We start with the government’s report on third quarter gross domestic product showing the economy grew at a 3.5% annualized rate between July and September. The Commerce Department reported the increase was primarily due to consumer spending, exports, and higher government spending on the federal, state and local levels. In four of the past five quarters, the economy has expanded at a rate of 3.5 percent or greater; the exception was in the first quarter, when the economy contracted by 1%. Year to date GDP is running at a 2.4% pace. Consumption and fixed investment, taken together, is up 2.8 percent over the last year. This is a pretty good growth rate, and it was better than estimates of 3% growth.
The economy has performed well of late, consistently adding jobs for 4-1/2 year and reporting sturdy sales of both homes and new automobiles. Meanwhile, many are optimistic that lower gas prices at the pump can lead to higher spending from consumers. Consumer confidence readings are at their highest level in seven years; but consumer spending has been tepid; keep in mind that lower gas prices are considered part of the consumer spending numbers, and if gas prices stay low, that could lead to fairly good news for the retail sector as we head into the holiday season. Consumer spending rose just 0.1% in September, after climbing at a 1.8% pace in the third quarter. For consumer spending to continue, we will need to see an increase in incomes. With the US adding jobs at the fastest since the recession ended five years ago, households have more money to spend. Yet so far Americans appear to be putting the extra income in the bank or paying down debt instead of spending the money.
In a separate report, the number of Americans filing new claims for unemployment benefits rose for a second straight week last week, but remained at levels consistent with a firming labor market. Initial claims for state unemployment benefits increased 3,000 to a seasonally adjusted 287,000 for the week ended Oct. 25
One unusual point to the third quarter GDP number was the increase in military spending, which spiked 16%. And of course, we did re-start military action in Iraq during the third quarter; that means more money for personnel, weapons and installation support; plus more on ammo, missiles and oil. Defense spending is notoriously volatile, but it doesn’t look like these expenditures will end any time soon.
The strong growth picture in the US contrasts with some red flags that have been raised about the global economy. The International Monetary Fund earlier this month cut its outlook for global growth in 2015, citing a deterioration in expectations for the euro area, Brazil, Russia and Japan, but the IMF raised its growth targets for the US for this year and in 2015.
And yesterday the Federal Reserve seemed to think the economy was on strong enough footing to stand on its own, without the aid of QE3. Time will tell, but at the least we should brace for a few more bouts of volatility.
And so, for now the money continues to flow to Wall Street. On Friday, October 17th we told you about a morning star bullish reversal pattern; since then the Dow has been on a roll, gaining 815 points, and closing above its 50 day moving average on Tuesday; yesterday it dipped back down to the 50 day moving average, held support, and just continued running today. The Dow industrials staged a rally of more than 200 points, after starting the session modestly higher. The rally marked the blue-chip indexes eighth straight triple-digit gain in an October that was frightful, at times. And after all that volatility, the Dow is in positive territory for the month of October. A similar chart pattern for the S&P 500 index.
If you are looking for confirmation, one of the oldest market timing systems is the Dow Theory. On January 31st, 1901 Charles H. Dow compared the stock market to the tides of the ocean when he wrote in the Wall Street Journal: “A person watching the tide coming in and who wishes to know the exact spot which marks the high tide, sets a stick in the sand at the points reached by the incoming waves until the stick reaches a position where the waves do not come up to it, and finally recede enough to show that the tide has turned. This method holds good in watching and determining the flood tide of the stock market.”
Dow theorized that there are three movements of the averages. The first, and most important, is the primary trend. The second, and most deceptive is the secondary reaction. The third, and usually unimportant, is the daily movement. Also, both the Industrial and Transportation averages must confirm a trend.
Well, the primary trend has been up, at least until September 19th, and then we saw a sharp and swift corrective action that ran for almost a month. Now, we have the markets returning to the primary bullish trend, and we look to the Transportation average for confirmation. The Dow Jones Transportation average was down 83 points today, but is still hit an intraday high of 8792, after hitting a closing high yesterday of 8759. That seems to confirm the Dow Theory. Of course, this is just a cursory treatment of Dow Theory; a buy signal would more typically occur in a bear market, and the buy would be a reversal signal. But in its most basic form, the idea is for transports to confirm industrials. The idea behind the transports confirming is that if the industrial companies are producing, they have to ship their goods to market, which means the transportation stocks should also be performing well.
More confirmation from the Dow Jones Utilities, which hit another record high close today, in what looks like a nice, smooth uptrend; the uptrend has been so strong you might expect a pause, but there is no indication of a reversal here; and importantly, no divergent move from the industrial average. Utilities have benefited from falling commodity prices and the lower cost of raw materials such as coal and natural gas, as well as the ability to rollover debt at lower interest rates. That combo could team up to fatten profit margins and raise the possibility of increased dividend hikes for the utility sector over the foreseeable future.
Now, it’s time once again for another edition of “Banks Behaving Badly”. Today we revisit the soft treatment afforded many of the banks in the past. As you know, no senior executives from big banks have been forced to pay for crimes with jail time; no big banks have been closed down for their transgressions; penalties are in the form of tax deductible fines, eventually sloughed off on shareholders. And it turns out that the slap on the wrist approach to punishment is a poor deterrent. The lack of prosecution has created a moral hazard, which is an insurance term that refers to the tendency of a policyholder to be less careful in avoiding loss because he or she will be indemnified if the loss occurs. And so it is with the banksters, willing to break the law because they are not concerned about the possibility of personal loss.
For years, prosecutors have been fining banks, as part of a deferred prosecution agreement, or DPA; which allowed the banks to avoid having to admit wrongdoing but said, if they broke the law again, the deal was off and they would have to be punished. It’s kind of like a convict violating parole. Now, the New York Times reports prosecutors in Washington and Manhattan are reopening investigations into Standard Chartered, Bank of Tokyo – Mitsubishi UFJ, Barclays and UBS. Standard Chartered and Bank of Tokyo violated sanctions against Iran; essentially money laundering with terrorists, and now they are being investigated for failing to disclose the extent of wrongdoing to the government.
UBS and Barclays reached settlements for manipulating interest rates, and after that deal was secured by fines and a promise to stop being a bad bank; well, they just couldn’t help themselves; like a junkie looking for a fix, they rigged the currency markets, which would violate their interest rate settlements. Since 2001, at least eight big banks have committed further offenses after receiving an initial deferred-prosecution agreement. UBS has reached three deferred or nonprosecution agreements since 2009.
A side note; earlier this week UBS said third-quarter profit increased 32 percent even as it took a charge of about $1.9 billion related to litigation and regulatory issues. And today, Citigroup cut third-quarter profit by $600 million because of mounting legal costs as the bank cooperates with criminal and anti-trust probes into foreign exchange rigging; the result is third quarter net income will be adjusted down to just $2.84 billion.
Lest you think I am being too hard on the banksters, we now turn our attention to high frequency traders. According to a new research report, public filings by corporations are supposed to be available to all investors at the same time through the website of the Securities and Exchange Commission. The studies focus on the SEC’s Electronic Data Gathering, Analysis and Retrieval system, or Edgar, which is used to disseminate earnings reports and other documents filed to the regulator. For a fee, certain traders, such as high frequency traders and hedge funds, can get the info from the SEC website 10 seconds earlier than the general public. They can then trade on that data, and skim off profits. The SEC for the past few years has been investigating high-speed traders and others for potential concerns about manipulation or other practices that may give some market players an unfair advantage. But in reality, the SEC is basically saying that insider trading is acceptable, so long as they get a cut of the profits.