After a ho-hum Monday, U.S. stock market averages are off between 1.3% and 1.5% Tuesday, as North Korea’s firing of artillery missiles into South Korea, its second aggressive attack this year, and ongoing worries in Euroland sent risk takers scurrying in search of safety. The U.S. dollar is trading up over 1% against a broad basket of currencies today, and the euro was down 1.7% in early afternoon trading in New York, while Treasury bond prices have rallied for a third day in a row. Economic news out this morning was mixed: the government revised its estimate of third-quarter GDP growth to 2.5% from last month’s early estimate of 2% (and market expectations in the 2.4% range); corporate profits from current production increased at a 12% annual rate (28% year over year) in the third quarter; and existing home sales declined 2% (a bit softer than the Bloomberg consensus forecast) in October, the third worst month for single-family home sales of this cycle – behind only July and August of 2010, when the expiration of home buyer tax credits depressed sales. The home foreclosure paperwork snafu is no doubt affecting sales.
• Notwithstanding the improvement in Q3 economic growth, the Federal Reserve said today that it had reduced its forecast of economic activity for 2011 at the FOMC meeting on November 2-3. Plotted nearby is a comparison of GDP and final sales growth for the current cycle with the two previous economic cycles. Note that in terms of final sales, recent growth has generally lagged what were rather anemic rebounds in the post-1991 and post-2001 recovery periods. Considering how steep the 2008-09 economic decline was, subsequent growth has to be judged disappointing. Viewing the economic recovery in this manner, one can understand the Fed’s 10-1 decision to launch a second phase of quantitative easing (Treasury bond buying) in an attempt to bring unemployment down faster than the slow progress seen to date and prospective in 2010. With the Fed’s reduction in forecast GDP growth for 2011 – from a 3.5%-4.2% range projected in June to a 3.2%-3.6% range currently – unemployment is forecast to be about a half percentage point higher next year (at around 9%) than was forecast five months ago. For 2012, the Fed expects unemployment to remain sticky high – in the range of 7.7%-8.2%, up from 7.1%-7.5% projected earlier.
• The Irish/Greece/Portugal debt crisis took the euro down to a two-month low of US$1.3367 Tuesday. Along with the Korean missile crisis, which helped send gold up over a percentage point today, ongoing euro uncertainties contributed to the Dow’s declining 140 points and the S&P 500 dropping 1.4%. Commodities prices generally fell Tuesday, with crude oil close to a two-month low at $81+ a barrel. The 10-year Treasury bond climbed roughly one-third point, its yield falling to 2.77%.
INVESTMENT OUTLOOK…Over the two months September-October, market momentum was impressive in financial assets as well as in real assets. But this November has not been as kind, as asset prices have run into some resistance. The escalation of inflation expectations – no matter how limited inflation appears to be in the official inflation indexes – recurring credit anxiety in Europe, and the rise in the dollar suggest that we may have embarked on an interim period of “risk-off” investing ahead. While these trends may prove to be no more than a temporary pause in this latest Fed-fueled bull market, it is worth remembering that easy-money-driven bull markets often do not end well. Strong corporate earnings of the sort seen in Q3 can overcome a lot of the market’s shortcomings. But, judging by the recent poor market reaction to Cisco’s injection of some caution into its outlook, equity investors never tire of asking “What have you done for me lately?”
Michael Flament (203-783-4360) <ahref=mailto:email@example.com>firstname.lastname@example.org</a>