. has an opportunity to re-establish itself as a leader in the global economy. Before this can occur, our government needs to show the world that we are capable of addressing our short- and long-term fiscal issues. The U.S. also needs to prove to rating agencies its resolve to face these enormous fiscal challenges. As of this writing, neither side of the aisle has shown the leadership to successfully put forth a solution.

Our Takeaways for the Week

• Despite positive economic data, the overhang of fiscal cliff negotiations weighed on the S&P 500, which was down 1.9 percent for the week
• U.S. bonds have maintained their safe-haven status with the yield on the 10-year Treasury falling to 1.69 percent

Disclosures

A Santa Claus Rally and Teflon Don Economy

by Shawn Narancich, CFA Vice President of Research

A Santa Claus Rally Preempted

Time is fast running out for politicians attempting to avert the fiscal cliff. Lack of a cross-party deal now complicated by a surprising lack of intra-party consensus dampened investors’ spirits, sending stocks lower on Friday and shrinking gains realized for the week. Bond yields rose modestly, but benchmark US Treasuries remain in a trading range yielding relatively little. With Congress now on break until after Christmas, any deal to avert the fiscal cliff is likely to be less meaningful than the Grand Bargain previously envisioned. 

A Teflon Don Economy

With fiscal uncertainty growing and the economy negatively impacted by Hurricane Sandy, investors might think that the US economy would struggle to keep its head above water. In fact, data argue the opposite. Retail sales reports remain relatively upbeat, manufacturers in the Northeast are reporting growth, personal income and spending are up more than expected, and housing continues to rise above the fray. All of which is to argue that despite Washington’s best efforts to put a lump of coal in everyone’s stocking this Christmas, the economy not only continues to grow, but probably is doing so at a fourth quarter rate underestimated by economists. More importantly, aggregate demand that has been delayed because of tax and government spending uncertainty appears to offer the potential for economic acceleration if the government’s solution does more than just kick the can down the road. Therein lies the opportunity and the risk for investors.

Business as Usual?

One bellwether company reporting earnings this week proved that business can actually thrive despite the fiscal handwringing. Oracle blew past Wall Street expectations for earnings while handily beating revenue estimates, and then proceeded to tell investors that business in December has actually been quite good for its suite of database and application-specific software packages. Oracle’s report is juxtaposed against a consensus belief that technology budgets are under pressure and likely not to experience year-end budget flushes, prompting the question of whether Oracle’s experience reflects market share gains or a consensus outlook that is off kilter. Whatever the reason, Oracle’s stock performed admirably in choppy markets, rewarding shareholders with nearly a 6 percent gain for the week. 

Sports apparel and footwear giant Nike also regained some lost luster. The stock gained 8 percent on better-than-expected earnings, reflecting less pronounced margin headwinds and a robust U.S. business. Nevertheless, despite accumulating evidence that the Chinese economy is improving, Nike’s orders in this important market continue to lag. Trading at 20 times projected earnings, the company’s stock already appears to presume success in overcoming challenging markets overseas.

Ahead of what should be one of the quietest weeks of the year for Wall Street, we wish all of our clients and friends of the firm a very Merry Christmas and a prosperous New Year!

Our Takeaways from the Week

• Surprisingly sound economic data and encouraging earnings reports suggest an economy growing at a faster-than-expected rate
• Despite surprisingly strong performance recently, stocks are likely to remain volatile on fiscal cliff newsflow

 Disclosures

George Hosfield, CFA, responds to recent data about employers giving more year-end bonuses

Northwest NewsChannel 8’s Joe Smith talks with George Hosfield, CFA, principal and chief investment officer, about how employers are recognizing and rewarding workers. Hosfield also comments on the possibility of more hiring by employers in 2013.  Click here to view the news story.

