“The terrorists in Paris are no more true Muslims than the KKK are true Christians”.
– Pastor Robert Emmitt
What do you say about the terrorist attacks on Paris? Really words don’t suffice…action does. But the challenged posed by groups like ISIS and Al Qaeda is they are not state-sponsored organizations (at least not overtly). They are renegades, bound together by a skewed view of religious principles following their own interpretation of biblical text that no god would endorse.
Hence, neither France, the U.S. nor any nation can launch cruise missiles at the capital of ISIS because it does not exist. Hardcore, misguided religious fundamentalists are spread across every inhabited continent. While the Muslim religion receives most of the attention, in this regard there are radicals within every major religion including Christianity (remember the Oklahoma City bombing). Terrorists live among us – a sober reality. To this end, it was revealed over the weekend that one of the individuals responsible for the attacks in Paris was a native French citizen and at least two others were French nationals.
So what can we do? We can elect officials that support strong U.S. defense capabilities and hope that government anti-terrorism efforts continue to evolve to halt these heinous acts before they occur. Yet no system is perfect and it is impossible to expect that governments alone can stop every planned terrorist activity.
Some of the responsibility for preventing terrorist acts falls on average citizens. We cannot allow terrorists of any religion to deny us the benefits of a free society that so many throughout history have given their lives for. That does not mean that we should blithely go about the business of our lives. Rather, we should go about the business of our lives while being vigilant of those around us and contacting the proper authorities if there is genuine reason for suspicion.
With enemies integrated into society, often times it is the members of society that will be best equipped to detect unusual behavior that reveals their presence.
Six consecutive weeks of equity market gains induced investor complacency that was shattered last week. Global equity markets suffered weekly losses greater than 2%, while the U.S. markets were hit harder with major indices declining more than 4% on the week (the S&P 500 is now flat for the year). The value of fixed income instruments rose, though not at a pace commensurate with the losses in equities. The UST 10-year bond yield declined 6 bps to yield 2.27%, while the 30-year bond fell only 3 bps to an annual yield 3.05%. The combination of new debt issuance last week by the U.S. Treasury combined with a potential December rate hike by the Fed likely prevented yields from declining further. Hard assets provided no refuge during the week, with WTI crude plummeting 8% to $40.73 per barrel. In reaction to the negative risk sentiment, hedge protection was bid causing the VIX Index to jump by 40% to 20 (from 14 a week earlier). All-in-all, it was a pretty ugly week for the financial markets. Additional market detail can be found here.
P.S. There will be no weekly synopsis next week due to the Thanksgiving holiday.
Developed world equity markets punched higher by about 1%, with domestic stocks recording their sixth consecutive week of gains. Chinese stocks rocketed up more than 7% entering a new bull market, though they remain more than 25% below their mid-summer highs. Following a strong October employment report, expectations of a December rate hike jumped (see below) and US Treasury yields rose (the yield on the UST-10 year reached 2.33%, the high end of a 2% – 2.5% trading range established in May). Expectations of higher rates caused the US dollar to soar 2.3% on the week, pushing the global reserve currency up more than 10% on the year. The prices for precious metals (gold -4.6%) and crude (-4.4%) fell on the week. Additional market detail can be found here.
Labor Market Tightening
The labor market report for October, released last week, was unequivocally strong across multiple dimensions:
1. Unemployment rate declined to 5.0% (from 5.1%)
2. U-6 underemployment rate fell to 9.8% (a seven-year low)
3. Hourly wage growth increased to 2.5% year-over-year (six-year high)
Following the release of the report, the market rerated the probability of a December interest rate hike to 68%, nearly double the odds from a month ago.
Will the Fed raise rates in December?
Over the last several years the Fed has refrained from raising rates citing a weak labor market. In spite of evidence to the contrary, in September the Fed did not raise rates for a variety of different reasons: economic weakness abroad, a struggling domestic energy industry, the strong dollar and high market volatility (particularly in China).
While little has changed with regard to the international demand, the US dollar or the energy sector, the strong employment report has largely been interpreted as a “green light” for the Fed to raise rates in December. Absent, weak economic data between now and the FOMC December meeting, the market expects the Fed to raise rates. As such, this next meeting will be a good yardstick for measuring Chairman Yellen’s reputation as a fiscal dove. I hope and expect the Fed to raise rates. I am less concerned about the impact of a 25bps rate increase on the economy than I am about the Fed’s loss of credibility if they don’t raise rates. The former is manageable – the latter could be calamitous.
Economic Data Release Summary
The US ISM manufacturing index slipped to 50.1 (from 50.2) as weak global demand and a strong US dollar continue to weigh on US-based manufacturers (note that a reading below 50 indicates the sector is contracting). On the other hand, the US ISM non-manufacturing index increased close to a decade high at 59.1 in October (from 56.9 in September). While there is little reason to expect the manufacturing sector to rebound in the near future, the strong reading from the non-manufacturing index indicates that the services sector of the economy is expanding at a healthy pace. On this note, last week’s data showed a nice uptick in private sector credit expansion: revolving credit (i.e. credit cards) grew by 6.7% (on a 3-month annualized basis; commercial banking credit rose by 8.5% (on a 3-month annualized basis); auto loans jumped 1.4% month-over-month in October; and there was an uptick in residential and commercial real estate lending.
Following two difficult months (and the worst quarterly performance in more than four years), global equity markets staged a massive rally in October recording their single strongest monthly performance in four years. The rally, which produced high-single-digit returns amongst developed and emerging market stocks appears to have been spawned by expectations of additional monetary stimulus from the People’s Bank of China, the Bank of Japan and the European Central Bank. The strong relationship between loose monetary policies and positive stock market performance in the absence of real economic growth has been a hallmark of the ongoing recovery from the Financial Crisis.
The reaction of fixed income instruments was more muted, with the yield on the UST-10 year bond rising a mere 0.06% to 2.14% during the month, although high yield spreads declined nearly 0.7% in sympathy with rising equity prices. Hard assets prices generally rose on the month, though gains were less impressive than equities with gold and crude each rising between 2% – 3%. Additional market detail can be found here.
Sibling rivalry – After more than 40 years of controlling population growth by limiting married couples to a single offspring, the Chinese government increased the number of allowable children to two per couple. The law was originally designed to prevent population growth from outstripping China’s resources, but it had at least two unintended consequences: 1) it led to the murder of countless infant girls as men were desperate to perpetuate their family name by siring a son; and 2) over time the math of replacing two parents with a single offspring created a declining and aging population in China. The Chinese government’s decision to allow two children per couple does not signify an altruistic shift towards improved human rights in that country, but rather a practical effort to reduce the negative economic effects of an aging population and declining workforce. For the first time in more than a generation, the Chinese will now have a new parenting challenge: sibling rivalry.
2011 Redux? – As has been well documented, the third quarter drawdown in stocks and the subsequent rally in October both resemble equity market performance in 2011. If the similarities to 2011 continue to play out, what can we expect from equity market performance through year-end? The answer is that equity market performance will be slightly negative for the balance of the year. This is not a market call, merely an observation of the parallels between this year and 2011.
Economic Wrap-Up – Annualized third quarter GDP growth was +1.5% as strong private consumption (2.2%) was offset by the drag of elevated inventory levels (which subtracted 1.4% from third quarter growth). All in all it was a decent report, consistent with previous quarters showing the U.S. economy continues to expand at a moderate pace.