ECB Delivers, FOMC on Deck

Performance for Week Ending 9/7/12: The Dow Jones Industrial Average (Dow) gained 2.35%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 2.44%, the Standard & Poor's 500® Index (S&P 500) rose by 2.75% and the NASDAQ Composite Index (NASDAQ) tacked on 2.88%. Sector breadth was ...

September 10, 2012    |    By Mike Schwager

Performance for Week Ending 9/7/12:

The Dow Jones Industrial Average (Dow) gained 2.35%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) added 2.44%, the Standard & Poor's 500® Index (S&P 500) rose by 2.75% and the NASDAQ Composite Index (NASDAQ) tacked on 2.88%. Sector breadth was positive as all 10 of the S&P sector groups finished higher. The Financials sector (+3.60%) led the way higher followed by Materials (+3.52%) and Consumer Discretionary (+2.80%).

Index* Closing Price 9/7/2012 Percentage Change for Week Ending 9/7/2012 Year-to-Date Percentage Change Through 9/7/2012





Wilshire 5000




S&P 500








*See Last Page for Index Definitions

MARKET OBSERVATIONS: 9/3/12 - 9/7/12

The major market indices finished the week solidly higher after the European Central Bank (ECB) announced a new bond buying initiative. Adding to the positive tone was the growing likelihood that the Federal Open Market Committee (FOMC) will follow suit at this week's two-day meeting.

Stocks have been in rally mode since early June on speculation that global central banks would begin to pump additional liquidity into the markets to prop up confidence and encourage risk taking. Last week, in addition to the announced ECB bond buying program, the People's Bank of China (PBOC) announced a pair of infrastructure related initiatives geared towards reviving sluggish domestic growth. The question now becomes whether the Federal Reserve (Fed) will announce additional easing initiatives this week.

Expectations heading into the FOMC meeting are very elevated and if the Fed fails to offer a new bond buying initiative or, at a minimum, a detailed framework of their intentions, the market would likely be very disappointed. The Fed is scheduled to announce their decision on rate policy on Thursday afternoon (12:30 ET) followed by a press conference from Fed Chairman Bernanke at 2:15 ET.

With interest rates already zero-bound, the two most likely options are an extension of their commitment to keep rates low through 2015 (versus their current pledge of late-2014) and/or the announcement of an open ended asset purchase program (QE3).

ECB announces OMT
Expectations of a new stimulus effort from the ECB have been elevated ever since ECB President Mario Draghi pledged several weeks ago to do “whatever it takes” to save the euro.  At the conclusion of Thursday’s ECB meeting, Draghi announced the “Outright Monetary Transaction” (OMT) program to help support the debt markets of fiscally challenged Eurozone countries.  Draghi said the bank will buy government bonds with maturities between one and three years without announcing any limits in advance.

The initiation of the OMT is an effort to bring down soaring funding costs in countries such as Italy and Spain and to ultimately provide investors with an “effective backstop to avoid destructive scenarios.” While the reaction to the news was very favorable as the program significantly lessens the odds of a near term collapse of the Eurozone, on a longer term basis, the program seems to do little to solve the growth and structural issues that plague the monetary union. In other words, the program just “kicks the can down the road” and buys European leaders time but does little to address the growth related issues that have pushed the Eurozone into recession.

Payroll Report
On Friday, the Labor Department released the August Payroll report.  The data showed nonfarm payrolls during the month rose by a weaker than expected 96K and the unemployment rate dropped to 8.1% from 8.3%.  Private payrolls—which filter out government hiring/firing—rose by 103K well short of the 142K expected by economists. While the unemployment rate declined, the reason it fell was due to a contraction in the labor force as 368K people gave up trying to find work.  In fact, the labor force participation rate fell to 63.5%, the lowest rate in over 30 years.

With the Federal Reserve having a mandate of “full employment,” the weak jobs report is bittersweet in the sense that the weakness enhances the odds that the FOMC will reapply their foot to the monetary gas pedal at this week’s FOMC meeting. This in turn should keep the “stimulus junkies” happy knowing that another shot of “monetary morphine” is likely in the offing

Economic Round-up
While the Payroll data was clearly disappointing, the outcome still signals an economy that is growing at a modest pace. Elsewhere, the Institute for Supply Management (ISM) reported that their non-manufacturing (services) index rose at a better than expected rate during the month of August.  In addition, the “guts” of the report (employment, new orders, etc) remained solidly in the expansionary zone.  Investors tend to watch this report as service oriented businesses comprise approximately two-thirds of the U.S. economy. While the services portion of the economy remains in expansionary territory, the manufacturing side continues to contract.  Earlier in the week, the ISM reported that their manufacturing index contracted for the third straight month and now sits at the lowest level in three years. Meanwhile, the Commerce Department reported that construction spending in July fell for the first time in four months. Both the ISM and construction spending data raised fears that the U.S. recovery is teetering and the Fed may be behind the curve in pumping more liquidity into the economy.  Remember monetary stimulus typically works with a lag where changes in policy usually take anywhere from take six to 12 months to filter its way through the economy. 

The Week Ahead:
The focal point of the upcoming week will be the two day FOMC meeting. The consensus view is that the Fed will announce a new round of quantitative easing (QE3) at the conclusion of Thursday’s gathering. Reports of interest on this week’s economic calendar include the producer price index, jobless claims, the consumer price index and retail sales. Third quarter earnings season won’t kick off for several weeks, however, in the interim, investors will pay close attention to earnings guidance from company management with a particular focus on how slowing global growth is weighing on business conditions. One other event of interest will be Wednesday’s ruling from Germany’s Constitutional Court on the legality of the European bailout fund.


I continue to believe that the U.S. equity markets remain well positioned for positive performance over the course of the next few quarters especially relative to cash and safe-haven Treasury bonds. This upbeat view reflects the markets attractive valuation, the overall healthy nature of corporate balance sheets, the recovering (albeit modestly) economy, expectations that corporate profits will remain favorable, and the pledge from the Federal Reserve that monetary policy will remain accommodative through at least late-2014. In light of these favorable dynamics, I continue to believe that market weakness represents an attractive entry point, especially for longer-term investors.

Potential Risks/Wildcards: Expectations that equity prices will trend higher over time assumes that a resolution to the debt problems in Europe will be found, that monetary policy will remain accommodative, and that no major fiscal policy mistakes are made.  An adverse outcome to any of the above factors would likely lead to a reevaluation of the bullish outlook.


The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Nasdaq Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

The S&P/TSX Composite Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange (TSX). The index was developed with a base level of 1000 as of 1975.

Institute for Supply Management (ISM) Manufacturing Index is a monthly composite index that is based on surveys of 300 purchasing managers throughout the United States in 20 industries in the manufacturing area. The index is released on the first business day of the month and covers the previous month’s data, which makes it particularly timely. If the index is above 50, it indicates that the economy is expanding. Values below 50 indicate a contraction.  

Institute for Supply Management (ISM) Non-Manufacturing Index (or Services Index) is based on surveys of 370 purchasing and supply executives. If the index is over 50, it typically indicates expansion among non-manufacturing components of the economy. A value under 50 indicates contraction. There are ten sub-indices. Of those, the business activity sub-index is most influential. The other nine indices are new orders, supplier deliveries, employment, inventories, prices, backlog of orders, new export orders, imports, and inventory sentiment. A limitation of the survey is that it doesn’t include any questions on wages, which is an important component of overall costs.


Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

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