by Shawn Narancich, CFA
Vice President of Research
Flies in the Ointment Stocks took a breather this week following gains in the S&P 500 totaling nearly 14 percent since June. As investors digest these gains and ponder the longer-term ramifications of central bank largess, several developments bear watching. Following last week’s Fed announcement of open-ended quantitative easing, Japan anteed up and announced a further extension of its QE program. With Japan’s economy mired in a deflationary funk, the Bank of Japan’s latest action is designed to dampen the yen and thus support its export markets at a time when China, one of its biggest trading partners, is threatening to reduce Japanese imports in the wake of the countries’ ongoing territorial dispute. Just as important, Japan is attempting to keep up with the Fed; a failure by the Bank of Japan to inject more yen into its monetary base would predict the type of yen strength that Japan hopes to avoid. Competitive devaluations are not a new concept and not universally applicable to all central banks. In Europe, where the ECB has threatened quantitative easing but has yet to execute it, the euro has rallied over 7 percent in just two months. As this week’s preliminary September manufacturing statistics from the Eurozone demonstrate, a stronger euro is doing no favors for an economy that appears to be falling deeper into recession.
No Free Lunch
Against the backdrop of incrementally easier money in the developed world, three key emerging market countries have failed to follow suit in the past couple weeks: Russia, India and South Africa. Why are they not attempting to keep up with the Joneses? In a word, inflation. The fact that Russia raised short-term rates last week while both India and South Africa kept rates steady this week speaks to the relative importance of commodity costs within these nations’ consumer price baskets. While food and energy account for about 15 percent of our domestic price index, the number for emerging markets is roughly three times as large. With key commodities such as oil priced in dollars, which are likely to become more numerous thanks to QE3— and inflation levels still above 5 percent in several emerging market economies—their central banks can’t necessarily afford to open the monetary spigots any wider. Life is a series of trade-offs, and in this case, easy money policy in developed markets is not without consequences; it poses important risks to the emerging markets that have been so important to the global economic expansion.
Shots Across the Bow?
Historically, transportation stocks have been harbingers for the broader economy and stock market and on this score, warning flags have emerged. Following Fed Ex’s fiscal first quarter earnings miss announced earlier this month, one of the world’s largest shippers reduced annual earnings guidance this week because of weakening trade flows and concerns about higher fuel costs. Meanwhile, railroad operator Norfolk Southern warned that weaker coal volumes would dent its profitability and truckers Swift Transportation and Werner both cited weak volumes to the same effect. With third quarter earnings season right around the corner and equities perched on gains approaching 20 percent year-to-date, the stock market could be vulnerable to some profit-taking amid continued evidence of slower economic growth globally. Amid the cross-currents, benchmark Treasuries remain well bid, trading to yield a slim 1.75 percent.
Our Takeaways from the Week
- Stock prices flattened this week as investors pondered bellwether profit warnings and the nuances of central bank policies worldwide
- Third quarter earnings season is right around the corner