NOTE: Content was written on 11/4 and posted 11/7. Certain events already took place.
I hope everyone is ready for winter. It is coming. We had our first snowflakes of the season last Friday along with massive waves on the lakefront which ruined the walking path.
THE KEY ECONOMIC LANDMARKS WE PASSED
Pending home sales are a noisy number to follow, but there was an interesting piece of information within the information. According to the real estate agents who were surveyed for the index, approximately 15% of the deals they were involved with did not close due to the buyer not being able to secure lending. Credit remains tight, however, there are signs we could see looser practices coming. Two weeks ago, regulators decided to remove a requirement for a 20% down payment in order to obtain a high-quality mortgage. Fannie and Freddie followed with an announcement that buyers could obtain lending for as little as 3% down. Hopefully the mortgage industry can contain itself this time around and not offer no money down, no proof of income loans.
Housing prices continue to moderate as the industry recovers. Monthly changes in the 20 city Case-Shiller composite have fallen sharply since March. The YoY change falls lower as each month passes, which means we are out of the bottom zone and will likely not see double digit gains in the future. As long as employment stays healthy, wages inch up, and lending loosens; softer prices should bring more buyers to the table.
2. Durable Goods: -1.3% vs. 0.5% est.
The headline number paints a worse story than the underlying data. Excluding the transportation sector, orders slipped 0.2% in September. The majority of the top level decline was attributed to a 3.7% decline in transportation orders. Business investment was weaker (-0.2%) so we will keep an eye out next month to see whether the trend is reversing or if spending cooled off after large increases earlier in the year. Growth on an annual basis appears to be strong. For now, we will consider the trend to be intact.
3. Q3 GDP: 3.5% vs. 3.0% est
We are starting to look a lot better on an annual basis than we thought we would, especially given Q1’s issues. We still are stuck in the low-2% YoY growth environment though. The last two quarters certainly help to bring us up to this level from where we stood in the spring but how do we move past it? QE ended and the global economy is consistently shaky. Where do we go from here? The U.S. economic engine appears to be catching its wind again, but it has been a slow and painful process. Q3 experienced growth from personal consumption, exports, and government spending. Inventories negatively contributed which was expected after a 1.42% increase in Q2.
4. Quick Hits
- Chicago PMI: 66.2 vs. 60.0 est. – Manufacturing looking strong!
- QE3 End: Monthly pace reduced to $0B from $15B
LAST WEEK’S MARKET IN THE REAR-VIEW: “Less Tricks, more Treats”
If you pulled a Chicken Little on October 15th, you’ve probably had to blink twice last week if you looked at the S&P 500 Index’s closing price for the month. October was one of those months you should have only looked at the first day and the last day. If you paid too much attention to the in-between, you might have panicked. What appeared to be a straight shot down mid-month turned into a month of almost 2.5% in gains for the Index. On absolute point basis, the S&P 500 took a 150+ point dive to the lows and then recovered nearly 200 points to give a open-low-close range of around 350 points. In a reverse course of the action seen most of the year, small caps lead the way with mid caps and then large caps trailing behind. The Russell 2000 Index (i.e. small caps) flew to a 6.5%+ return on the month to bring the gap between large and small cap stocks to a much narrower 8.3% from a high of 12.6% reached early in the month. The question to answer now is “Why did we rally?” There are plenty of reasons to give here and I would not feel comfortable pinpointing a specific headline or event. Corporate earnings were good, Japan looks to be entering into more stimulus, the Fed here seems to still be on course for a mid-2015 rate hike, news from emerging and developed markets were better, investors bought the dip, etc, etc.
LOOKING THROUGH THE WINDSHIELD
A good chunk of the data is already out for the week but many reports remain on the schedule. Nonfarm payrolls will be a big focus on Friday as well as other employment numbers (wages, participation rate, etc.). I doubt we will see runaway wage inflation, but the market is jittery right now when it comes to rates so there are a lot of eyes on those types of numbers. ISM Non-manufacturing will notch another month above 50 and get closer to 60 consecutive months in expansion territory.
A week of muted price movement would do us all well. I think we could use a breather after October’s wild ride. Time to reset, look to the future, and move forward with what is increasingly looking like a solid domestic economy. Keep a watch out for the dispersion between large, mid, and small cap stocks. We are firm believers of mean reversion here. Large caps could pull in or stay flat while smaller company stocks move higher. Fears about a higher USD impacting earnings for large multi-national companies will continue to give reason to buy small.