Keeping the Powder Dry
All eyes were on the U.S. Federal Reserve and the European Central Bank (ECB) this week, but both failed to deliver the immediate monetary gratification investors sought. Speculation swirled that the Fed would decrease interest on excess bank reserves held with the central bank, lengthen its forecast period for zero percent short-term rates, or possibly announce QE3. While Wednesday brought none of the above, investors were somewhat assuaged by the Fed’s post-meeting statements indicating heightened vigilance about combating further economic malaise. Simply put, the Fed is likely to act if job growth doesn’t pick up.
Stocks Ascend the Podium
So what about the employment picture for July? Clear as mud. Friday brought better news from the non-farm payroll report, which showed net job gains of 163,000. Government agencies once again cut jobs, but this was offset by improving private payroll gains. However, the parallel household survey of employment used to derive the unemployment rate showed jobs declining by 190,000 last month. As a result, the reported jobless rate rose to 8.3 percent. While July is a slow month for retail sales, the nation’s cash registers were busier than last year, as monthly same-store sales outpaced estimates and rose at a faster pace than in June. This could be an indication of better back-to-school sales in August, which is a significant month for retail. With July’s ISM report once again showing contraction in domestic manufacturing, investors are left to ponder the Fed’s next move. If economic data in the interim remains moribund, our best guess is that Bernanke will jawbone vigilance later this month at the Fed’s annual confab in Jackson Hole, and announce some additional monetary stimulus at the September Federal Open Market Committee meeting. Markets responded enthusiastically to the headline jobs number, reversing losses from earlier in the week to end the period with modest gains. True to recent form, Treasury bonds pulled back, with the benchmark 10-year Treasury trading down to yield 1.58 percent.
Actions Speak Louder Than Words
As for Europe, who could really be surprised by ECB Chairman Mario Draghi’s lack of follow-through from last week’s admonition that it would do “whatever it takes” to support the euro? Investors apparently, judging by the market reaction. Spanish and Italian debt prices plunged anew following equivocation from the ECB; countries like Italy and Spain will need to apply for aid from the Euro zone bailout fund as a condition for potential ECB open market purchases of their troubled debt. Faced with well publicized German criticism of quantitative easing and necessary agreement from finance ministers across the currency bloc to enact it, the ECB once again finds itself in a policy straight jacket that will limit its ability to employ blunt force monetary policy in a timely manner.
Following more than 500 additional reports domestically this week, earnings season now winds down. While we’ve yet to hear from the retailers who will report later this month, companies in general are making earnings numbers by keeping strict control of costs and using excess cash flow to repurchase stock. Amid an economy growing nominally at 3 to 4 percent, revenue gains are increasingly difficult to come by.
Our Takeaways from the Week
- Central banks disappointed investors who were anticipating additional monetary stimulus
- Stocks remain resilient because of their attractive valuations and their dividend yield in this low interest rate environment