An editorial opinion
by Derek Vogler, CFA®
Vice President - Investments
November 14, 2013
Last month, news of a delayed tapering of the Quantitative Easing program was cheered by investors. Stock and bond prices both moved higher and rates came down, reacting to the continued easy money policy of the Federal Reserve. If you will recall, in June, Chairman Bernanke spooked the markets when he hinted that the program would soon begin to wind down. He never gave an exact date, but the inference was that changes would begin sometime in the Fall. Once the euphoria from the latest delay faded, market volatility began to increase as Fed governors hit the airways and reminded investors that the tapering decision was still imminent. But they hedged by saying it was totally dependent on economic data. In other words, if they didn’t see sustained strength in employment numbers or other signs that the economy was on firm footing, they would likely choose not to change the current pace of monetary injections. Conversations then began swirling about the actual reason for the delay. Is the economy worse than everyone expected? Was the decision made to give wiggle room to the new incoming Fed Chair (who we now know is Janet Yellen)? Or was this a preventative measure made in reaction to upcoming government talks that have now taken center stage? The Fed knew that a reduction in stimulus measures at the same time that Washington was struggling with a government shutdown and debt ceiling breach would not be well received.
With the QE decision postponed, investors have had more time to ponder the ongoing U.S. government shutdown. The shutdown confirms what most already knew – that our elected officials do not agree on what is best for our country. Constitutional purists could claim victory that the process is working just as it should, with both parties expressing their desires and negotiations ensuing. However, listening to news programs might lead to the conclusion that the end of the world was near and this sort of thing just doesn’t happen in the U.S. Not to diminish the issues faced by those directly impacted by the current shutdown, but this a relatively common occurrence. In fact, the government has endured 17 prior partial shutdowns in the last 37 years. Some would argue that this time is different since it is based on such a fractured partisan debate. However, most of the shutdowns in the past had similarly passionate, ideological views driving the shutdown. So yes, we have seen this before and it’s definitely not the end of the world. Assuming there is an agreement forthcoming, the overall impact should be relatively limited.
Throughout the year, the U.S. government releases batches of economic data, giving armies of economists and market strategists information on which they can base their forecasts and upcoming market guidance. Sometimes these releases fall on deaf ears. Recently, they have been closely watched and traders place their bets as soon as the data comes out. These reports, perhaps more than ever, are thought to provide insight as to what action the Federal Reserve will take regarding the Quantitative Easing (QE) program. When the September employment report came out weaker than expected, investors cheered because they assumed this would mean a continuation of QE for at least another few months. October’s employment report came in much stronger than expected. Interestingly, investors cheered again, this time because the economy was improving at a faster pace than previously thought so the Federal Reserve could begin to wind down the QE program more quickly. No, you don’t have to re-read the above two sentences. In both cases the stock market rallied, first when bad news was good for the market and later when good news was good for the market. Sometimes this is a strange business.
The U.S. non-farm payrolls for October suggest labor markets were beginning to heal prior to the government shutdown. The reported figures of +204,000 were much higher than the forecasted +125,000. In addition, the prior two months were adjusted up +60,000. While on the surface, these results appear relatively good, the distortion from the government shutdown and the impact on November’s figures are yet to be fully determined. Some of this impact was seen on the unemployment rate that ticked up to 7.3% during the month. As the markets contemplate the Fed’s next move, it’s important to remember that the stated policy is predicated on achieving a long-term unemployment rate below 6.5%. Until that level is reached, they have hinted that actions will be highly accommodative.
Other economic releases continue to paint a mixed picture about the strength of the U.S. economy. In the latest statement by the Federal Reserve, they highlighted consumer and business spending as showing some strength prior to the government shutdown, but they also noted that factory orders and housing have slowed. Overall, the messages conflict and suggest a continued cautious approach from the Fed. The good news is that inflation remains subdued at 1.2%. Since the other stated objective is to achieve a 2.0% inflation rate, the Fed should have plenty of flexibility to either extend the QE program further in the future or keep rates low for longer than originally expected.
The other big news this month was the long-awaited rollout of the Affordable Care Act (aka Obamacare). Initial demand for the new, government-sponsored coverage seemed to exceed expectations, but then problems with the website began to develop. In addition, reports of thousands of individuals being dropped from their existing plans have peppered the airwaves and forced some government officials to issue public apologies. Ultimately, all of these problems could be a big deal for U.S. consumers and businesses as it could re-ignite uncertainty about the law. Business owners and managers alike need to understand the rules or the tendency is to put off hiring decisions for another time. In an environment where significant economic growth remains elusive, this could be another obstacle for the continued recovery. The Department of Health and Human Services has vowed to have the system fixed by the end of November. If this does not happen, politicians will be scrambling to create short-term solutions before year end. This could be an even larger challenge since it would require cooperation in Washington’s politically fractured environment.
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