/perspectives/weekly-viewpoint/the-game-of-chicken-begins

The Game of Chicken Begins

Performance for Week Ending 11/9/12: The Dow Jones Industrial Average (Dow) fell 2.12%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 2.41%, the Standard & Poor’s 500® Index (S&P 500) declined by 2.43% and the NASDAQ Composite Index (NASDAQ) shed 2.59%. Sector breadth was negative ...

November 12, 2012    |    By Mike Schwager

Performance for Week Ending 11/9/12:

The Dow Jones Industrial Average (Dow) fell 2.12%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) lost 2.41%, the Standard & Poor’s 500® Index (S&P 500) declined by 2.43% and the NASDAQ Composite Index (NASDAQ) shed 2.59%. Sector breadth was negative as all 10 of the S&P sector groups finished lower.

Index* Closing Price 11/9/2012 Percentage Change for Week Ending 11/9/2012 Year-to-Date Percentage Change Through 11/9/2012

Dow

12815.39

-2.12%

+4.89%

Wilshire 5000

14228.05

-2.41%

+9.50%

S&P 500

1379.85

-2.43%

+9.72%

NASDAQ

2904.87

-2.59%

+11.51%

*See Last Page for Index Definitions    
 

MARKET OBSERVATIONS: 10/29/12 - 11/9/2012

The major market indices finished the week broadly lower on growing fear policymakers won’t be able to find middle ground ahead of the looming fiscal cliff and renewed concerns over the European debt crisis. The fears over fiscal policy offset what looks to be greater clarity surrounding monetary issues as the reelected Obama administration is likely to support keeping in place a more “dovish” tone to monetary accommodation.

While the conclusion of the U.S. elections has removed one source of uncertainty, it has also opened the door to the next. On the surface, the U.S. elections yielded a status quo outcome; however below the surface Congress appears to have moved further apart. 
This division has led to elevated concern that gridlock and political brinkmanship will prevent policymakers from finding some middle ground in attempting to address the fiscal cliff by year end. In speeches following the election, both sides of the aisle talked about the need to compromise; however it also appeared that these statements came with an asterisk that said “as long as we play by my rules.”

While the likelihood that politicians will come to some eleventh hour agreement to avoid the fiscal cliff still seems better than a coin toss, any stalemate between now and then is likely to result in much uncertainty and therefore an increased period of volatility. Using the debt ceiling debate during the summer of 2011 as an example, it appears things may have to get “very ugly” before politicians become willing to “blink”. Last summer the S&P 500 plunged by over 18% from mid-July to early August. That pain ultimately provided a wake-up call to politicians who suddenly saw the light and found resolve.

With economic growth seemingly gaining traction over the past few months, there is now a growing risk that economic activity could slow over the remainder of the year as political posturing could result in a virtual standstill of business investment and hiring between now and the end of the year. Underscoring that doing nothing should not be an option, the Congressional Budget Committee released an updated assessment showing that letting the economy go over the fiscal cliff would result in a recession next year and send the unemployment rate back above the 9% level.

Also weighing on sentiment last week was heightened worries over the situation in Europe with the primary focus on funding concerns in Greece. Greek politicians voted last week to impose additional austerity measures in exchange for receiving the next tranche of bailout funding, however, European policymakers appear to be playing hardball and could further delay more bailout funding. Adding insult to injury, the European Commission (EC) reduced their outlook on the Eurozone economy while at the same time European Central Bank President Mario Draghi warned that the European debt crisis is starting to weigh on Germany, the Eurozone largest economy. The EC report noted that Europe will see a deeper-than-expected recession in 2012 and will only start recovering very slowly and unevenly in 2013. The EC expects the economy of the 17-member euro zone to contract by 0.4% in 2012 and grow a mere 0.1% in 2013.

Economic Roundup
Last week’s economic calendar was relatively light and the few reports that were released were overshadowed by the political saga. On the jobs front, the Labor Department reported that initial jobless claims during the week ended November 3 fell by 8K to 355K. Results were slightly better than the 365K gain expected by economists.   Continuing claims—the ongoing number of people collecting unemployment benefits—fell 135K to 3127K. Also getting little fanfare was the Institute for Supply Management’s non manufacturing report. The report, which focuses on the services side of the U.S. economy, showed the segment expanding for a 34th consecutive month. While this report got pushed to the backburner due to political news flow it is important to note that service oriented business account for almost 90% of U.S. economic activity.

Q3 Earnings
With over 90% of the S&P 500 having reported third quarter results, the overall tally appears to be solidly better than the dire expectations analysts were forecasting coming into earnings season. Through Friday, 452 members of the S&P have reported results with overall earnings up by 4.7%. Of the companies that have reported, 64% have beaten expectations while 25% have fallen short.  The current “beat” rate is slightly better than the 61% long-term average. When all is said and done, analysts now expect S&P 500 earnings to grow by 4.3% in the quarter. Looking ahead to fourth quarter results, analysts are currently forecasting S&P 500 earnings growth of 5.7%.

The Week Ahead:
News flow surrounding progress (or lack thereof) surrounding the fiscal cliff will be the focal point as Congress returns to Washington. The economic calendar picks up this week with reports on inflation, retail sales and regional manufacturing expected to take center stage. On the earnings front 24 members of the S&P 500 scheduled to report results this week.

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 the year progresses. 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 Federal Reserve 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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