Weekly Update: 'The True North strong and free'
I had the pleasure of traveling this week out of the U.S., where Washington politics is currently being criticized as being worse than that of Italy. I visited Vancouver for the first time in my life, which was exciting. The first thing I noticed stepping out of the airport was the clean, crisp air. Driving in, I saw charming neighborhoods and shops. Then, crossing the bridge, was a downtown filled with high-rise living and business buildings. Owing to our meeting schedule, I couldn’t explore this city. Too bad, because a frequent American visitor to the area suggested “there is no more beautiful place on earth.” If I were to summarize my encounters with the people of Vancouver, from the hotel staff to waiters, clients and people on the street—without exception, in one word it would be “gracious.” I can't wait to return. I’ve always liked Canada’s national anthem and particularly the line that entitles this piece. It’s patriotic, strong, unifying—qualities that seem to be lacking in Washington. Government shutdowns historically have not been market-moving events, but this is the first for many members of Congress—and it is different. Unlike past budget deliberations, there are no real discussions going on between party leaders. There are a few natural deadlines to consider as the shutdown enters day four. Watch to see if Congress remains in session over the weekend, an indication they may try to hammer out a deal. Another deadline would be next Friday, when Congress is due for a one-week recess for Columbus Day. Then there’s Oct. 17, when the Treasury expects to exhaust its borrowing capacity under the debt limit.
The debt ceiling increasingly is being linked to the shutdown. But the core of the current standoff remains the effort by the Republican’s Tea Party faction to undo Obamacare. One irony is that while the law has had a big impact on employment, the effects are largely behind us. Because of its look-back provisions, whether people are counted as full- or part-time is not based on how many hours they work the first week the mandate is in effect, it is based on their hours the prior year. As a result, most employers already had taken steps to comply—and cut hours—even before the Obama administration delayed the employer mandate for a year. For investors, the bigger issue may likely be the cost of health care for those in the individual market, which is estimated to go up 30-40% on average. This is what gets to the long-term viability of the exchanges that opened this week. If there is a stable risk pool, i.e., if healthier young people sign up, investors shouldn’t expect significant changes for at least the next three years. If it’s not stable, the law could be altered after the midterm elections. Watch the polls. The latest "generic ballot" polling during the shutdown suggests an uptick in support for Democrats for 2014’s election. As we watch the theatrics, keep in mind that this is probably the most important consideration for politicians. Meanwhile, analysts have been left playing a guessing game on the shutdown’s impact. Tuesday’s construction spending report for August and Thursday’s report on August factory orders, both inputs into GDP tracking, were put off, as was today’s report on September nonfarm jobs. Next week’s August trade balance report, August wholesale inventories report and September’s retail sales data hang in the balance.
Washington could be the catalyst for a market in need of further consolidation before it can support a sustainable advance into new high ground. ISI notes the internals look good (cyclicals are holding up vs. defensives, small caps still near the highs, etc.,) and inflation expectations have held up as well. It is good news that the forward growth outlook has not yet been impacted much by the shutdown. But yesterday’s 1% decline for the major averages was the worst session in some time, with the Dow and S&P 500 testing key uptrend lines. When the Executive branch publicly refuses to negotiate with one side of Congress and the Senate refuses to negotiate with the House, the House is left with nothing—and thus nothing to lose by refusing to raise the debt ceiling. That's the near-term risk for stocks, a better-than-expected rally in Treasuries and a good reason for Fed policy to simply go on hold until the next Fed chair is named and passes congressional muster. A debt-ceiling deadlock would get the VIX into position for a low risk buy on U.S. stocks, though the risk for those with dry powder is this is the commonly held view. It’s estimated every $100 billion of QE translates into 40 S&P points, which translates to about 1,800 by year-end. At our first dinner in Vancouver was an advisor who looked just like Sidney Crosby. Was it my imagination there in Canada where all the TVs above the bar showed hockey? Who cares, the Pirates were in the midst of their first playoff game in 21 years and I was nowhere near PNC Park! So the very friendly bartender turned the channel to the end of the Pirates game, which we won! I know it will be tough as we advance, but for now, Beat ’em, Bucs!
