The Economy: A Look Back and What’s Ahead (12.23.13)
Last Week
The FOMC decision to taper QE was the big news from an economic perspective, but beyond that, there were a few other notable takeaways that are important in light of the new trajectory of Fed policy.
Specifically, we learned last week that the economy in Q3 was stronger than we thought, that the manufacturing sector in December is a little slower than we thought and that the housing recovery is still ongoing, but concerns about a loss of momentum in the face of rising rates remain.
Starting first with the Fed, though, you all know by now the Fed announced it would “taper” its QE program by $10 billion a month (from $85 billion to $75 billion) starting in January. In a feat of monetary policy wizardry, though, the FOMC managed to taper QE yet come off somewhat “dovish.” They strengthened their “forward guidance” for keeping interest rates at 0%, saying the would keep rates at 0% well past 6.5% in the unemployment rate (thereby effectively raising the bar for when rates would start to rise). Overall the market welcomed the news, and stocks saw a big post-FOMC rally Wednesday afternoon. And bonds, while they did decline, largely “behaved.” It was the best-possible outcome for the Fed and for stocks.
Turning to the real economy, the other big surprise of the week came on Friday, when Q3 GDP was revised sharply higher from 3.6% to 4.1% (it was the first “4” print on GDP since ‘11).
As I’ve been saying, inventories are skewing the number higher (and did so again on the final revision), but there was also some evidence the “real” economy was stronger than initially thought: Final Sales of Domestic Product (which is GDP less inventories) was revised to 2.5% from 1.9%, and Personal Consumption Expenditures (which is consumer spending) were revised slightly higher to 2.0%. It’s likely that the big inventory builds that made Q3 GDP so strong will negatively affect Q4 GDP (now that manufacturers have tons of inventory, there’s no need to buy more), but it’s fair to say the economy was stronger than it looked in the third quarter.
But, just as we learned Q3 growth was better than expected, we also saw pretty consistent data that showed manufacturing-sector activity cooled a bit. The December “Flash” Manufacturing PMI, Empire State Manufacturing Index and Philly Fed Manufacturing Index all missed expectations this week, although each also remained in “positive” territory. This shows the manufacturing sector continues to grow, just a slower pace than expected (and slower compared to November).
The misses aren’t enough to cause concern regarding the economy, but now that the Fed is tapering QE, economic data will be scrutinized more closely, and any sign of real economic weakness (which this wasn’t) will weigh on stocks.
Finally, housing remains a mixed bag. Last week, housing starts handily beat estimates, but existing home sales missed, and the pace of existing home sales turned negative on a year-over-year basis. But, before we get too nervous about housing, low inventories are partially to blame for the existing home sales miss, and importantly pricing remains strong (up nearly 10% over last year). Bottom line is the housing recovery is ongoing, but clearly rising rates are a risk, and we’ll just have to keep watching.
In sum, I think that the No. 1 takeaway from last week was the validation by the market of something I’ve been saying for months now: that “good” economic data is once again “good” for the market. And by the same token, “bad” is “bad.” It’s been a long time since that was definitively clear, but it is once again, and that’s a positive for the markets and the economy.
This Week
Predictably, this is going to be a very slow week from an economic standpoint. The only material releases domestically are Personal Income and Outlays this morning, Durable Goods and New Home Sales Tuesday and Jobless Claims Thursday. And, barring a total disaster in any of these reports, expect them to have little effect on trading.
Internationally it’s also very quiet, as there is no material data this week out of Europe. In Japan there are several releases Thursday/Friday. But the bottom line is unless there’s a major positive surprise, none of the releases— whether they are “beats” or “misses”—will alter the current expectation of more stimulus from the Bank of Japan in early ‘14 (and none of the data will derail the bearish yen/bullish DXJ investment thesis).