Reno, NV (Marketmail) - December 17, 2012
The U.S. stock market careened up and down on an emotional roller coaster ride last week, ending with a small (0.3%) loss. Meanwhile, China's Shanghai index posted its best day in three years on Friday, rising 4.3% in one day and 9.7% in the last two weeks. Here at home, the Fed and the Fiscal Cliff grabbed all the headlines, but as the year draws to a close, it's important to remember that most companies typically rise or fall based on their earnings, generated by growth, rather than domestic political policies.
The Fed Decides to "Twist Again, Like We Did Last Summer"
The Federal Open Market Committee (FOMC) met again last week. At the conclusion of its meeting, on Wednesday, the FOMC made it clear that QE3 (buying $40 billion per month in mortgage-backed securities) would essentially become QE-to-infinity, or at least until the unemployment rate falls to 6.5%. The Fed also made it clear that its $45 billion per month of Treasury bond buying (Operation Twist) will continue, bringing the Fed's total security purchases to slightly over $1 trillion per year.
The Fed's "infinite liquidity pumping" and "eternal yield curve flattening" will continue at least until the Labor Department's unemployment rate hits 6.5%. Then, the Fed may merely change its target rate, or just "tap on the brakes" a bit by slowly reducing their $85 billion monthly faucet to $75 billion or less.
Interestingly, the Fed also reversed nearly 100 years of Fed policy by saying it would allow inflation to run above its 2% target as long as the unemployment rate remains high. In other words, unemployment is priority #1, and inflation is no longer a top priority. This policy will likely weaken the dollar, sparking commodity inflation. Fortunately the stock market has been a good historical hedge against inflation. In particular, I believe multi-national stocks will reap windfall profits from the gradual decline of the dollar.
The U.S. dollar should continue to steadily erode, simply due to 0% interest rates attracting few investors, while our $1 trillion deficits "as far as you can see" will erode the value of the dollar. Even a currently-troubled currency like the euro is now rallying against the U.S. dollar and should crack $1.32 soon simply because the euro's higher interest rates will attract more investors than the U.S. dollar.
Stat of the Week: 0.1% Core Inflation Gives the Fed Room to Ease
On Thursday, the Labor Department announced that the Producer Price Index (PPI) declined 0.8% in November. Energy prices plunged 4.6%, the largest monthly decline since March 2009. Meanwhile, the core PPI, excluding food and energy, rose 0.1%, below economists' expectations of a 0.2% increase.
On Friday, the Labor Department issued a similar report saying the core Consumer Price Index (CPI) rose by the same minuscule 0.1% in November. The headline rate was 0.3%, but the low (0.1%) "core" inflation rate clearly gives the Fed a green light to inflate the U.S. economy during its current slowdown.
In other statistics, consumer spending slowed to a 1.4% annual growth rate last quarter, down from a previously estimated 2% pace. Then, on Thursday, the Commerce Department announced that retail sales rose just 0.3% in November, a bit below economists' consensus forecast of a 0.4% rise. However, this report was generally positive, since sales at gas stations fell by a full 4% (due to lower gas prices), the biggest monthly drop since December 2008. Excluding gasoline, November's retail sales rose 0.8%. Retail sales rose by 2.5% at electronics and appliance retailers, 1.6% at home-improvement stores, 1.4% at auto dealers, 1% at home-furnishing stores, 0.9% at apparel outlets, and 0.8% at bars and restaurants.
Another bright spot for the U.S. economy is that factory activity rose briskly in December, partly due to a weaker dollar favoring U.S. exports. On Friday, we learned that Markit's purchasing managers index (PMI) rose from 52.8 in November to 54.2 in December, an 8-month high. The details are all positive: Markit's new orders index increased to 54.8 in December, up from 53.6 in November; its output index rose to 55.1 in December, up from 53.5 in November; its new export orders rose to 52.8 in December, up from 50.3 in November, and its employment index rose to 54.4 in December, up from 52.6 in November.
The only net negative number last week came from December's preliminary University of Michigan-Reuters survey of consumer confidence, which plunged from 82.7 in November to 74.5, a five-month low. Apparently, many consumers fear the financial cliff's impact on slower economic growth in 2013
Looking overseas, China's National Bureau of Statistics announced last Tuesday that copper output rose to a record level in November and +11.6% for the full year, while refinery activity is up 9.1% in the last year. We also learned that China's Purchasing Managers Index rose to 50.6 in November, up from 50.2 in October, as China's industrial demand heats up. (Any number over 50 signals a return to growth.)
Big Business Calls for a "Compromise" to Avoid the Financial Cliff
Early last week, a business roundtable of 158 chief executives of America's biggest companies called for a sensible compromise to avoid the fiscal cliff. These 158 CEOs, who control $7.3 trillion in GDP and 16 million employees, demanded that Congressional Republicans make some concessions on revenues, while they urged Democrats to give some ground on long-term entitlements, like Medicare and Social Security.
However, I must add that these 158 CEOs only speak for big business, not for small or medium-sized businesses, which generate most of the new hiring in America. Many small business owners would be impacted by an increase in their tax rate. Reflecting those concerns, Tuesday's release of the National Federation of Independent Business (NFIB) survey found that small business optimism plunged to 87.5 in November, down from 93.1 in October. This is the lowest score since 2009 and far below economists' expectations of 92.5. In addition, nine of NFIB's 10 business confidence indicators declined last month.
My main concern is that I do not think most Americans are aware that their paychecks will be smaller in 2013 than they are now, due to higher tax withholding as well as new Medicare and Social Security taxes. When you take money out of consumers' pockets, consumer spending slows, especially in January, when consumers try to balance a smaller paycheck against a big credit card bill for their holiday spending.
In Washington, House Speaker John Boehner said, "We're going to stay here right up until Christmas Eve" and then come back before the New Year "because we want to make sure that we resolve this in an acceptable way for the American people." Boehner reiterated his claim that the White House's new revenue demands simply will not pass Congress, since members of Congress who vote to raise taxes now fear being voted out of office in 2014. Treasury Secretary Timothy Geithner has already said that the White House is prepared to "go over the cliff" and allow tax rates to rise for everyone in 2013, so it appears that this impasse may continue until December 31st or even later.
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