Stocks continue to run in place this week. Short-term, investors are searching for the next catalyst to move the market. Washington and the Taper continue to be the most widely used headline to explain the market’s up or down moves. While you could get a headache trying to follow the volatile short-term news (or let me do it for you in the weekly wrap up, Big Picture), I like to continue focusing on the broader themes that are continuing to develop. Here’s a summary of those themes, which may pique your interest into doing more research.
Short-Term Themes
Economic Recovery
Manufacturing and Services have been expanding in the U.S. after a brief mid-cycle-slow-down in 2011 and 2012. Here, the ISM PMI shows that things are picking up once again.
Source: Moody’s Analytics
The employment situation has been improving as well. It may not be growing gangbusters and overheating, but slow growth is better than no growth. The Jobs numbers will be reported tomorrow, and based on the private ADP data that was released Wednesday, expectations are high that November’s numbers may exceed the consensus numbers by a wide margin.
Annualized Percent Growth in Jobs
Source: Moody’s Analytics
Housing has been on the mends for the past two years in both price and sales. Recently, new home sales began to drop in the 3rd quarter due to rising interest rates as well as the government shutdown. This week’s data showed that housing rebounded strongly in October as a result of the government going back to work and the economy is recovering strongly again. New home sales rose 25% in October to a seasonally-adjusted annual pace of 444,000, beating projections. It’s my belief that rising rates and falling sales were a big reason for the Fed to hold off a taper at its September meeting.
Washington (Fiscal Policy)
Long has Washington been a headwind to the economy. I’m hesitant to put this in a short-term theme because the public sector has been a headwind for many years. The short-term theme is the informal deadline Washington has set for a budget deal by the 13th of this month. Both sides may agree to increase discretionary spending to trillion, slightly more than dictated by the sequester. Oddly enough, if Washington can begin moving aside from the economy, the Fed may move its timetable forward for a taper.
Fed Taper (Monetary Policy)
As economic numbers begin to improve (see above), the Federal Open Market Committee may decide to start tapering its long-term purchases of Treasuries, allowing long-term interest rates to rise. Too strong of growth has been seen as a short-term negative because it may move the Fed’s taper plans forward on the calendar. I think this is just a short-term catalyst, and like we saw in August when the market began pricing in a taper, eventually investors will move past this theme and focus more on long-term themes.
Long-term Themes
Shale Boom
I wrote about the current shale boom in an article a couple months back. You can read a more in-depth analysis about it here. It was more discussing the current increase in production in 2013 due to a different kind of fracturing spread, closer to the wellbore and denser. I just read that Apache has found a way to cut more costs by recyclying the water it uses in its fracturing operations. So this industry isn’t done making technological advances. The main theme here is cheaper gas means cheaper production, cheaper transportation, and more discretionary spending into consumers’ pockets.
Unwinding the Globalization Trade
The worst performing equity markets were in emerging markets this year, while the best performing markets were in developed economies with the top 4 being Japan, Ireland, Finland, and the USA. The Brazil Bovespa Stock Index is down 17.6 percent, the India Bombay 30 Sensex Index is up 7.9 percent, the Russia SPDR ETF (RBL) is down 7.3 percent, and the China Shanghai Composite is down 1% year-to-date. With the exception of India, the BRIC has crumbled in 2013.
Perhaps one of the reasons that the globalization trade is unwinding is due to transportation costs. With oil & gas production on the rise in the U.S. due to the shale boom it’s no wonder that companies are moving operations back to the U.S. from China.
“The survey by Boston Consulting Group, conducted in August and released Tuesday, found that 38% of U.S.-based manufacturing executives who responded were shifting production to the U.S. or considering that, up from 18% in a similar survey in February 2012. The latest survey drew responses from 216 U.S.-based executives at companies with annual sales of more than billion.” Hagerty, James R. WSJ. Oct. 1, 2013.
Falling Commodity Prices
China slowing over the past few years has had a bearish effect on commodity prices. It’s uncertain whether the deceleration has ended long-term, but things have improved for manufacturing over the past few months. Time will tell, but most of the details from the four-day meeting by the Communist Party in November suggest that leadership will continue to promote consumption over infrastructure — which doesn’t bode well for basic materials.
Stable Dollar
The final long-term theme that has developed over the last couple of years has been a stable U.S. dollar. If the Federal Reserve Bank wasn’t purchasing Treasuries, the dollar might be a lot strong than it is. For now, the dollar has been traveling sideways since it bottomed when commodities topped after the first quarter of 2011. Slowing China growth and a debt crisis in Europe have shifted assets to a safer haven in U.S. assets. As our central bank is discussing the removal of bond purchases while keeping short-term rates low, Europe, Japan, and others are talking about doing more. Finally, strong economic growth in the U.S. will support foreign investment. All of these themes should hold up the value of the dollar.
Summary
The day-to-day trading has been 85% about sentiment, rotation, and trade flows while the other 15% has been about fundamentals. Yet if you ask the majority of technical and fundamental analysts, they’ll probably tell you that corrections should be shallow and that nothing has occurred to derail the trend. You may get some analysts trying to make a name calling the next big correction that “eventually will happen” and “something shaky, maybe a recession or a problem internationally, could trigger…a panic into Treasuries”. I’ve read too many of those arguments in Barron’s over the past two weeks which drove me to write about the yield curve two weeks ago.
The fundamentals are sound for the U.S. and Bernanke’s speech last week made it clear that tapering isn’t tightening. My yield curve paper last week ties in very well to his speech, which indicates we should see higher long-term rates in our future while short-term rates remain low. This yield spread will further encourage banks to loan; and with housing and jobs recovering, demand should be there to request those loans. That’s the long and short of it.
