Weekly Update: Kicking the turkey down the road
For the first time in my life I have been in Canada two weeks in a row. This week, I traveled to Toronto where, just as last week, Canadians were talking about the dysfunctional U.S. government. Watching the local news program, I listened to a story entitled, “The debt ceiling and you’’ ... “you” meaning the Canadian citizen. The story noted the U.S. is Canada's biggest trading partner and that a default could trigger a global recession as bad as or worse than 2008. “This is a high stakes game of chicken which doesn’t need to happen,” the expert said. “The USA has a history of brinkmanship and last-minute deals.” And the likely result will be an agreement to delay the difficult decisions for another six weeks, effectively “kicking the can down the road.” Here I had to laugh, as this non-technical term is one I use daily to describe D.C. and its effects on the market. The story finished with the expert quoting Warren Buffett as saying that "The USA will come up to the line of idiocy and not cross it.” Our Canadian friends are laughing at us. There is still some uncertainty regarding the path forward as most congressional Democrats want nothing less than complete capitulation from Republicans. But the Obama administration is showing a willingness to give Republicans a face-saving exit. And significantly on the Republican side, defunding Obamacare does not appear to be a condition for the debt-ceiling deal. This could be because a new NBC/Wall Street Journal poll found approval of GOP at a record-low 24%. The latest Gallup poll also shows the two highest-profile leaders of the GOP’s “Defund Obamacare'”effort, Ted Cruz and Mike Lee, have suffered a sharp fall in popularity. A possible six-week reprieve undoubtedly would be a relief for markets if it happens, but this will be tempered by the fact that we may have a repeat nearer Thanksgiving if a broader budget deal can’t be reached. So it’s kicking the turkey down the road perhaps. Perhaps 1 a.m. is the new midnight.
Altogether, the FOMC minutes from last month’s “no taper’’ meeting characterized the decision as a “close call” and consistent with the idea that policymakers exited with the idea that, based on their outlook for the economy, the FOMC would likely taper later this year and end purchases around mid-2014. This is consistent with expectations from our various sources that the Fed will begin slowing purchases at the upcoming December meeting. But the ongoing federal government shutdown/debt-ceiling showdown could push the tapering decision into 2014, when Janet Yellen assumes the chair. Even though her confirmation would represent policy continuity for markets and signal that supportive Fed policy would likely remain in place, significant turnover in both the policy-setting FOMC membership and its voting composition lies ahead. While the markets expect Yellen to advocate for a dovish policy—her speeches suggest she’s acutely focused on the long-term economic damage inflicted by extended periods of labor market slack—she will need to integrate the views of newly appointed members to the FOMC. That said, the chair of the Fed historically has been granted a significant amount of leeway by the rest of the committee in setting of monetary policy and there’s little reason for this to change in a Yellen-led Fed. Another argument for delaying tapering until 2014 comes from Encima Global Research. It notes even after the government reopens and releases data, the Fed will want to assess the full impact of the shutdown. Some of the GDP effect won’t show up until December, with the data not reported until January and February, giving the Fed an excuse to continue the current pace of bond buying well into the New Year.
Despite the intense rhetoric, the relative calm in markets before Thursday’s breakout over a potential can-kicking deal reflected the reality that fiscal uncertainties currently are less than in 2009-2012. There’s no risk of broad increases in tax rates; the fiscal deficit is declining so a major downgrade of the U.S. credit rating is unlikely; and the August 2011 debt limit increase disclosed some of the boundaries (e.g. that U.S. bond yields would fall in a crisis, not rise). Even though Thursday was the second-best day for equities this year, we could still have a bit to go on the post-shutdown showdown bounce. That being said, given the level of market valuation and the mixed macroeconomic data, market returns will be earnings dependent once the fear of default has been completely unwound. On that front, S&P 500 earnings per share are expected to exceed 2007’s peak by 25% next year—by comparison, equity prices are only 8% above their 2007 high. In other words, 17% of the incremental EPS gains are not yet reflected in valuations. Moreover, the IBES diffusion index of S&P earnings revisions, which captures the percent of companies whose earnings have been revised up minus the percent revised down, has turned up recently, suggesting real GDP continues to reaccelerate. The 2014 consensus for real GDP is around 3%, a level more or less necessary to meet earnings expectations and to push multiples higher. As a person who travels every week, I often wake up in the morning and turn on the TV before getting out of bed. Thursday morning, the news commentator warned us to get ready as Thanksgiving Day is on Monday. Well, a shiver of panic hit me; my husband and I are hosts to the family event this year and the house is not ready! Wait a minute, I'm in Canada—let’s find some coffee and get the brain going. (BTW, they serve turkey here as well.) I better get back to the USA for my travels. Still, I love to visit our neighbors to the north, who remind me that while baseball is America's pastime (better luck next year, Pirates), hockey is too much fun. Let’s go Pens!
