Why the Pennant Race Could Coincide with Market Volatility

Global CIO Commentary by Scott Minerd

For baseball fans, it is hard to beat this time of year. The pennant race is hot and the excitement of the playoffs will soon be upon us. For investors, the time between now and the Fall Classic could be equally action-packed. There is the battle between doves and hawks at the Federal Open Market Committee, and what I believe will be a near-term period of volatility before we cross into seasonal strength that generally coincides with, you guessed it, the start of the World Series.

On Wednesday, dovish Fed policymakers opted not to grant concessions to the hawks or indicate a willingness to modestly increase rates sooner than the market had previously anticipated. That decision was reflected in the FOMC's statement that rates would stay near zero for a “considerable time” after quantitative easing ends, and came after weaker-than-expected inflation data and the central bank lowering its GDP forecast for 2015.

In her post FOMC press conference, Fed Chair Janet Yellen went to great pains to express the committee’s concern for the plight of the unemployed, for whom she displayed great empathy. On more than one occasion, Dr. Yellen commented that, based on the Fed’s own projection for unemployment by the end of 2015, the U.S. economy would still not have reached full employment by that time. Comments such as these soothed the market despite the fact that the Fed’s own projection for interest rates – signaled in the so-called “dots” – forecast the federal funds rate at 1.375 percent by the end of 2015, 25 basis points higher than its June forecast of 1.125 percent. Reconciling these seemingly conflicting messages is the challenge for market participants in the coming year.

The debate between the hawks and the doves has not yet reached its conclusion, and still, the U.S. economic recovery seems to be gaining momentum. Economic data, after a lull in July, has shown solid gains and we expect third-quarter U.S. GDP to be about 3.2 percent. Both small-business optimism and the Thomson Reuters/University of Michigan consumer confidence survey are climbing toward post-recession peaks. The net monthly change in U.S. credit has finally stabilized. Now, credit card debt is no longer shrinking, but instead is consistently expanding, along with loans for big-ticket items such as automobiles and appliances.

The bottom line is things are looking pretty good, but while financial markets are in encouraging shape longer term, now is often the worst time of year for markets. Indeed, October is remembered for the stock market crashes of 1929 and 1987, and the 2008 financial meltdown. The buy signal for the S&P 500 traditionally coincides with the first game of the World Series, so we may have to wait to relax, at least until October 21, when the Fall Classic is scheduled to begin. Until then, investors will likely go through some periods of higher volatility.

Labor Market Index Suggests No Rate Hike until Late 2015 or 2016

Contrary to the Federal Reserve’s forecast in its “dots,” a labor market conditions index from the Federal Reserve Bank of Kansas City suggests the timing of the Fed’s first rate hike should be no earlier than late 2015, or possibly even 2016. The index, cited by Yellen in her recent Jackson Hole speech, uses 19 labor market indicators to measure overall job market conditions. In the prior two rate hike cycles, the index was positive before the Fed began raising rates. The underutilization in the labor market, combined with recent inflation softness, suggests the Fed should maintain the current level of policy rate for a considerable period of time.

KANSAS CITY FED LABOR MARKET CONDITIONS INDEX

Source: Federal Reserve, Bloomberg, Guggenheim Investments. Data as of 9/17/2014. *Note: Projection is made by using the average monthly change in the index since the beginning of this year.

Economic Data Releases

U.S. Inflation Slows, Sentiment Improves

• Retail sales were in line with expectations in August, rising 0.6 percent after July’s upwardly revised 0.3 percent gain. Excluding autos and gas, sales rose 0.5 percent.
• The Thomson Reuters/University of Michigan Consumer Confidence Index increased to 84.6 in July from 82.5, the best monthly increase since April.
• August housing starts missed expectations, decreasing 14.4 percent from July to 956,000. The weakness was led by multi-family starts.
• Building permits fell more than expected in August, down 5.6 percent to 998,000.
• The NAHB Housing Market Index increased to 59.0 in September from 55.0 in August, above expectations of 56.0 and the highest level since November 2005.

• Initial jobless claims fell by 36,000 for the week ended September 13, falling to 280,000. The one-week change was the largest since 2012.
• Industrial production fell 0.1 percent in August, the first drop since January, primarily due to a 7.6 percent reduction in auto industry output.
• The consumer price index on a year-over-year basis unexpectedly fell to 1.7 percent in August from 2.0 percent in July. Month-over-month prices declined for the first time in nearly one and a half years.
• The producer price index increased 1.8 percent in the 12 months through August after rising 1.7 percent in July, in line with market expectations.

European Data Mixed, Chinese Economy Disappoints

• Euro zone industrial production had a strong July, rebounding 1.0 percent.
• The euro zone CPI was revised up in the final August estimate, increasing to a still subdued 0.4 percent.
• The ZEW survey of investor sentiment in Germany dropped to 25.4 in September. The large declines over the past two months are the worst streak since 2008. The expectations index was also down.
• France’s CPI fell to 0.5 percent year over year in August, nearly a five-year low.

• U.K. retail sales, excluding autos, increased a modest 0.2 percent in August, the second consecutive increase.
• The CPI in the United Kingdom ticked down to 1.5 percent in August, matching a five-year low.
• Chinese industrial production in August grew much less than expected, up 6.9 percent year over year, the slowest pace since February 2009.
• Japanese exports returned to negative year-over-year growth in August, with exports down 1.3 percent from a year earlier. The trade balance narrowed due to imports falling even faster.

VIDEOS AND PODCASTS

 

2022’s Upside: The Fed Has Put the Income Back in Fixed Income

Anne Walsh, Chief Investment Officer for Fixed Income at Guggenheim Investments, joined Asset TV to discuss macroeconomic conditions, risk, and relative value in the bond market.

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2022’s Upside: The Fed Has Put the Income Back in Fixed Income

 

Macro Markets Podcast Episode 26: Mortgage-Backed Securities, Structured Credit, Market Liquidity

Karthik Narayanan, Head of Securitized for Guggenheim Investments, discusses value in the residential mortgage-backed securities market and other ABS sectors. Anne Walsh, Chief Investment Officer for Fixed Income, answers a listener question on liquidity. Jerry Cai, an economist in our Macroeconomic and Investment Research Group, brings the latest on the labor picture and an update on China.

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Macro Markets Podcast: Episode #26