04 Nov 2016 We Will Go On
As the election draws near, stock and bond markets have been divided as to the significance of the outcome. A Trump victory injects policy uncertainty – something markets generally dislike. And a Clinton presidency provides more policy certainty, but with recent revelations from the FBI, a high probability of constitutional embranglement.
The two players in the capital markets are sending separate signals. As Trump’s chances have improved, stocks have sold off 2.5% during the last seven days. The Chicago Board of Option Exchange’s Volatility Index, (left chart below) a measure of implied stock market swings, has reached its highest level since June.
Bond traders, on the other hand, show little if any concern over the outcome of the presidential election. As demonstrated in an article in today’s Wall Street Journal, the Merrill Lynch Option Volatility Estimate index (right chart below), which uses options to measure the implied swings in interest rates over the next month, is hovering near record lows this week. It was last at 66.9 on Wednesday, up slightly in recent days but down from 70.3 five months earlier. It’s lower than on 85% of days over the last 12 years.
Some suggest that the bond market may be predicting a victory for Clinton, but the more likely reason is that bond investors look considerably further into the future than do stock investors. As Ralph Axel of Bank of America says, “near-term events will not create substantial and lasting market moves.”
Today the Labor Department reported that non-farm jobs increased by a seasonally adjusted 161,000 in October from the prior month. According to the WSJ, the unemployment rate, derived from a separate survey of American households, ticked down to 4.9% last month from 5% in September because the labor force shrank. The labor-force participation rate edged lower, to 62.8% in October from 62.9% the prior month. Hiring over the past three months averaged 176,000 per month, slower than the pace of 181,000 per month in 2015. The chart below bears this fact out.
A bright spot in the report was that average hourly earnings for private-sector workers rose 2.8% in October compared with a year earlier, the strongest annual wage growth since June 2009. The increase provide the Federal Reserve more cover to raise rates at its next policy meeting in mid-December.
On Wednesday, the The Fed said it “judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress toward its objectives.” Fed Chair Janet Yellen, speaking to both of the Fed’s mandates said “although the unemployment rate is little changed in recent months, job gains have been solid.” She also welcomed the tightening of the job market as evidenced by improvements in the labor participation rate this year, without generating intense pressure on wages and prices due to inflation. She said “We’re not seeing strong pressures on utilization suggesting overheating, and my assessment would be, based on this evidence, that the economy has a little more room to run than might have been previously thought” before rates need to rise.
Third Quarter GDP
The US economy expanded at 2.9% in the third quarter of 2016, higher than the 2.5% expected by economists. It was a substantial bump from the second quarter’s 1.4% and marked the strongest quarter of growth in two years, according to the WSJ. Individual components of GDP were as follows: Consumers didn’t help as much in third with spending slowing to a 2.1% annual growth rate from the second quarter’s robust 4.3% reading. But in all personal-consumption expenditures added 1.47% to the quarter’s total GDP, according to the Commerce Department. Business spending rose modestly and added 0.15% to GDP, while rising inventories contributed 0.61%, reversing their drag on the economy for the previous five quarters. Net exports surged 10% to add 0.83% while housing shrank for the second straight quarter to pull 024% from GDP. Government spending added a modes .09%.
Third Quarter Corporate Earnings and Valuations
According to Factset’s latest earnings release report, dated October 28, 2016, with 58% of S&P 500 companies reporting Q316 earnings so far, 74% have reported earnings above the mean estimate and 58% have reported sales above the mean estimate. In aggregate, companies are reporting earnings that are 6.7% above the estimates. This percentage is above the 5-year average of +4.4%.
In forward guidance for Q416, 36 S&P 500 companies have issued negative EPS guidance and 21 S&P 500 companies have issued positive EPS guidance. The forward 12-month P/E ratio for the S&P 500 is 16.4, above the 5-year average of 14.9 and the 10-year average of 14.3.
According to Factset, the upside in earnings surprises to date have led to a $10.1 billion increase in earnings for the index since September 30. All eleven sectors have contributed to the increase, however, the Financials sector has been the largest contributor adding $3.6 billion.
Following the most bizarre, unsettling, and sorrowful elections in modern times, our country will pick up once again on Wednesday November 9th to go about life. While there doesn’t appear to be a Kennedyesque or Reaganesque upswing in our nation’s mood coming anytime soon, our institutions and economy will go on. Both Trump and Clinton bring unprecedented uncertainty in policy and constitutional law, respectively, but we can take comfort in the resiliency of our governmental institutions and our economy. While America is far from a “shining city on a hill” our hopes for that ideal will not die November 8th.