FINANCIAL REVIEW

Halloween Treats

Sinclair Noe — October 31, 2014

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Financial Review
DOW + 195 = 17,390
SPX + 23 = 2018
NAS + 64 = 4630
10 YR YLD + .03 = 2.33%
OIL – .44 = 80.68
GOLD – 25.90 = 1173.90
SILV – .28 = 16.28

Record highs, again.

Back on September 19th, the Dow hit a record high close of 17,279. And then we watched the market tumbled for nearly a month. On October 17th we told you about a bullish reversal pattern, and it has been a strong move to new highs; up 1,100 from when I called the reversal, and up 1,545 from the lows of October 15.

Also, a new closing high for the S&P 500, however, we did not take out the intraday high of 2019 from September 19. Let’s break down the moves for the month of October. The Dow is up 248. The S&P added 46 points. The Nasdaq is up 137 points for October to a 14-1/2 year high. In October we saw the yield on the 10 year note drop 18 basis points from 2.51%. Gold took a hard fall on Friday, at one point trading at levels not seen since 2010. And of course, a big move in oil down 10.75 a barrel. If you are looking for a really dramatic move, the Russell 2000 index of small cap stocks has bounced from a low of 1046 on October 13, to close today at 1173, a 127 point gain; and once again above the 50 day and 200 day moving averages.

For the week the Dow rose 3.5 percent, its best percentage weekly gain since January 2013. For the week, the S&P 500 was up 2.7 percent and the Nasdaq was up 3.3 percent.

And if you think the rally of the past two weeks is impressive you should see the 2-day rally on the Nikkei, up almost 5% today. The Bank of Japan announced it expand its QE purchases and will now buy about $720 billion worth of Japanese bonds each year. So, the Federal Reserve ended QE3 large asset purchases on Wednesday, but really they just passed the baton to Japan.

Here is what has happened in Japan. December 2012, Shinzo Abe was elected as Prime Minister in Japan. Abe appointed Haruhiko Kuroda as governor of the Bank of Japan, and they set out on a very aggressive stimulus campaign to lift the Japanese economy out of decades of funk. They called it Abenomics. It started with promise. In early 2013, the yen fell, and the Japanese stock market rallied. And then the politicians got involved and started making a mess of things; they raised a consumption tax to try and rein in budget deficits. The economy contracted and disinflation returned. This has now become a familiar pattern. We’ve seen it here in the US; the central bank tries to stimulate the economy; the politicians tighten the belt. We’ve seen it in the Eurozone; Draghi promises to do whatever it takes; the austerians slam on the brakes.

In Japan, Abe is going all out. International commodity prices have been falling, and so the idea is to weaken the yen. Japan’s public pension system will also step in with direct purchases of exchange traded funds to prop up the equity markets. The idea is to mitigate deflation risks while also creating price inflation in other asset markets. The target is 2% inflation, and Prime Minister Abe seems hell-bent to make sure it happens.

So, the Fed ends QE, The Bank of Japan doubles down on QE (literally, they don’t even call it QE, it’s called QQE2); next up is the European Central Bank; next week the ECB will likely announce something, exactly what is still a guess. The main refinancing rate is already at 0.05%, a level ECB boss Mario Draghi several times has described as the “lower bound”. And with deposit rates at -0.2%, consensus is also for no changes there. As for full-scale QE? Well, Draghi has said he’ll do whatever it takes, but Draghi doesn’t have the same clout in Europe as Abe does in Japan. Draghi will surely face opposition from the Germans. Earlier in the year, the central bank laid out plans to buy asset-backed securities and covered bonds, dubbed private or mini QE. It started purchasing covered bonds in October, but has yet to push the buy-button for ABS.

Today, the Commerce Department reported that inflation in the US remains subdued. The price index for personal consumption expenditures, which is the Fed’s preferred way to measure inflation, held steady at 1.4% in September. Excluding the often-volatile categories of food and energy, prices rose 1.5% on the year. Annual core inflation has been steady at that level since May. The PCE inflation index has been under 2% for the past 29 months. The Fed warned in its policy statement on Wednesday that “inflation in the near term will likely be held down by lower energy prices and other factors.” Still, the Fed said that the chances of inflation “running persistently below” the 2% target had “diminished somewhat since early this year.”

The final October reading on the University of Michigan/Thomson Reuters consumer-sentiment index rose to 86.9, the highest reading since July 2007, from a final September level of 84.6. Consumers have kept their focus on improved job and wage prospects, and lower prices at the pump don’t hurt.

In a separate report, consumer spending fell in September for the first time in eight months, as Americans spent less on energy; and because we were spending less of gas, fewer people felt the need to replace the old gas guzzler with a new, more fuel efficient model, and auto sales dropped. They spent more on services, however. Personal spending dropped a seasonally adjusted 0.2% last month to mark the first decline since January.

By the way, it is estimated that sometime tomorrow, the nationwide average price for a gallon of gas will drop under $3 a gallon. The decline in gas prices is estimated to help consumers save roughly $250 million a day.

Meanwhile, the Bureau of Labor Stats reports labor costs are up 0.7% in the third quarter, matching the gain in the second quarter. Wages increased 0.8%, while the cost of benefits rose 0.6%. Over the past year, employment costs are up 2.3%, the fastest growth since 2008. Real, steady growth in wages is the missing ingredient in the economy right now. For months, economists have been saying the steady decline in the unemployment rate would inevitably lead to higher wages, as employers would have to bid up the wages they offer to recruit and retain productive workers. That prediction was fine in theory, but it didn’t seem to be showing up in anyone’s paycheck, until now, and it is still too early to say that to say it is entrenched, but we are seeing signs. Wages for private-sector workers are up at a 3% annual pace over the past six months. Average hourly earnings for nonsupervisory and production workers (about 80% of workers) are up 2.6% in the past year. And with inflation running at 1.4%, this means workers are actually getting ahead, just a little.

And don’t forget we are in earnings reporting season. And earnings are looking good; data sources vary, but according to FactSet, of the 362 companies that have reported earnings so far, 78% have reported earnings that have beaten the mean estimate of analysts. The blended earnings growth rate for the quarter is 7.3%, well above the estimated growth rate of 4.5% that was expected by analysts as of Sept. 30.

Exxon Mobil said its third-quarter earnings edged up 2.5% as higher refining margins and improvements at its refining and marketing segment helped offset lower production. Shares rose about 2%.

Chevron reported a third-quarter profit that rose well above expectations, offsetting a bigger-than-expected decline in sales. Earnings for the quarter ended Sept. 30 came in at $5.6 billion, or $2.95 a share, up from $5 billion, or $2.57 a share, in the year-earlier period.

AbbVie posted net profit of $506 million, or 31 cents a share, in the quarter, down from $964 million, or 60 cents a share, in the year-earlier period. They beat estimates and raised guidance.

It was a very, very bad week for privatized space travel. On Tuesday, an Orbital Science Antares unmanned rocket blew up on the launch pad in Virginia. Today, one of Virgin Galactica’s spacecraft crashed during a test flight in Southern California, killing one pilot and injuring another. The company was testing a new rocket engine on the craft, which is eventually supposed to carry paying tourists on suborbital flights high above the Earth. The accident is a major setback to Virgin, which had aimed to start regular commercial flights in 2015.

Next week, we have two really big events: the mid-term elections on Tuesday, and the jobs report next Friday.