Tower Private Advisors
- Capital markets recap surprise
- Earnings and quantitative easing
- Small business optimism stinks
Capital Markets Recap
There was at least one surprising move this week. That was Japan‘s stock market. It outperformed every other index shown below. The biggest loser was the volatility index, which fell by 4%. It reflected lower complacency but far from worrisome levels.
Earnings season kicks off this week with 19 of the S & P 500 companies reporting earnings. So far they’re off to a great start, reporting average year-over-year growth of 35.83%. Of the 19, the usual 75% beat earnings estimates. By the time the third quarter EPS reporting is done, about 68% of companies will have beaten earnings estimates. Yawn. Google surprises by 14.4%; its stock soars by 10%. GE surprises by 5.8%; its stock falls by 5.2%. JPMorgan Chase surprises by 14.3%; its stock falls by 1.4%. Intel surprises by 3.6%; its stock falls by 2.7%. On and on it goes, and yet market participants looks forward to earnings season as if it has any relevance.
For some time now the markets have been preoccupied with quantitative easing, or QE. The Fed already concluded, in March 2010, one round of quantitative easing, so the next round is being referred to as QE2. What quantitative easing entails was covered in the 9/24 WR&O (here). Even with our late-to-the-party approach to developments, we’ve beaten the mass of folks out there as measured by the surge in search activity around that phrase. Oddly–at least at first glance–search volume has been higher in Singapore, Hong Kong, and the U.K. The first two are easier: their currencies are pegged to the dollar and the interest rates on the dollar . . . and mortgage rates are tied to interest rates . . . and Hong Kong real estate is rocking and rolling. I don’t know why the Brits care.
This week’s minutes from the Fed’s September 21 Federal Open Markets Committee meeting revealed more about the committee’s concerns. Those minutes said that “such accomodation [QE] may be appropriate before long.” While Japan has said its QE efforts would entail buying many types of securities, the Fed said its purchases would be, “focused primarily on further purchases of longer-term Treasury securities and on possible steps to affect inflation expectations.” In other words, whatever their goals will be, one of the results will be lower interest rates, and that seems to be about effective as pushing on a string since consumers and businesses are hunkering down. What’s more, while buying securities is a way of increasing the money supply–more on that in a moment–most of the securities are held on bank balance sheets, and they don’t seem too cracked about letting loose the cash. Still, while mortgage rates hit another all-time low, they–surprisingly–have quite a bit of room to go (lower) if they are able to regain their old relationship to Treasury rates. That is, Treasury rates have fallen far faster than mortgage rates.
As to money supply . . . quantitative easing increases the money supply, as it replaces securities with money printed by the Treasury and spent by the Federal Reserve. The Quantity Theory of Money says that the money supply (M) multiplied by the velocity (V) of money (its turnover) equals GDP (P x Q). Specifically, it’s MV=PQ.
Most of the market reactions to quantitative easing developments seem to be of the jerking-knee type; that is, without resorting to facts. The traditional way of thinking about the quantity theory of money is that V, velocity, is constant, so if the money supply increases then output has to go up; the economy has to improve. That seems to have been the general way of thinking: QE is mentioned . . . stocks rally and the dollar falls. Also, if the money supply is growing faster than the economy, then the excess will find its way into other productive venues . . . like stocks.
The Fed has a dual mandate of promoting full employment and price stabilty, and it has one tool with which to accomplish that: monetary policy. It’s sort of like being a dentist with a sledgehammer and chisel as the only tools to use.
Here, though, is how QE is supposed to work–sort of a boiling down of all the stuff above. It’s the textbook answer to what’s-the-Fed-supposed-to-d0?
- Since the Fed can’t lower policy rates any further it buys Treasury securities. (There’s nothing that requires it buy government securities; it can buy anything it wants, including stocks.)
- That both increases the money supply and drives interest rates lower. The excess money isn’t–presently–needed by the economy’s growth, so it finds its way into financial assets, like stocks.
- Savers are hurt by the lower rates, so they go in pursuit of higher-yielding, riskier assets.
- 401(k) values go up.
- Consumers feel wealthier.
- They buy more stuff.
- Businesses hire. Check off the employment mandate.