Disclosures

QE4 and Good news from Europe?

by Shawn Narancich, CFA Vice President of Research

 A Game of Chicken

Politicians failed to make any headway on the U.S. fiscal cliff, but with only 18 days to go, stocks are holding up relatively well in light of additional monetary stimulus announced by the Fed and more evidence that China’s economy is reaccelerating. In contrast to modest losses in domestic blue chips stocks, emerging market equities rallied 1.6 percent and provided a nice tailwind to investors owning international stocks in general. Though international equities lagged domestic benchmarks by notable margins throughout 2012, after a strong rebound in recent weeks, both equity styles are now up 13 percent for the year. With global equity indices mixed, benchmark U.S. Treasuries sold off modestly on news that the Fed will ring in the New Year by expanding their balance sheet an additional $45 billion per month.

QE4 Investors expected the additional quantitative easing, but what caught most by surprise was the Fed’s announcement that it was dropping reference to any calendar restraints on its open market operations in favor of instituting explicit macroeconomic targets. The yield curve grew steeper on news that monetary largess would remain in place as long as projected inflation remains quiescent and unemployment remains above 6.5 percent. The Fed’s announcement had some asking the question, “Does this mean monetary policy is now partly beholden to the U.S. Bureau of Labor Statistics?”  Probably not.  The Fed’s post-meeting statement disclosed that Bernanke & Co. would consider drops in the unemployment rate caused by people giving up their search for work to be one of the contingencies that would preclude it from prematurely raising rates.

Its latest moves come in addition to the $40 billion of mortgage backed securities it is already purchasing, putting our central bank on track to add $85 billion of liquidity to bank balance sheets every month. While the monetary base expands, we question how many more loans banks will actually make with their additional cash reserves, and more broadly, whether additional monetary stimulus will produce the incremental jobs targeted by the Fed. One thing seems certain -- the Fed’s new communication strategy promises to make each month’s employment and inflation statistics that much more meaningful in divining central bank policy.

Good News from Europe? While the Fed continues to do its best to ensure that the U.S. economy doesn’t end up like Japan’s, a meeting of Euro-zone finance ministers made key progress in its attempt to backstop the region’s banking system. Leaders announced broad new powers for the European Central Bank to supervise the Continent’s biggest banks, granting the ECB regulatory oversight similar to that enjoyed by the Fed.  Just as importantly, this agreement will enable the European Security Mechanism Bailout Fund to make direct investments in large banks without first lending money to regional governments already saddled with too much debt. In combination with ECB President Draghi’s promise this summer to backstop the bond markets of troubled southern European nations, this latest pronouncement should further reduce systemic risk in the region and promote healthier capital markets in general.

 Our Takeaways from the Week

• International stocks outperformed on regulatory progress in Europe and further evidence of an economic rebound in China

• Odds of a meaningful year-end deal to avert the fiscal cliff appear to be waning

Disclosures

More Fiscal Cliff Woes, LNG and Operation Twist

by Shawn Narancich, CFA Vice President of Research

Marking Time

In a week when investors were expecting the monthly jobs and manufacturing reports to reflect Hurricane Sandy disruptions, weather wasn’t blamed for the disappointingly low level of manufacturing activity, nor did it seem to hinder the surprisingly strong payroll report. While a net gain of 146,000 jobs in November was a pleasant surprise, the unemployment rate fell for the wrong reason. A four-year low of 7.7 percent resulted from an estimated 350,000 people dropping out of the labor force, as discouraged job seekers stopped searching for work. In manufacturing, the storm that blew through was not produced by Mother Nature, but rather by the politicians in Washington who still have yet to resolve the “fiscal cliff.” As businesses hunker down, they are ordering less and hiring fewer. Against this mixed backdrop of economic indicators, stocks and bonds finished the week largely unchanged.

LNG Boosters Receive Key Endorsement

Natural gas also failed to advance despite the results of a widely anticipated report from an economic consulting firm that supports the case for liquefied natural gas (LNG) exports.  Free market advocates cheered the Department of Energy-commissioned study concluding that LNG exports would boost economic output and create jobs without a disproportionate increase in prices. Environmental reviews of such exports are still ongoing, and while the DOE won’t decide on permitting until the first half of next year, this week’s report is a key input to the agency’s ultimate decision. Despite the potential demand boost from natural gas exports, the commodity succumbed to selling pressure on Friday because forecasts are predicting warmer than normal weather that threatens to reduce seasonal heating demand. Following last year’s winter that wasn’t, traders are keeping prices under wraps as they weigh increasing industrial demand for gas with evidence that supply from curtailed drilling will soon impact production levels.

