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Third Quarter 2013 Forecast and Opinion

At the time of this writing, the Federal government has been partially shut down due to Congressional bickering over Federal spending, the debt limit ceiling, and “Obamacare”, or the Affordable Health Care Act. It is difficult to say how long this will continue, but economic estimates call for a reduction in national growth of 0.1% per week that it endures. If it continues beyond two weeks, the negative impact is likely to accelerate. So far, the stock market has not reacted that adversely, anticipating a speedy resolution. This marks the 18th government shutdown in U.S. history. Traditionally, the stock market declines for the month that precedes the shutdown and then trends higher (on average) for the next three months.

In September, the Federal Reserve unexpectedly decided to ”stay the course” on their stimulus plan, electing not to begin tapering their program of bond purchases at a rate of $85 billion per month. The Fed feels that despite the summer’s improvement in the unemployment rate to 7.3%, the underemployment rate of part-time workers seeking full-time work remains stubbornly high at 14.6%. The labor participation rate has also been falling, as many discouraged unemployed have simply given up and have thus dropped off the labor force count. The current labor participation rate of 63.2% of the population is a full 3% lower than it was ten years ago, and still falling monthly. Lawrence Summers dropped his candidacy to become the next Fed governor in January, leaving FOMC member Janet Yellen, known for her "dovish" (or generally stimulative) policies, as the likely contender for the post when Ben Bernanke steps down.

In a speech presented on October 2, Federal Reserve Board member Eric Rosengren said that there were three reasons to be cautious about tapering the current economic stimulus: 1) Recent economic data has been "disappointing", 2) The fiscal deadlock in Washington might lead to a slowdown in economic activity, and 3) Bond yields, and thus mortgage rates, have climbed to levels which could threaten the recovery. With comments like these being issued, it is increasingly likely that the Fed will continue its stimulus program for longer than the market expects, which would be positive for stocks.

US manufacturing continues to perform well, and profit margins in the US are at record highs. Provided that they remain elevated, this could augur for a continuation of this year’s rally into year end. There is potential for a considerable rise in capital expenditures by businesses in the U.S. Capex-to-GDP ratios are still depressed relative to their long term averages, because companies have preferred to keep their profit margins and their cash levels high. This should continue to boost manufacturing new orders.

Rising US real estate prices have positively impacted the “wealth effect", leading to improving consumer confidence. Recent Fed reports indicate that homeowners equity has just risen to levels which equal home mortgage debt for the first time since the third quarter of 2007.

The global economy is growing as well at a slow and steady rate, as evidenced by improving manufacturing indexes in Europe and China. Asian markets, having been hard hit this year, are demonstrating some improvement, aided by more active government policies. Looking forward, they may begin to perform better and revert to more normal levels of growth.
There has been a lowering of tensions between the U.S. and Iran, which may have the favorable impact of lowering oil prices, particularly for Brent crude, which trades at a higher price than Texas crude. This will benefit European economies more than the U.S., but provide a positive tailwind globally.

It is important to temper optimism, however, with the recognition that a prolonged government showdown will have negative consequences on the stock market, at least in the short term. A default, though highly unlikely, would lead to very serious consequences for all financial markets.

For the first three quarters of 2013, the Dow gained 15.46%, the S&P 500 increased 17.9%, and the Nasdaq rose 24.9%.

Grant Rogers

Partner

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