NFIB gauge holds steady September’s monthly National Federation of Independent Business gauge remained near post-recovery highs, slipping slightly on a decline in respondents who expect the economy to improve even as the percentage expecting higher sales rose. While small business confidence has held relatively steady the past few months, the government shutdown poses a significant downside risk—the debt-ceiling debate in summer 2011 and the fiscal-cliff issues near year-end 2012 contributed to sharp declines in confidence.
Q4 GDP could surprise If you toss out the latest weekly figures because of their statistical quirks (more below), jobless claims have made a 15-year technical downside breakout, a move historically associated with a change in the perception of the economy, ISI observes. This suggests if Washington puts its mess behind it and economic data improves, the perception of the economy could quickly shift to the positive. And the year-over-year data should start looking better given activity was hard hit in late October/early November 2012 by Sandy. Elsewhere, Deutsche Bank notes capex confidence is rising and unlikely to be derailed by budget fights, while U.S. ports container data showed year-over-year export traffic grew in August by its fastest pace in two years.
It’s still the early innings in single-family housing recovery While single-family sales and starts have bounced off the bottom, they remain at historically low levels. The gain in residential construction to date has been driven by a larger rebound in multifamily building, owing to the increase in the number of renters and rising rents.
Shutdown cuts into confidence Americans' confidence in the economy deteriorated more in the past week during the partial government shutdown than in any week since the Sept. 15, 2008 Lehman Brothers collapse, Gallup said, putting confidence at its lowest ebb since the recession and financial crisis. The IBD/TIPP optimism index also plunged to its lowest level since August 2011, the date of the last debt-ceiling debacle. The IBD/TIPP drop-off sparked fears October’s initial Michigan sentiment gauge might plunge given the two indices’ high correlation, but it fell less than expected; though at 75.2, it’s still at its lowest level since January.
Consumer credit reflects cautious consumer Even before the shutdown cut into their confidence, consumers appeared hesitant to spend. While August consumer credit outstanding rose to a more than expected $13.6 billion, almost all of the increase was tied to surging student loan debt. The revolving component that includes credit cards fell a third straight month, the longest losing streak in three years.
Don’t read too much into jobless claims spike They jumped by 66,000 in the latest week to 374,000, the largest increase since Hurricane Sandy. The Labor Department cited continued distortions associated with California's computer system switchovers, which reportedly accounted for about half of the increase, and layoffs of non-federal workers impacted by the shutdown, which it’s estimated accounted for about 15,000. Adjusting for these two special factors would put the level of initial claims just a bit below its four-week moving average as of the last week in August, before California's processing problems began to distort the series.
We love the income story In a recent trip, I met an advisor from the state of Washington who asked if he could tell me about his business and get my reaction. He has three buckets that he describes to his clients: cash, income (not just fixed) and growth. He tells his clients not to watch the income bucket go up and down with the market. This is for yield, he tells them. This is your income! The bucket holds corporate bonds (he avoids government bonds, saying that he watched the white-haired ladies pull their hair out as interest rates rose five times in the last cycle) and dividend-paying stocks. Yes! Yes! (Check out our Investor Mindset Survey.)
Wouldn’t that just be a waste of good beer? Watching more TV in my hotel room, I saw a CNN interview with a beer billionaire who said that with all the new offerings, this is the best time in history to be a beer drinker. However, the government shutdown is affecting the industry as new beers that are ready to be brought to market can't get the required approval, nor can new breweries be opened. “We may have to dump beer!” the billionaire quipped. “Perhaps we should send some 6-packs to our leaders in D.C." In a related note, on my way home from Toronto, I sat next to a young man with friends in D.C. politics. He says that while the shutdown is in effect, senators have to pay double at bars, while for the rest of the government workers, it's always happy hour.
Could it be déjà vu all over again? This from ISI: 2013’s economy has a similar amount of labor market slack to what it had in 1982. And through early 2013, the stock market had been unchanged for 13 years, similar to the 13-year stall that ended in 1982. Hmm.