- Increased demand allows them to raise prices. Check off price stability.
- Oh–almost forgot–in printing money the Fed lowers the value of the dollar, which produces an additional spark of inflation.
In the short run this will be good for financial assets–good in the same way that a bowl of Super Sugar Crisp gives a child energy. Or it’s like giving a wagon a push. If it gets over the hump it’s fine. If not it’ll roll back down. In the long run, though, I’d guess it’s likely to fizzle. There’s too much balance sheet repair–hunkering down–going on.
Not a whole lot of market-moving stuff this week, although the first trade on Thursday mornings is always–no matter what–the result of a good or bad initial jobless claims, just like the first trade on the first Friday of the month is always–no matter what–the result of a payrolls report.
The week’s first report was the NFIB Small Business Optimism index. It’s going nowhere fast; it improved by 0.20% in September to 89.0. It bounced early in 2009 as small business owners saw their 201(k)s become 301(k)s. Since the index’s inception, the average has been 98.9; in 1986, the survey was recalibrated to a reading of 100. Other than a plunge in 1980 and 2009 the index has really never been at the current levels (92.0 was the low between the two plunges.) The index is comprised of ten components. The biggest improvements were in the following categories:
- Expect economy to improve
- Plans to increase inventories
Deteriorations were seen in the following:
- Plans to increase employment
- Expect real sales higher
Yuck. The introductory summary paragraph of the press release was along the lines of, “do you still pick your nose?”
The increase is certainly not a signficant move, but at least it did not fall. Still, the Index remains in recession territory. The downturn may be officially over, but small business owners have for the most part seen no evidence of it.
There is a wealth of information in the release, and you can see it by clicking here. For example, when asked what the most significant problem facing them, small business owners ranked things like this:
- Poor sales (30% of respondents; 24% a year ago) – 25% increase
- Taxes (23%; 24%) – 4% decrease
- Govt. requirements and red tape (16%; 11%) – 55% increase – if my ruler and eyeballs are working, that’s higher than anytime since 1998, but far below the approximate 28% high of 1995
- Competition from large business (6%;6%)
- Cost/availability of insurance (6%;8%)
- Other (5%;4%)
- Inflation (4%;4%)
- Quality of labor (4%;3%)
- Financing and interest rates (3%;4%)
- Cost of labor (3%;4%)
Ben Bernanke‘s biggest worry is deflation. In a speech today at the Boston Federal Reserve conference he said that, “inflation is running at rates that are too low,” relative to the Fed’s targets. I think my compensation is deflating, and I know my home has deflated. A word on semantics is probably in order here. It’s not just inflation and deflation from where the Fed sits; there’s also disinflation, which is a way of describing inflation that’s too low. It’s not outright year-over-year declines. However, on the line connecting inflation to deflation is disinflation. We’re presently at disinflation, and Ben & Company is intent on making sure we stop there.
I like Wordle because it makes cool pictures out of words. Occasionally, it says something. Here’s the Wordle picture from Chairman Bernanke’s 15-page speech (all Fed speeches are written beforehand). It looks like the desparate attempt of a man trying to jawbone an economy.
The Producer and Consumer Price Indexes released this week came in as expected, doing little to change the disinflation perception. On a year-over-year basis Producer prices are up by 4.0%, up by 1.6% when food and energy are excluded. Similarly, Consumer prices are up by 1.2% and 0.9% on the same bases.
- Initial Jobless Claims increased by 13,000 to 462,000.
- Empire State Manufacturing survey improved slightly from 4.1 to 6.0 (zero demarcates expansion/contraction)
- University of Michigan Consumer Confidence fell slightly. The Current Conditions component fell, while the Expected Conditions component rose.
Not much going on.
Key indicators to watch
- Industrial Production (September) – Monday
- Capacity Utilization (September) – Monday
- NAHB Housing Market Index (October) – Monday
- Housing Starts & Building Permits (September) – Tuesday
- Federal Reserve Beige Book – Wednesday
- Initial Jobless Claims (weekly) – Thursday
- Philly Fed (October) – Thursday
Graig Stettner, CFA, CMT
Vice President & Portfolio Manager
Tower Private Advisors