Strategic Flip-Flop

Sticking with an energy theme, the shale bonanza that first sent natural gas prices plummeting had a similar but much more immediate impact on Freeport-McMoran’s stock, which cratered on news that it would purchase Plains Exploration and the portion of McMoran Exploration that it doesn’t already own. After making a decision in the early 1990s to ditch the energy business in favor of its bread-and-butter copper and gold mines, management shocked investors by announcing the twin deals worth a combined $20 billion. Investors fled the stock in droves, sending the large-cap miner’s stock down over 20 percent for the week. As if the strategic about-face wasn’t enough, eyebrows were raised further upon revelation that Freeport’s CEO owns material positions in both Plains and McMoran, and that neither deal is subject to shareholder approval. The end result is that Freeport goes from being a pure-play miner to a BHP Billiton-like natural resources conglomerate, with a balance sheet burdened with five times as much debt.

On tap next week is the Federal Reserve’s last meeting of the year, at which investors hope to learn what kind of encore might await the end of Bernanke and Co.’s bond buying and selling program, dubbed “Operation Twist.” Expectations are that the Fed will continue buying long-term Treasuries to keep rates low, without sterililzing those purchases with sales of other securities. If so, monetary policy is set to become even more stimulative.

Our Takeaways from the Week

• Fiscal cliff uncertainty continues “ad nauseum” as markets await resolution
•  Odds of LNG export approval increased as a key study highlighted the potential economic benefits

Disclosures

Fiscal Cliff Posturing, Kicking the Can and "Special" Dividends - Week Ending 11/30/12

by Shawn Narancich, CFA Vice President of Research

A “He Said, She Said” Kind of Market

In a week when stock prices swung back and forth based on press conferences and proclamations about ongoing “fiscal cliff” negotiations, investors are left to conclude that markets are being held hostage to politics. Against this backdrop, stocks struggled to gain traction and benchmark Treasuries remained well bid. The fiscal uncertainty weighing on investors continues to manifest itself in the real economy. Notwithstanding an upwardly revised third quarter GDP number, details underlying the 2.7 percent growth rate point to a low quality recast. A large portion of the improvement came from inventory builds greater than first estimated, while both consumption spending and private sector investment were weaker than first thought. 

It’s Not What You Make, It’s What You Spend

Another detail in this week’s GDP report is worth mention – a lower-than-expected trade deficit for third quarter that subtracted less from the economy than first thought. We know that the U.S. economy is beginning to benefit from a recovery in housing, but what gets less press is how the renaissance of the U.S. energy industry is reducing our nation’s oil import bill. With half of our trade deficit currently attributable to oil imports, the shale boom that is boosting domestic oil and gas supplies promises to increase U.S. energy self sufficiency and create economic tailwinds. Investors are wise to discount fiscal contraction, but the Fed-engineered housing rebound and Yankee-inspired energy rebirth promise to provide key offsets to an otherwise sluggish U.S. economic outlook.

A Well-Worn Can

As fiscal cliff posturing continues to play out domestically, Europe congratulated itself on a new agreement to keep Greece solvent. The latest bailout package defers principal repayments, reduces interest rates, and approves another cash advance to this country whose economy continues to implode. Slowly but surely, Greece’s disastrous economy is washing up on the balance sheets of countries like Germany and France, where taxpayers will ultimately foot the bill for Greece’s transgressions. For now, that battered can is again kicked down the proverbial road.

A “Special” Year

While corporate executives may not be able to forecast the details, they know that tax rates are likely to rise, and with this knowledge, they are speeding the return of capital to shareholders. So far this year, U.S. companies have declared over 170 “special” dividends, which are cash payouts in addition to the typical quarterlies that have in many cases also been increased in 2012. This week, Costco, Las Vegas Sands, Guess and Whole Foods Market joined the parade, aiming to make payouts advantaged by a low 15 percent dividend tax rate likely to end soon.

