June 2013 Economic Outlook

Sweeney, Greg

Read our Economic Outlook, a monthly newsletter authored by Greg Sweeney, CFA, chief investment officer at Bell State Bank & Trust. Sweeney holds a bachelor’s degree in business from the University of North Dakota, is a CFA charter holder, and is a 27-year veteran of the Investment Management team.

 

Federal Reserve Monetary Policy

  • At the next Federal Reserve meeting on June 20, we expect the Fed to leave rates unchanged between zero and 0.25%. The Fed continues to indicate that rates will remain near these lows until 2015, but dissension remains among the Fed members on this subject.

Inflation

  • The most recent year-over-year consumer price index (CPI) shows inflation at 1.1%. All indications are that the next number will push higher when it is announced on June 18 reporting for the month of May.

Economic Activity

  • On May 30, three disappointing reports about the economy were released. Gross domestic product (GDP) did not increase as much as expected, unemployment claim filings increased and pending home sales did not increase as anticipated. News like this would not normally be supportive of the stock market. Instead, the stock market moved higher on the prospect that the Federal Reserve would maintain its QE programs artificially supporting the market. The very next day, two good economic reports, better business activity and a jump in consumer confidence resulted in a stock market sell-off because it was suggested that the Fed would reduce its QE programs.
  • The Federal Reserve had been targeting reduced unemployment and stable inflation as benchmarks for its QE program, but the Fed now openly talks about managing the markets as it considers altering QE. This confirms feelings many investors already had.
  • The bottom line is that Fed activity has an elevated influence on the level of the bond and stock markets, and odds are increasing that market volatility could be sudden and larger than normal.
  • If solid economic growth does not develop as a result of the QE programs, it will be difficult to exit the QE programs.
  • On a separate note, we expect the Fed to err on the side of more accommodation, risking the prospect of a bit higher inflation to avoid a more painful deflationary environment.
  • Average hourly earnings are barely keeping up with inflation. Combine this with rising taxes, and consumers are not able to increase their standard of living. This has been the case for the last six years.

Fixed Income

  • Bond markets met rising interest rates over the last month, with 10-year Treasury bonds losing more than 3% in May as interest rates increased from 1.67% to 2.08%. That is 15 months’ worth of interest income lost to declining market value in one month.
  • We don’t expect to see rising rates continue near term and expect 10-year Treasuries to trade in a new range between 1.8% and 2.25% for the time being.
  • Remember, longer-term bonds are more sensitive to interest rate changes than shorter-term bonds.
  • Yields are volatile, as investors wrestle with defining how much influence QE programs have on market valuations.

Stock Market

  • The keys to sustained stock market levels are rising top-line corporate revenues and rising earnings in an acceptable risk environment. Revenue growth has been a challenge, and the risk environment is being assessed. Corporate earnings have been acceptable on the heels of increasing efficiencies. The prospects for future sources of growth appear to be relying more heavily on the successful outcome of federal monetary programs.
  • There are different ways to define fair stock market valuations. The current P/E ratio is 15.89, which is within the range of normal averages. What remains a mystery is the comfort level about the portion of those earnings supported by QE programs.

View previous Economic Outlook newsletters.

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