Manufacturing should add to Q3 GDP September’s manufacturing ISM unexpectedly rose to 56.2 as both production and employment improved, the latter to its highest level since June 2012. The reading put the quarterly average at 55.8, which in the past has been consistent with 3%-plus real GDP growth. In all, this was a very encouraging report and suggests that Q3 was a solid quarter for manufacturing. Several regional readings also were much better than expected as the Chicago PMI rose a third straight month, the Milwaukee manufacturing index reached its highest level since February and the Texas manufacturing gauge expanded at its fastest pace since February 2012.
More evidence of a synchronized global expansion in September China’s service PMI rose more than expected to 55.4, the final euro-zone PMI was revised up to 52.2, European retail sales slipped just 0.3% year-over-year vs. expectations for a 1.5% decline after August’s 1.3% drop, and the UK service PMI remains at very high levels of 60.3.
This is where our focus should be Strategas Research thinks we may be in for an upside surprise in the Q3 earnings season that kicks off next Tuesday, abetted by the aforementioned evidence of an accelerating synchronized global expansion. It notes the preannouncement ratio (negative to positive earnings preannouncements) rests at an extremely high 5.2. History has shown that such high readings and low expectations lead to outsized gains in the market during the reporting period. JP Morgan notes that as we head into earnings season, the S&P is trading at 14.3 times forward earnings vs. the 15-year average of 16.3 times.
ISM services disappoints It was expected to fall to 57 from August’s 58.6 reading, which was its highest level in nearly eight years, but came in at a much lower 54.4. This put the index back at levels in the center of the range seen over the last two years, as both business activity and employment fell and new orders edged down. On the plus side, the report doesn’t add any pressure on the Fed to begin tapering. Kick the easy-$ can.
In the absence of a government, this is your jobs report ADP estimated private payrolls rose 166,000 in September, a bit below consensus, implying job growth continues to advance at a sluggish pace. Tax withholding receipts for the third quarter also were consistent with monthly gains in the 180,000 range. However, the latest weekly jobless claims held at six-year lows and have been trending down more rapidly since mid-summer, and ISM employment measures are suggesting a faster pace of growth. Within the ADP report, small-business employment—which is nearly double large-business employment—continued to make new highs. Overall, the data indicates the labor market’s improvement is not sufficient to justify tapering at the Fed’s October meeting. Kick the easy-$ can.
September auto sales slippage not as bad as headline Vehicle sales slowed to a below-consensus 15.3-million annualized, down from August’s 16.1 million rate. The timing of Labor Day seems to be at play—it came earlier than normal this year, pushing the typically heavy-volume holiday sales into August at the expense of September. Averaging out the two months, vehicle sales ran 15.6 million annualized sales rate, still above the Q2 average.
We’ve seen worse in Washington The Institutional Strategist shares that over the 200-year plus history of America, the type of political theater, name calling, hyperbole and downright stupidity has been seen before. If you think the atmosphere in Washington is acrimonious today, take a look sometime at the campaign ads run by the opposition during Jefferson’s run for the presidency or the names Lincoln was called—sometimes by members of his own party. Republics are a messy thing, but in the end, it is precisely the kind of turmoil we are seeing now in Washington which produces a cathartic effect on the nation and has often produced the man for the hour. Cometh the hour, cometh the man is the old phrase. Confidence can be a fragile thing and right now, the S&P has been the repository of a lot of investor confidence in America. If that confidence takes a hit, so will the S&P.
A few things I learned about Canada … 80% of the Canadian population lives within 100 miles of the U.S. border. Do they ever explore the rest of their huge country? Not for long, as the weather can be extremely cold in the wintertime (-40 degrees, I was told), and in the summer there are too many bugs … Canada is the No. 1 source of energy for all 50 states—this includes hydro, oil and natural gas reserves. (Didn't know that? My hosts suggested that is because they're such “nice guys.”). The oil sands are No. 1 for oil in the world.
… and that was one fun last dinner! We hosted two advisors and their wealthy clients, a restaurateur, pilot, lawyer for the entertainment industry and several engineering consultants at our last night in Vancouver. The dinner featured lots of toasting and colorful language. I knew it would be too much fun when the advisor opened the “meeting” by having each of us introduce and say something unique about ourselves, and say something nice about one of the people in the room. Oh, but you must look into his eyes or there will be seven years of bad …, you know. As the only woman in the group of “western guys” (this is how they think of themselves and they feel very strongly about it), I was apologized to numerous times for the colorful language. No need, I had a great evening.