The economic calendar picks up pace next week, when investors will glean the latest read on U.S. manufacturing and labor markets, key readings that may put additional pressure on policymakers to resolve the fiscal cliff.

Our Takeaways from the Week

•  Posturing over the fiscal cliff took center stage as stocks struggled to advance
• The U.S. economy remains in slow-growth mode, but with important underlying supports that should help ameliorate increasing fiscal headwinds

Disclosures

Black Friday 2012

by Shawn Narancich, CFA Vice President of Research

 Black Friday? Unexpected comity by politicians aiming to avert the U.S. fiscal cliff put investors in a better mood ahead of Thanksgiving, and enthusiasm for stocks carried over to a holiday shortened trading session on Friday. After several weeks of post-election malaise and with just 39 days left to resolve the automatic spending cuts and tax increases slated to take effect January 1, stocks rebounded 3.5 percent on the week as benchmark Treasury bond prices waned.

Sparsely populated trading desks and light volumes signaled a start to the Christmas selling season, when shoppers thronged storefronts ahead of late night openings designed to create buying frenzies and fat retail profits. While investors will parse initial reports of Black Friday sales for indications of company-specific success or failure, the end game is harder to predict nowadays. With increased use of the internet and more stores offering online deals to rival in-store specials, more shoppers are choosing to sleep in and avoid the crowds, opting instead to make purchases on their computers, tablets, and smartphones. As a result, online sales continue to take market share from bricks-and-mortar retail. Inasmuch as shoppers visit Amazon.com or Target.com instead of venturing out, traditional retail could be losing out on the all-important impulse purchase. Retailers like Wal-Mart and Macy’s count on these and other full-priced sales to make enough money to offset losses incurred on their “door buster” specials. So while holiday sales may reach the 4 percent gains anticipated by investors, we won’t know until much later in the season how promotional these added sales turned out to be.

From Bad to Worse In a relatively light week of corporate news, disappointing earnings from Hewlett-Packard sent more of its investors fleeing for the exits. Quarterly earnings beat estimates, but only after excluding a laundry list of non-recurring charges, the most significant of which was an $8.8 billion write-down of the goodwill it booked in purchasing U.K. software firm Autonomy. Amid allegations of accounting impropriety, investors were left to believe that former CEO Leo Apotheker and his management team were duped into the purchase, leaving current CEO Meg Whitman to pick up the pieces of a company whose stock has now lost over half its value this year. Ironically, reported sales of software represented the only division of sales growth within HP, but even at that, this business accounts for a small portion of overall sales. Looming as much larger issues standing in the way of an HP turnaround are declining sales of PC’s, servers, storage, printers and ink.  Technology trends favor tablet computing, smart phones, and virtualized workloads accessed in the cloud, leaving HP to face secular headwinds that show no signs of abating.

An Asian Bright Spot Investors have had to take recent economic data in the U.S. with a grain of salt, as the effects of super storm Sandy continue to skew readings of weekly unemployment claims, retail sales, and industrial production. As a result, foreign data flow has become more meaningful in gauging global economic health. Notwithstanding the occasional nugget of good news, Europe continues to be a macroeconomic problem, as evidenced by last week’s data confirming that the Continent is officially in recession. As lawmakers there attempt to cobble together the latest bailout package for Greece and wrangle over a new EU budget for the next seven years, trading partner China appears to be rising above the fray. Amid data showing stronger electricity demand and better industrial production numbers, a preliminary reading of Chinese purchasing managers now indicates manufacturing growth there for the first time in 13 months. What all of this could indicate is that the Red Giant may end up being a savior of sorts for economic growth next year. If China can continue its nascent transition to a more consumer oriented economy, global growth in 2013 could actually reach the 3-4 percent level that many economists expect.

Our Takeaways from the Week

• Stocks rebounded amid optimism for a solution to the impending fiscal cliff

• While the global economy remains lackluster, China’s expansion appears to be picking up and could help deliver anticipated global growth in 2013

Disclosures

Around the World and Back

By Ralph W. Cole Senior Vice President of Research

Around the World and Back I had the opportunity last week to travel to Hong Kong and Mumbai and meet with investment industry experts. Both economies appear to be improving, or at least, bottoming.

