/perspectives/weekly-viewpoint/gridlock-fears-grow-as-politicians-remain-in-a-dea

Gridlock Fears Grow as Politicians Remain in a Dead Heat on a Merry-Go-Round

The Dow Jones Industrial Average (Dow) fell 1.77%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 1.56%, the Standard & Poor's 500® Index (S&P 500) declined by 1.45% and the NASDAQ Composite Index (Nasdaq) shed 1.78%. Sector breadth was negative as all 10 of the S&P sector groups finished lower.

November 19, 2012    |    By Mike Schwager

Performance for Week Ending 11/16/12:

The Dow Jones Industrial Average (Dow) fell 1.77%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 1.56%, the Standard & Poor's 500® Index (S&P 500) declined by 1.45% and the NASDAQ Composite Index (NASDAQ) shed 1.78%. Sector breadth was negative as all 10 of the S&P sector groups finished lower.

Index* Closing Price 11/16/12 Percentage Change for Week Ending 11/16/12 Year-to-Date Percentage Change Through 11/16/12

Dow

12588.31

-1.77%

+3.03%

Wilshire 5000

14006.34

-1.56%

+7.79%

S&P 500

1359.88

-1.45%

+8.13%

NASDAQ

2853.13

-1.78%

+9.52%

*See Last Page for Index Definitions    
 

MARKET OBSERVATIONS: 11/12/12 - 11/16/12

The major market indices finished broadly lower for a second consecutive week. The poor performance reflected policy uncertainty, the lack of headway in resolving the Eurozone debt crisis, slowing global growth and an uptick in geopolitical tensions in the Middle East. While almost all of these problems have been festering for quite some time, the sheer lack of progress in tackling these issues coupled with the looming fiscal cliff in the United States had investors booking profits and heading for the exits.

While resolving the fiscal cliff by year end still appears better than a coin toss, investors appear to be voting with their wallets, a potential sign they have little confidence in policymakers to reach a solution by year end. On a positive note, party leaders met with President Obama on Friday, and while no decision was reached, the after meeting press conference seemed to indicate that everybody is on the same page.  However, with Washington being Washington, actually putting together a deal that everyone ultimately agrees to still seems like an uphill battle.

It's all about the fiscal cliff
Worries over the fiscal cliff have pushed the S&P 500 down by over 7% since the highs reached in mid-September. The small stock focused Russell 2000 and the technology-heavy NASDAQ Composite has fared even worse, with both indices falling into correction territory (defined by a 10%-plus decline from a prior high). The pullback has significantly pared the major indices year-to-date performance, although all still remain in positive territory. The selling pressure in the equity markets, amongst a host of other things, seems related to fears over higher taxes on both capital gains and dividend income, as dictated by the expiration of the Bush-era tax cuts.  If these tax cuts are not extended then capital gains, for high income investors, will be taxed at 20% and taxes on dividend income will jump to 39.6% (both rates are currently at 15%). In addition, high income earners will also be subject to a 3.8% levy associated with Obamacare on both capital gains and dividend income, therefore the ultimate tax burden could rise to 23.8% and 43.4%, respectively.

FED Minutes/FED Heads
The meeting minutes from the October 23/24 Federal Open Market Committee (FOMC) meeting were released last week followed by a parade of speeches from several FED officials. The overall tone coming out of the FED remained quite "dovish" and it appears that more policy accommodation could be on the way. The FED minutes highlighted what looks to be a growing consensus toward incorporating "economic thresholds" versus (or in addition to) time/calendar based commitments. This would mean that the FED would continue with their accommodative policies until some economic objective is reached, for example an unemployment rate of 6%, instead of pledging to keep rates low until some future point in time. The FED minutes also suggests that they could step up their bond buying activity into next year. As stated in the minutes "looking ahead, a number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program (i.e. Operation Twist) in order to achieve a substantial improvement in the labor market." This suggests that the current bond purchase rate of $85 billion per month will be sustained for the foreseeable future.

Eurozone Double Dips
Economic data last week showed the Eurozone economy contracting for a second straight quarter, meeting the common definition of recession.  This is the second time in less than 4 years that the monetary union has fallen into recession. The Eurozone economy continues to be plagued by debt related issues and the resulting austerity measures that have been put in place to battle out of control spending. So far, the overall recession has been relatively mild with growth contracting by only 0.2% in the third quarter. Up to this point economic weakness in most of the Eurozone region has been cushioned by solid growth out of Germany, the Eurozone's largest economy. This could however begin to fade as pointed out by ECB President Draghi two weeks ago. Draghi, speaking at a conference in Frankfurt said “Germany has so far been largely insulated from some of the difficulties elsewhere in the euro area, but the latest data suggest that these developments are now starting to affect the German economy.”

Economic Roundup
This week’s batch of economic data, in many cases, fell well short of economists’ expectations.  Most of the setbacks, however, appear related to hurricane Sandy and are likely to prove temporary in nature. On the labor front, initial jobless claims surged by 78K to 439K, the highest reading since April 2010. Meanwhile, the Census Bureau reported that retail sales during the month of October fell by 0.3% well below the 0.4% gain expected by economists. While storm related issues are likely to continue to cloud the economic data in the near-term a “payback” period will likely occur at some point reflecting pent up demand and the rebuilding efforts associated with the storm.

The Week Ahead:
Data releases will be front end loaded reflecting the Thanksgiving holiday on Thursday.  The economic calendar features several housing related releases as well as the closely watched initial jobless claims release. In addition, the University of Michigan confidence data will be a focal point to see how the storm, election and recent pullback in the market has impacted consumers attitudes.

MARKET VIEWPOINT

While uncertainty surrounding the resolution of the fiscal cliff will likely weigh on near term stock performance, expectations of an eventual solution should set the stage for higher asset prices as we approach the end of the year. Domestic growth has been gaining traction reflecting the resiliency of the consumer and the improving housing sector.  While the political "noise" will dominate the investment landscape in the near-term,  Equities remain attractive on a longer-term basis reflecting the combination of attractive valuation,  the overall healthy nature of corporate balance sheets and the commitment from the FED to maintain accommodative monetary policy through at least mid-2015.

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.


Definitions

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.

 

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.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.


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