Economic Notes – November 12, 2012


Written by: Jon McGraw

The election was the big event this week, and it happened to be a light week for economic releases.

Non-Manufacturing ISM was a bit weaker than expected at 54.2 in October versus an expected 54.5. Some parts of the report were weak, such as forward-looking new orders and business activity, but employment strengthened. The ISM mentioned that Hurricane Sandy had no large impact on the Oct. report, but will end up affecting the Nov. figures. Stay tuned.

Initial jobless claims came in at 355k for the Nov. 3 ending week, which was a drop of 8k on the previous week and below the forecasted 365k figure. Continuing claims for the Oct. 27 week ended at 3,127k, which was below the forecasted 3,257k figure by a fair amount. In regard to the Hurricane Sandy effect, the DOL mentioned that the effect was mixed to some extent—power outages may have suppressed claims in some areas, while it may have bumped claims in others. We’ll likely see more accurate and more complete numbers in coming weeks as the damage estimates become clearer and clean-up efforts help get electrical grids and other resources back to normal.

The trade balance narrowed from -$43.8bn to -$41.5bn in September, which was improvement upon expectations for a widening to -$45.0bn. As implied by the change, exports outgained imports—mostly due to a decline in imported petroleum. The ebb and flow of oil tend to be the major factor in trade balance differentiations from month to month. Import prices rose more than expected for October, at a +0.5% reading versus a consensus of zero change. Wholesale inventories rose by +1.1% for September, which was much more than the expected +0.4%.

The University of Michigan consumer sentiment index improved to 84.9 in November, which was higher than the anticipated 82.9 reading, and continued a series of positive months for the reading. The index of ‘current conditions’ was the primary driver of the index, but the ‘expectations’ component for the economy also improved. Inflation expectations for the next year and 5-years ahead were largely flat and fell in the 2.8-3.0% range (near the long-term average, anyway, so probably not a bad guess).

Market Notes

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Despite a few decent days early in the week, the Wednesday response to the Obama re-election was sharply negative before flattening out towards the weekend. Why? The composition of government will be essentially unchanged from where it is now and investors appear to be skeptical of the three branches of government finding compromise solutions to upcoming issues like the fiscal cliff. We would agree with how one of our favorite economists, Dr. David Kelly at J.P. Morgan, put it with the highest three probabilities categorized into an ‘early’ compromise, ‘last minute’ compromise or ‘late’ compromise (while the probability for the greatest worry, a ‘no compromise,’ remains quite low). Despite billions of dollars of advertising, a very contentious campaign, and vague as opposed to substantive promises, the composition of government has changed very little from what we have dealt with for the past few years. Regardless, we are left with a major issues that needs to be addressed, as well as broader concerns such as deficit reduction and work on tax policy (likely a longer-term effort).

In the U.S., losses were largely similar between large- and small-cap, while mid-cap stocks fared a little better. Interestingly, materials and industrials stocks were the best performing on the ‘risk-off’ week, while utilities and telecom brought up the rear. Lower-beta stocks such as the latter two sectors mentioned have become a bit more expensive as of late as investors have paid a lot for perceived ‘safety.’

Emerging markets fared better than developed on a country-by-country basis, with some slowdown fears taking a backseat to U.S. election results. European stocks, such as indexes in Germany, Italy and Spain, dropped by the largest amounts with continued slow economic growth conditions.

With the re-election of Obama, chances of continued easy monetary policy and low rates (per the last four years) appeared more likely and fears of taking the punchbowl away too soon evaporated. Accordingly, bonds did well and long rates fell by about 15 basis points. Long-term government bonds were up by the largest amounts, while longer corporates performed decently as well, as did munis. Lower-rated bonds like high yield generally lost ground a bit.

In real estate, Asian REITs escaped the week as best performing with minimal losses, while U.S. residential also faired decently. The largest losses were in European REITs (in keeping with general European equities) and U.S. industrials and retail. This was a similar pattern to sectors in the broader equity markets.

In commodities, precious metals rallied strongly (up +3%, due to gains in gold and silver). Energy also bounced back a bit, by about half as much. Agricultural commodities and industrial metals were down marginally.

With Obama’s re-election, there are a few folks we have heard from looking for some alternatives to protect against, “Obama’s policies and perceived deterioration of America’s standing in the world over the next four years (and beyond).” In a micro form, we saw some of this concern last week in the strong results for bonds and precious metals—as thoughts of Obama administration-oriented prolonged and/or additional quantitative easing could be potentially inflationary and debasing to the U.S. dollar.

There are several reasons why this extreme thinking may be misguided. Generally, election reactions tend to be emotional and short-lived, and one has to believe also that a president has the ability to exert much more power over the economy than he actually does. Abandoning the discipline of a diversified portfolio with a variety of asset classes and a balanced set of risks in favor of concentrated ‘niche’ strategies that target policy positions and seem so obvious at the time (like precious metals or others) can create other unintended risks, such as concentration risks, not to mention the risks of being wrong in concept, timing or implementation.

One thing to remember is that while political headlines sometimes affect markets and overall sentiment, longer-term fundamentals generally outweigh those concerns over time. With a Republican majority in the House and Democratic Senate, our chances of seeing more of the same gridlock could be more likely than any push towards the extremes. Both parties agree that the U.S. debt load is a long-term problem—the devil is in the details of where cutbacks occur. From a market standpoint, individual companies make up the stock market—companies with diversified business lines, innovative products and strong competitive advantages in many cases, at least when talking about the large- and mid-cap markets. Revenue and earnings growth is what drives success here, not the latest soundbite out of Washington. When looking at this from a portfolio level, diversification into foreign investments, alternatives and different types of fixed income also critical in lessening impacts from single risks.