The Chinese have a fascinating process of selecting their new government leaders. While jockeying goes on for years in advance, the final selection process takes approximately a week behind closed doors. The announcement is made as the new regime takes the stage in The Great Hall of the People in Beijing. The country is literally waiting and watching to see who comes out on to the stage, and in what order. The seven members were led by Xi Jinping, who is the new President. Xi Jinping is viewed as somewhat of a reformist, but overall the seven member group is viewed as conservative, and reforms will continue at a slow pace. This selection process takes place once every ten years, which allows the Chinese government to be a little more strategic than ours here in the U.S.

As we all know, democracies can be messy, and while India’s is messier than most, they are making real progress. In the last couple of months India has passed pro-growth initiatives including: companies’ bill for improved corporate governance, and the allowance of foreign direct investment in aviation, multi-brand retail, insurance, broadcasting and power exchanges. Management teams in these industries will improve profitability, but more importantly, drive infrastructure improvements throughout the country. Several more government actions are expected to take place in the coming quarters.

Man Bites Dog The International Energy Agency said the U.S. will overtake Saudi Arabia as the world’s leading oil producer by 2017 and become a net exporter by 2030. The IEA went on to say that natural gas will surpass oil as the largest fuel in the U.S. by 2030. We have written extensively about the shale oil and gas revolution ongoing in the U.S., but even we were surprised by this headline. We will continue to weave this theme throughout client portfolios in the coming years.

Anyone Tired of the Fiscal Cliff yet? The President and Republicans have begun jockeying on the fiscal cliff and long-term fiscal reform. Having won the election, the President is pushing for higher tax revenues of $1.6 trillion over the next ten years. This is double the $800 billion that was almost agreed to last year during the debt ceiling debate. The President appears to be going “all in” on his populist platform, but the Republican House will be the key check on his ambitions. We hope that the initial salvo from the Oval Office is only a negotiating technique, and both sides can come to a reasonable agreement. The S&P 500 finished the week down 1.36 percent and the 10 year treasury yield drifted lower.

Our takeaways from the week

• Political and economic reforms occurring in India and China should make the countries more attractive to investors

• Market volatility will likely continue as long as lawmakers debate solutions to the fiscal cliff

Disclosures

Post-Election and Earnings Season Recap

by Shawn Narancich, CFA Vice President of Research

What’s Old Is New Again

 Investors on both sides of the aisle hoping that the certainty of having a declared winner of the U.S. presidential elections would lift stocks out of their recent funk were sorely disappointed this week. The post-election landscape looks much like the one that existed before Tuesday: a split Congress, an Obama presidency, and plenty of uncertainty about how the national leadership will address the fiscal cliff. Despite some evidence from both parties indicating a willingness to compromise, stocks fell sharply after the election and retreated 2.4 percent for the week. In contrast, fixed income investors took heart in an Obama presidency that would retain Bernanke and his easy money policies (for as long as he’s willing to serve), leaving Treasuries well bid in an environment of open-ended QE. Coupled with increased uncertainty about the fiscal cliff and its effect on economic growth, Treasury bonds gained, pushing the already low yield of the benchmark 10-year security to a slimmer 1.61 percent.

Jockeying for Position

The equity sector moves that followed Tuesday night’s drama spoke volumes about how investors view the post-election prospects for various industries. While the stock market was experiencing its worst daily decline in months, hospital stocks like HCA and Tenet Healthcare surged on the now certain implementation of ObamaCare, which promises to boost patient volume and reduce the bad debts of this industry that has long suffered write-offs from uninsured patients unable to pay their emergency room bills. In contrast, bank stocks like JP Morgan and Wells Fargo sank, as investors speculated that a continued slow-growth economy would mute loan volumes and hinder profitability. Energy stocks were also hit hard on concerns about more exacting environmental standards and a reduction of potentially available drilling acreage. And while consumer stocks outperformed on the belief that demand for Tide laundry detergent won’t vary much regardless of who occupies the White House, the typically defensive utilities sector outperformed by a surprisingly small margin due to concerns about tax rates on dividend income that are poised to rise.

