19 Oct 2010 Investors Overreact
Yesterday’s rally of nearly 1.5% brought the US equity market halfway back from its 3% decline dealt largely on Tuesday over concerns China’s growth may be slowing. A similar drop in Treasury bonds also rattled investors as they feared the Fed’s $600 billion bond purchase program designed to stimulate the economy would spark inflation. Investors sold US government debt driving some yields their highest levels in more than three months. The 7-10 year Treasury index is down a little over 1% for the week as of yesterday’s close.
Both reactions seem overdone. Treasury buyers have been anticipating (and buying) for weeks in anticipation of the Fed’s Quantitative Easing program. Officials have openly shared their plans with the market, so the run-up in prices is completely understandable. It should equally understandable that prices would not climb to the sky. At some point there would be a sell-off and that point was when the Fed announced the details of its plan. Traders are known for “buying the rumor and selling the news.”
If the rout in Treasuries was powered mostly by traders, then the fundamentals will eventually take over. There are signs the economy is picking up, but it is highly doubtful that growth will be sufficient to reduce unemployment or spark inflation any time soon. Fed governor Janet Yellen said last week “I’m having a hard time seeing where really robust growth can come from, and I see inflation lingering around current levels for a long time.”
The government announced two key metrics on inflation this week and both were below expectations. Prices at the producer level held steady at 0.4% in October, coming in significantly below the consensus forecast for a 0.8% increase. At the core level, the PPI surprisingly fell 0.6%, down from a 0.1% gain in September and coming in lower than the median forecast for a 0.1% uptick.
At the consumer level inflation worsened marginally, but less than forecast. The overall CPI in October posted a 0.2% gain, following a 0.1% rise in September. Market consensus was for a 0.4% gain. Excluding food and energy, CPI inflation was unchanged for the third month in a row. Analysts had projected a 0.1% rise for October. Year-on-year, overall CPI inflation increased to 1.2% (seasonally adjusted) from 1.1% September. The core rate in September slipped to 0.6% from 0.8% the prior month.
At the retail level the consumer is gradually coming back. Overall retail sales in October jumped 1.2% after gaining 0.7% in September. The result was significantly better than analysts’ projections for a 0.7% increase. Autos explained the biggest portion of the increase, but other components still managed a 0.4% increase following a 0.5% rise in September. Getting the consumer back on board will be huge for the economy’s recovery. Hear that Washington? Keep the tax cuts!
Manufacturing, which has sustained the recovery from the beginning, may be showing some signs of fatigue. The New York Fed’s report which often serves as a bellwether for the national manufacturing came in considerably weaker than expected. November showed a month-to-month decline in new orders of minus 24.38, together with an equally significant decline in unfilled orders, at minus 24.68. Shipments also fell at a very steep 25 points to minus 6.13 in the month, the workweek fell to a minus 12.99.
Fortunately however, Tuesday’s report of Industrial Production showed that manufacturing on a national basis rose quite nicely with and without autos. Overall production was unchanged in October, but that was largely due to a sharp drop in utilities’ output. Manufacturing increased by a strong 0.5%, following an upwardly revised 0.1% rise in September (previously a 0.2% dip). Excluding motor vehicles, manufacturing rose 0.5%, following a 0.1% increase the month before. The output of durable goods increased 0.9% and nondurable goods moved up 0.2%.
Data on the housing market was mixed this week with few clues of improvement anytime soon. The home builders’ housing market index rose one point in November to 16, a gain offset by a one-point downward revision to October, as reported by Bloomberg. The traffic component rose one point but stands at an anemic level of 12. Buying expectations rose two points to a 25 level that leads the data. The current buying component is unchanged at 16.
Housing starts fell October by 11.7%, following a revised 4.2% decline the month before (previously up 0.3%). The dip in October was led by a monthly 43.5% plunge in multifamily starts, following a 19.2% decrease in September. The single-family component slipped 1.1% after edging up 2.1% the prior month.
Permits edged up in October, rising 0.2% after declining 4.2% in September. Overall permits came in at an annualized rate of 0.550 million units and are down 4.5% on a year-ago basis. The rebound was led by the single family component which was up 0.5% while multifamily permits eased 0.7%. Due to continued concern over excessive supply which is likely to increase through pending foreclosures, homebuilders remain extremely cautious about new construction with starts holding at record lows.
The Conference Board’s index of leading economic indicators for October showed a .5% increase mirroring last September’s revised increase (revised from plus 0.3%). A wide yield spread is the largest contributor to the increase, enhanced by the Fed’s quantitative easing. A rise in money supply, also related to QE2, is an increasingly significant plus. In the real economy, strength in the factory workweek continues to provide a significant lift in manufacturing.
As of this week 483 of the S&P’s 500 companies have reported their earnings which are on track for a 23.5% increase over last year. A whopping 70.5% beat analysts’ projections indicating businesses are running efficiently and profitably. If domestic and global demand endures, they are presumable highly competitive and ready for the next wave of growth. Confidence boosters like GM’s successful initial public offering and Cisco’s addition of $10 billion to an already huge $72 billion stock buyback program serve to let investors know, optimism is out there.
Markets and our office we will be closed Thursday for the Thanksgiving holiday. We will be open Friday morning and close at 1:00 pm. Have a nice weekend and a wonderful Thanksgiving.