A fourth straight month of solid retail sales sent stock prices higher early Tuesday, but the better-than-expected sales produced brutal selling pressures in the Treasury bond market. By the close of trading, stock prices had given up most of their gains, and the Barclays U.S. bond market aggregate lost close to 0.6% on the day, trimming its year-to-date gain to 5.5% (from nearly 9% before Election Day and the start of QE2). Despite criticism from virtually all corners of the globe, the FOMC left intact its QE2 plan to buy $600 billion in Treasury securities by the middle of next year. After the conclusion of today’s last FOMC meeting of the year, the Fed said it will “maintain the target range for the federal funds rate at 0 to 1/4 percent” and that it “continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.” Nevertheless, the bond vigilantes were galloping in the direction of higher interest rates today. The 10-year Treasury bond lost roughly a point and a half today, its yield climbing 19 basis points on the day – almost all of that rise coming on the real interest rate side. Indeed, rising 10-year inflation expectations have accounted for just 11 bps of the 87 bps rise in 10-year Treasury yields since October.
• Increased retail sales point to stronger Q4 GDP growth and more momentum in the U.S. economy than we’ve seen since the recession ended in June 2009. Along with the likely effects of the Obama/Republican stimulus plan working its way toward enactment, the faster pace of retail sales ought to provide more vigor to the economy’s job-creating engine in the New Year. Q4 2010 GDP growth looks like it could be north of 3%, and it looks more and more that we will see that sort of growth for all of 2011 as well. Is QE2 behind the quickening in the economy’s growth rate? That seems unlikely, in our view, and for the moment, the sell-off in bonds raises some questions as to its efficacy. While stock prices have yet to reflect it – the S&P 500 having closed at a 27-month high today – the bond market’s downdraft is not without its risks to the economy and to the bull market in stocks down the road.
INVESTMENT OUTLOOK…Over the two months September-October, market momentum was impressive in financial assets as well as in real assets. But in November, the rally in stock prices ran 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 – and December’s trends are certainly much more pleasant – 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. And the profits outlook for 2011 is gets better with the stimulus that appears likely to come out of Washington in the New Year. But, as we saw with the poor market action in Cisco’s shares following management’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) <a href=mailto:firstname.lastname@example.org>email@example.com</a>