October Economic Update

Monthly Economic Update

October 2012

THE MONTH IN BRIEF September’s stock market gains were brought to you by the Federal Reserve and the European Central Bank. Their policy moves helped turn the ninth month of the year into an uncharacteristically good one for the S&P 500 – the index rose 2.42% across 30 days. Other global benchmarks also advanced, as did key commodity futures. Had the two central banks refrained from action, last month might have been subpar at best for equities: the economy was still sputtering, the “fiscal cliff” was drawing closer and there was still plenty to worry about when it came to China and Europe. On the upside, the real estate market seemed to be getting better and better, and manufacturing and consumer confidence gauges improved.¹

DOMESTIC ECONOMIC HEALTH The Fed announced QE3 on September 13. Unlike previous rounds of quantitative easing, it was open-ended – and it did not involve buying Treasuries. The Fed said it would buy $40 billion in agency mortgage-linked securities per month until it decided otherwise. With Operation Twist lasting through the end of 2012, that meant the central bank would be buying $85 billion per month of longer-term securities in the last third of the year. The FOMC also pledged to keep interest rates at “exceptionally low levels” into mid-2015. Essentially, the Fed is betting that its new stimulus can bolster the real estate sector (and reduce unemployment) without triggering excessive inflation.²

August’s economic indicators amounted to a mixed bag of positives and negatives. Personal spending rose 0.5% in a month, but the healthy gain was attributable to households shelling out more at the gas pump. While the unemployment rate fell to 8.1% in August, the economy only added 96,000 workers with 30% of them being hired for restaurant or bar jobs.^3,4

American manufacturing rebounded – the Institute for Supply Management’s manufacturing PMI went from 49.6 in August to 51.5 in September. This was especially good news, coming days after the Commerce Department recorded an astonishing 13.0% drop in durable goods orders in August. (ISM’s service-sector PMI had improved to 53.7 in August from 52.6 in July.)^5,6,7

While the federal government’s PCE price index rose 0.4% in August (the biggest one-month gain since March 2011), its year-over-year gain was but 1.5%. The Consumer Price Index rose 0.6% in August, yet annualized inflation was merely at 1.7%, helped by the CPI going flat for June and July. Wholesale inflation soared 1.7% in August, the biggest one-month jump for the Producer Price Index in 38 months; energy prices had risen 6.4% for wholesalers and manufacturers since July.^3.8,9

September indicators showed consumer confidence rising. (Perhaps QE3 and stock gains had something to do with that.) The University of Michigan’s final September survey rose 4.0% from its final August reading to 78.3, a 4-month high. The Conference Board’s September poll soared 9.0% to 70.3, a 7-month peak. All this came after the Commerce Department noted retail sales rose 0.9% in August.^1,3,8,10

GLOBAL ECONOMIC HEALTH On September 7, the European Central Bank announced a major bond-buying endeavor – the OMT, or Outright Monetary Transactions program. It would purchase sovereign bonds in the secondary market (with maturities of three years or less) from nations agreeing to austerity cuts, with the goal of reducing borrowing costs for Spain, Italy and other nations with unsustainable debt levels. Germany was the only member of the ECB’s governing council to vote against the program – but on September 12, its high court ruled that it could legally continue to participate in the EU’s debt relief effort. Spain announced austerity measures and economic reforms for 2012-13. Euro area inflation ticked up to 2.7% in September and unemployment reached 11.4% in August.^1,11,12,13

As for China, its manufacturing sector contracted in September – just as it had in August. Many economists took the government’s 49.8 PMI reading as a sign that China’s growth would slow for a seventh straight quarter in Q3 2012 – even though China has loosened capital ratios for lenders, cut interest rates twice and begun $150 billion worth of infrastructure projects. There was slightly better news from Europe, where the Markit Eurozone Manufacturing PMI improved to a (still poor) 46.1 in September from 45.1 in August.¹⁴

