About every six weeks the U.S. Federal Reserve Board (the "Fed") releases a report titled the Beige Book. The report, which provides anecdotal information collected by the 12 Federal Reserve district banks, showed continued growth in economic activity but with "widespread signs of a deceleration."
For anyone paying attention, the fact that economic activity in the United States has slowed should not come as a big surprise. In fact, Wednesday's release of the report was generally shrugged off as old news.
While the overall indications were of slowing growth ahead, the slowdown does not yet appear drastic enough for the Fed to initiate a new round of stimulus at the upcoming Federal Open Market Committee (FOMC) meeting.
Recall a few weeks ago, Fed Chairman Ben Bernanke pledged that the Fed was prepared to provide additional stimulus if necessary, especially if the economic outlook weakens significantly. The data within the Beige Book summary, while weakening, seemed to fall short of the "weaken significantly" requirement.
With that said, we still believe there remains a better-than-average chance that some sort of stimulus initiative by the Fed will be required to help the economy counter the fading contribution from last year's $787-billion fiscal stimulus program. The issue then becomes one of timing. As we know, mid-term elections in the U.S. are scheduled for Nov. 2. It just so happens that there is a FOMC meeting scheduled the very next day.
Although the Fed is considered an independent entity, a move to stimulate the economy ahead of the election would likely be considered politically motivated. Waiting until Nov. 3 to announce new stimulus programs would eliminate any signs of political bias and more importantly, it would give the Fed more time to evaluate incoming economic data and whether additional stimulus is actually required.
| Index | Closing Price 9/10/2010 |
Week Ending 9/10/2010 |
Year to date through 9/10/2010 |
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| Dow Jones Industrial Average | 10462.77 | 0.14% | 0.33% | ||
| Wilshire 5000 Total Market | 11439.55 | 0.27% | 0.16% | ||
| S&P 500 | 1109.55 | 0.46% | -0.50% | ||
| NASDAQ Composite | 2242.48 | 0.39% | -1.18% | ||
| S&P/TSX Composite | 12097.09 | -0.39% | 2.99% | ||
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Economic data has been "less bad"
Economic reports over the past few weeks seem to be having a pacifying effect on the markets. Since the end of August, the U.S. market, as measured by the S&P 500, has added over 5% in what has historically been a seasonally weak month for stock price performance. While the economy still appears to be stuck in a soft patch, recent data has been "less bad" and the positive reaction by the markets suggests that the level of pessimism may have outpaced what is ultimately coming to fruition in the economy.
The data seems to have reduced fears over the durability of the recovery and has significantly decreased the likelihood that the economy returns to a recessionary state, in my opinion. Recent reports on manufacturing, employment and housing have all signalled stabilization in the economy. While the transition from recovery to expansion still seems to be occurring, the pace has been excruciatingly slow.
More stimulus proposed
Last week President Obama proposed several stimulus measures to try and jumpstart the flagging economy and weak employment outlook. The markets generally dismissed the initiatives as they appeared to be politically motivated and generally too little, too late. The one initiative that received the best reception was the proposal to allow businesses to fully write-off new purchase of capital equipment (i.e. computers, new plants, machinery, etc.) through 2011. If passed, this would likely give the economy a near-term boost; however, because of its temporary nature it would likely steal investment from future years. This is what has generally happened in the housing and auto markets with the first-time home buyer tax credit and cash for clunkers programs.
Without getting into the accounting mumbo jumbo, the initiative is geared toward getting businesses to dip into the elevated cash hoards on their balance sheets, which are collectively estimated at close to US$2 trillion. The one initiative that most members of the business/investment community desire -- the extension of the Bush tax cuts for all income groups -- is still vehemently opposed by the Obama administration.
While the Obama administration argues that it is a "business friendly" administration, it seems that not extending all the tax cuts is, in some ways, anti-business. Many small business owners will ultimately see their tax bills rise as a result of the ending of the Bush tax cuts. This, coupled with the likelihood of higher health care bills due to health care reform, doesn't seem to be the attractive recipe to jumpstart hiring. We must remember that the bulk of new jobs in the U.S. are a result of small business hiring. With it being an election year and Democrats drowning in the polls, let's hope lucidity emerges.
Markets still stuck in sideways range
Since the beginning of June the S&P 500 has been stuck in a trading range between 1130 on the upside and 1050 on the downside. Trading volumes have also slowed to a crawl as investors seem to be waiting for the dust to clear before committing capital back into the equity markets. The question then becomes what will be the catalyst to push the markets above the upper end of the range. While better news regarding the economy would likely do the trick, it is a catalyst that will likely need time to develop.
Unfortunately we may need to go through this process, to get through it. With that said, the kick-off of third-quarter earnings season early next month, and the likelihood of an "investor friendly" outcome to the mid-term elections may mean better times are just over the horizon.
Looking ahead
The economic calendar will be the focal point this week, with a grab-bag of reports on inflation, retail sales, consumer sentiment, regional manufacturing and industrial production. Investors will be looking to see if the string of "less bad" data continues.
The U.S. Congress is also scheduled to return this week from its summer hiatus. Look for political dog fights between the Democrats and the Republicans over the next several weeks as both parties try to posture ahead of the mid-term elections. Items likely to be on the near-term agenda include a debate over the extension of the Bush tax cuts, additional fiscal stimulus and ways to jump-start hiring.
While the media will be abuzz with fresh promises and one-liners from politicians, in reality, the bar for accomplishments is not set high as neither party seems likely to bow down ahead of the upcoming elections.
