By Jerry Webman, Ph.D., CFA, Chief Economist for Oppenheimer Funds
After drifting lower for much of the week despite a string of encouraging data, stocks spiked higher last Friday after the second favorable monthly jobs report in a row. With bullish sentiment already elevated, equities (as measured by the S&P 500 Index) had struggled to continue the eight-week, roughly 7% advance that started in early October.(1)
With fewer bargains to be found, investors have likely been waiting to see the extent to which incoming data on the economy and corporate earnings justify the gains made so far. Additionally, investors continue to weigh the potential for positive economic news to raise the probability of a near-term tapering of the Fed’s large-scale asset purchase program (aka quantitative easing, QE) against the possibility that good economic news is simply good news.
On that score, I would argue that markets are now more sanguine than they were during the summer’s "taper tantrum." The Fed seems to realize that it bungled its communications leading up to the September taper-that-wasn't, and it has been making greater efforts ever since to assure investors that a taper decision will be both cautiously undertaken and heavily dependent on the tone of the economic data. Good economic news is therefore no longer necessarily bad (short-term) news for financial markets. Instead, a consensus seems to be building that a Fed taper decision will be, on balance, positive—as long as the economy is improving unambiguously. We view tapering when it does begin as different from Fed tightening because unlike a series of interest rate hikes, tapering should not generate a flat yield curve, which is the actual sign of restrictive financial conditions.
Two Themes to Watch
The November payrolls report bears on two themes I’ve been watching: The awaited return of “animal spirits” (the willingness of companies to take the risk of expanding through hiring and/or increased capital expenditures), and U.S. income and consumption trends.
With 203,000 new jobs created in November, the unemployment rate dropped to 7.0% for the first time in exactly five years. It was the 38th consecutive month of job gains, but the U.S. still has about 10.9 million officially unemployed workers, and about double that many if you include the underemployed and those who need a job but have given up looking for one. Unlike in many past monthly payroll reports, the unemployment rate dropped even though more people participated in the workforce than in the previous month (when shutdown-related furloughs caused many who were technically still employed to be considered out of the workforce during the reporting period). Over the past three months, nonfarm payroll gains have averaged about 193,000 and have, in fact, averaged about 195,000 for the past 12 months. Such a pace is probably enough to keep chipping away at the unemployment rate even as the population grows, but it remains far below the rate of improvement we’d normally see in a healthy recovery.
Companies remain hesitant to expand their workforces dramatically, even though surveys of hiring plans have tended to be promising. Similarly, many companies report plans to increase spending on new equipment, but capital spending has been even slower than employment to pick up in the current expansion. The animal spirits have yet to arise in force. Financial conditions remain supportive, but commercial and industrial loan growth has slowed recently. As we enter 2014, I’ll be looking for capital expenditure growth increasingly to converge with employment growth as a sign of those spirits’ return.
In a week of generally strong data, manufacturers provided a boost with the release of the Institute for Supply Management’s (ISM) Manufacturing Index, which continued a string of recent gains by hitting its highest level in 2½ years. The index rose to 57.3 from 56.4 the previous month, with 50 representing the dividing line between expansion and contraction. New orders, the most important forward-looking component, were quite strong at 63.3, as were export orders and backlogs. Employment growth is picking up, and the strong new orders component should help keep production robust.
Within the manufacturing sector, automakers reported exceptional sales in November, with sales of domestically-made autos tracking at 12.8 million on a seasonally adjusted annualized rate, and total auto sales hitting 16.4 million on the same basis—the best level since early 2007. Discounts and incentives played an important role, but the strong data clearly point to a greater willingness and ability among Americans to replace their aging vehicles with new ones.
State of the Consumer
With an increasing number of Americans able to find work, consumption—the backbone of the economy—is rising at a modest pace (0.3% month-over-month in October; just over 2% year-over-year), even though personal income remains soft. Very low inflation (especially lower energy prices) is certainly helping consumers to maintain their buying power, as is rising consumer credit.
Consumers’ gradually growing ability to spend and borrow is helping support the housing market, which in turn continues to contribute to U.S. growth. Despite muted payroll and income growth, for example, new home sales shot up 25.4% in October, ending a lull that began last summer as interest rates spiked. And while consumers’ outlook darkened substantially during the government shutdown this fall, consumer sentiment is improving once again. According to the latest data, released last week, the University of Michigan's Consumer Sentiment Index hit 82.5 in early December compared to 75.1 in mid-November and 72.0 at the beginning of that month. Views on current conditions were the strongest they've been since July.
The strong pace of growth in the third quarter—3.6% as of the latest estimate—may moderate, since much of that strength came from inventory builds. Overall, however, I believe the economic data we’re seeing point to a continuation of modest growth and low inflation as we move into the New Year. If 2013 is any guide, that may be enough to please financial markets, while allowing the Fed to ease off QE gradually.
ECB to Remain Accommodative
The Fed’s counterpart in Brussels remains in a similarly accommodative stance. European Central Bank (ECB) President Mario Draghi stressed last week that the bank remains ready to act, if necessary, to support the still-struggling Eurozone economy. There has been some question as to the extent of the bank’s dovishness amid paltry growth and signs of disinflation within the currency bloc, and Draghi stopped short of announcing any new monetary stimulus at the ECB’s final policy meeting of 2013. Still, he left open the door to the possibility of future long-term loans to banks beyond the €1 trillion in such loans the bank has already made. He indicated that other supportive measures could also be on the table, if needed. A fragile recovery is emerging in the Eurozone, as evidenced by a spate of economic “green shoots”—rising household consumption and renewed export growth in some of the peripheral countries, for example. But Europe’s recovery still has a way to go, making the ECB’s continued support critical, unspecified though it may still be.
(1) Bloomberg, 12/6/13. The S&P 500 Index is a broad-based measure of domestic stock market performance. The index is unmanaged and cannot be purchased directly by investors. Index performance is shown for illustrative purposes only and does not predict or depict the performance of any investment. Past performance does not guarantee future results.
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