WORLD MARKETS Most global benchmarks did well in September. A few did not: CAC 40, -2.24%; Nikkei 225, -1.81%; FTSE 100, -0.58%. Aside from those retreats, things looked better: DAX, +3.05%; Hang Seng, +5.19%; Sensex, +5.67%; Kospi, +3.35%; Bovespa, +1.32%; Shanghai Composite, +0.63%; All Ordinaries, +0.44%; Bolsa, +2.29%; TSX Composite, +2.56%. In U.S. dollar terms, the MSCI Emerging Markets Index and MSCI World Index respectively advanced 5.84% and 2.52%.^15,16

COMMODITIES MARKETS

Precious and base metals saw big gains last month. Silver futures rose 10.0%, copper 8.7%, platinum 8.6%, gold 5.1% and palladium 1.8%. Apart from metals, NYMEX crude slipped 4.2% last month, corn lost 4.3%, soybeans plummeted 8.9% and cotton dropped 8.6%; natural gas futures, on the other hand, soared 19.0%. The U.S. Dollar Index lost 1.56% for August.^17,18,19,20

REAL ESTATE The National Association of Realtors said existing home sales jumped 7.8% in August, with the median sale price up 9.5% from 12 months ago. Short sales and foreclosures accounted for 22% of the market activity, compared to 31% in August 2011. Existing home prices were up 1.2% annually in August according to July’s S&P/Case-Shiller Home Price index. Not all the news was great: NAR said pending home sales had declined 2.6% in August, and the Census Bureau noted a 0.3% retreat in new home sales for the month (though the yearly increase in new home buying was 27.7%).^7,21,22,23

QE3 was already having an impact on home loan rates by the end of September. Between August 30 and September 27, the average interest rate on the 30-year FRM dropped from 3.59% to 3.40%. Mirroring that descent, the average rate on the refinancer’s favorite – the 15-year FRM – went from 2.86% to 2.73% in that period. Freddie Mac’s Primary Mortgage Market survey also measured decreasing rate averages for 5/1-year ARMs (2.78% to 2.71%) and 1-year ARMs (2.63% to 2.60%).²⁴

LOOKING BACK…LOOKING FORWARD In what historically has been the poorest month of the year for stocks, the DJIA logged its third best monthly gain of 2012.^1,25

Sources: cnbc.com, bigcharts.com, treasury.gov – 9/28/12^1,26,27,28

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly.

These returns do not include dividends.

Octobers past have brought good and bad news to investors (sometimes really bad news, as in 1929, 1987 and 2008). What will this October bring? Out of the gate, analysts were pessimistic about the latest ISM manufacturing PMI – but it surprised them by showing expansion. Market bulls still see a half-full glass. Bears are waiting for some kind of event to justify a retreat – the September employment report, a poor fall earnings season or something from overseas – but it could be that the month passes without notable market moving events, with Wall Street simply keeping an eye on the presidential campaign and awaiting the November return of Congress. The way the bulls are running, institutional and retail investors may just resolve to retain faith in the market during the next few weeks, with the potential for a positive impact on stocks and commodities.

UPCOMING ECONOMIC RELEASES: October’s data stream plays out as follows: ISM’s service sector index for September (10/3), August factory orders and the release of the September Fed policy minutes (10/4), the September employment report (10/5), August wholesale inventories and the Fed’s latest Beige Book (10/10), September’s PPI and the University of Michigan’s initial October consumer sentiment survey (10/12), September retail sales and August business inventories (10/15), September’s CPI, October’s NAHB housing market index and August industrial output (10/16), September housing starts and building permits (10/17), the Conference Board’s September Leading Economic Indicators index (10/18), September existing home sales (10/19), September new home sales, an FOMC policy statement and the latest FHFA housing price index (10/24), September pending home sales and durable goods orders (10/25), the government’s initial estimate of Q3 GDP and the University of Michigan’s final consumer sentiment survey for the month (10/26), September consumer spending (10/29) and finally the Conference Board’s October consumer confidence survey and the August Case-Shiller home price index (10/30).