Taxes … Nowhere to Go but Up?

Which brings us back to the fiscal cliff, the $600 billion of tax increases and spending cuts set to occur on the first of January absent Congressional action between now and year-end. We believe that lawmakers and the President will reach an agreement to forestall the most austere aspects of the cliff, but the more important question is, “When will true tax and spending reform occur?” If political leaders kick the proverbial can down the road and fail to establish a permanent tax structure while forestalling the entitlement reform necessary for putting the nation back on a sustainable fiscal path, new investment and hiring are likely to remain depressed. And while the fiscal detail is impossible to know, investors are correct to assume that taxes are going to increase and government spending is likely to fall. If any “grand bargain” is to occur between the Democrats and Republicans, it must contain both elements.

A Book End to Earnings Season

As investors continue to speculate about which platforms will prevail in the smart phone wars—Android, Apple’s iPhone or the new Windows 8 for those who prefer out of the money call options—one industry participant common to all three platforms continues to win … Qualcomm. Snapdragon chipsets flew off distributor shelves in the most recent quarter and, unlike most semiconductor companies, its chip prices actually increased. Against a backdrop of declining stock prices, Qualcomm’s stock rose 4 percent for the week as sales and earnings blew past expectations.

 Our Takeaways from the Week

•  U.S. elections reverberated through financial markets, pushing stocks broadly lower as investors jockeyed for position amid the new political reality
•  Fiscal headwinds are intensifying and threaten to slow the growth of an already modest economic expansion

 Disclosures

Kralj discusses economic outlook and consumer sentiment for Oregon and the U.S.

Northwest NewsChannel 8’s Joe Smith talks with Mark Kralj, principal, about how trends in economic data seem to be improving, not deteriorating. How consumers feel about the economy is subjective, but there are indications that home ownership and retail sales are growing. A recent report from the Federal Reserve indicates that Oregon is one of three states anticipating growth greater than 4.5 percent in the next six months.  Click here to view the news story.

Weekly Market Makers - Week Ending 11/2/12

by Shawn Narancich, CFA Vice President of Research

A Perfect Storm?

Hurricane Sandy left investors with idle stock screens this Monday and Tuesday as the New York Stock Exchange closed for two consecutive days—the first time that weather has done so since 1888. The loss of life and property is sobering. Our collective thoughts and prayers go out to those affected by this killer storm, which left traders and media commentators to speculate about its economic and company specific impacts. Home improvement retailers Lowe’s and Home Depot, United Rentals and pump maker Pentair were among the winners when trading resumed Wednesday. Stocks succumbed to a late Friday sell-off that left the major indexes largely unchanged for the week, with benchmark Treasuries rallying modestly.

Our best guess is that Sandy will negatively impact fourth quarter GDP, but that a massive rebuilding effort in the nation’s most densely populated corridor will result in somewhat faster economic growth early next year. Insurable losses, excluding flood damage backstopped by the federal government, are estimated to be as high as $20 billion. Catastrophic claims will ding the near-term earnings of insurers like Allstate and Chubb, as well as their reinsurance partners, but the more important question for investors is whether Sandy will precipitate the kind of rate hikes that have historically enabled property and casualty insurers to exchange near-term pain for long-term gain. Ironically, both Allstate and Chubb recently reported better-than-expected earnings, with both citing benign claims activity.

Silver Linings

Despite the hurricane, the U.S. government hewed to its plan of releasing the October payroll report as originally planned. The numbers out Friday were better than expected, with net job creation totaling 171,000 and the previous two months’ job tally being upwardly revised by a cumulative 84,000 jobs. Service sectors such as retail and healthcare were notable contributors, and manufacturing jobs rebounded. The headline jobs number was encouraging, but an uptick in unemployment to a 7.9 percent rate coupled with an underemployment rate that remains near 15 percent are stark reminders of how just how slow the labor market recovery has been. Third quarter productivity gains of 1.9 percent confirm the job market weakness, portraying a private sector that favors squeezing more output from its existing employees to hiring anew. Because unemployment remains high, workers have little leverage to demand higher wages and, as a result, unit labor costs are falling. So while revenue gains are hard to come by at this point of the economic cycle, productivity is helping buoy corporate America’s bottom line.

The Late Innings of Earnings Season

Meanwhile, earnings season rolled on. Notable misses came from oil giants ExxonMobil and Chevron, both companies displaying continued declines in petroleum production exacerbated by cyclically low natural gas prices domestically. On the flip side, automakers GM and Ford reported surprisingly good numbers in light of the losses they continue to incur in Europe. Capacity there is being curtailed, but cutting jobs in Europe is a process, not an event.

Our Takeaways from the Week

•  Hurricane Sandy is exacting a substantial human and economic toll, but a resilient U.S. economy will likely recover lost output longer term
•  A surprisingly poor earnings season is beginning to wind down

Disclosures

Norris Discusses the Threat of Hurricane Sandy

Northwest NewsChannel 8’s Joe Smith talks with Jason Norris, CFA, senior vice president of research, about the NYSE and NASDAQ closing for Hurricane Sandy. He also speculates how the economic impact the super storm might affect the final days of the election.  Click here to view.

Weekly Market Makers - Week Ending 10/26/12

by Shawn Narancich, CFA Vice President of Research

More Questions than Answers

Evidence of business malaise and a maturing business cycle continued to pile up in week three of the third quarter earnings season, with stocks succumbing to questions about peak sales and profit margins. For corporate executives, discretion is proving to be the better part of valor. Hesitancy to provide outlooks for 2013 reflects a European recession, slowing growth in China, and approaching fiscal headwinds that threaten to weaken a U.S. economy already flying at close to stall speed. Against this backdrop, earnings estimates and stock prices are falling. Benchmark Treasuries rallied modestly as large cap U.S. stocks fell 1.5 percent.

Hand in Glove

An initial read of 2 percent domestic growth for third quarter GDP provided apt context within which to consider the earnings of Caterpillar, DuPont, 3M and chipmaker Broadcom— all cyclical companies that told investors to reduce their fourth quarter profit expectations. Corroborating the weakness in machinery, chemical and semiconductor sales seen anecdotally in corporate America, the Commerce Department reported today that a decline in capital spending detracted from third quarter economic output. The irony of 10 percent growth in government spending lending a boost to third quarter GDP ahead of the looming fiscal cliff failed to give investors much confidence in the economy’s ongoing durability. Exports also detracted from GDP, confirming the slowdown in global trade. A bright spot is housing, which stands out for the contribution it is once again making to the GDP equation.

Exceptions to Every Rule

In a slow-growing economy exhibiting late cycle characteristics, the rare company reporting good third quarter earnings news was amply rewarded. For such disparate companies as Peabody Coal, Procter & Gamble and Yahoo, the lift these stocks received from earnings had much more to do with company specific factors than diverging views about the macroeconomic outlook. Peabody’s investors were greeted by 13 percent gains in the stock following a rare sales beat that occurred despite shuttered mines and low coal prices, with earnings benefitting from good cost control. At Procter & Gamble, better-than-expected sales and earnings cleared a low bar set after a string of disappointing quarters in which the consumer staples stalwart has ceded market share and attracted activist investor Bill Ackman. While the latest numbers were enough to alleviate some of the pressure on top management, P&G still needs to reinvigorate its top line and pare a bloated cost structure. Yahoo’s investors finally caught a break as well, with new CEO Marissa Mayer presiding over a quarter where numbers beat low expectations despite continued lackluster display add revenue.

Halfway through third quarter earnings season, an unflattering die has been cast and expectations reduced. Next week investors will tune into to reports from automakers GM and Ford, blue chip energy producers ExxonMobil and Chevron, and a slew of utilities that may have benefitted from an unusually warm summer that boosted air conditioning demand.

 Our Takeaways from the Week

• Poor third quarter earnings reports reflect a slow growth economy facing fiscal headwinds
• Limited earnings visibility has caused stocks to consolidate recent gains

Disclosures

2012 Q2 Market Letter

2012 Q3 Market Letter