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Stocks Gain as a 307 Year Old Union Remains Intact

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For the week stocks were up, bonds were flat, and commodities declined. The S&P 500 gained almost 1.3% this week, while the Dow Jones Industrial Average led the way (+1.7%) and the tech-heavy NASDAQ Composite lagged (+0.3%). As of Friday’s close the S&P 500 is now back in double digit territory (+10.4%) for 2014 on a total return basis.

The Fed’s FOMC had a two day meeting this week and released a statement on Wednesday as well as updates to the Committee members’ economic projections. Overall the official statement was much the same, with some modest tweaks to the language on the Committee’s view of GDP growth, the labor market and inflation. The Fed pledged to continue tapering its asset purchases in October by dropping the amount of Treasury and Agency securities it buys from the current level of $25 billion to $15 billion. The program is expected to be wound down completely at the next meeting on October 28/29.

Perhaps the most surprising part of the statement is that the Fed still expects to maintain a zero percent fed funds rate for a “considerable time after the asset purchase program ends.” Before the announcement the market had begun to wonder if the FOMC would hint at an impending rate hike, however it chose not to do so this time around. While the Fed does not quantify what exactly defines a “considerable time,” in all likelihood the first rate hike will come sometime during the second or third quarter of next year. And thus the Fed appears to be talking from both sides of its mouth as the pledge of a zero percent fed funds rate for a “considerable time” contrasts with the economic projections of the Committee members where the median forecast calls for a 1.375% fed funds rate by the end of 2015. If the fed intends to make good on both fronts, then it will be raising rates at a faster pace than the tightening cycles of recent memory.

Despite all the actions of the Fed this week, by the time Friday’s close came around the Treasury market was little changed from the week before. The yield on the 30 year fell six basis points to 3.28%, while the 10 year yield dropped four to 2.58%. Yields for all other maturities were virtually unchanged.

Economic data out this week included new numbers on inflation. PPI came in exactly as expected, while CPI was expected to be flat MoM but actually showed a 0.2% decline. Falling energy prices including a 4% drop in the price of gas was the culprit. The FOMC noted in its statement this week that inflation “has been running below the Committee’s longer-run objective” but also that “longer-term inflation expectations have remained stable.”

On the housing market front, the National Association of Home Builders’ market index rose to 59, a level last scene in 2005. At the same time, the number of new housing starts fell to an annual rate of 950 thousand from last month’s reading of more than 1.1 million. For buyers looking to purchase a home, the national average on a 30 year mortgage rate is still just 4.23%.

cotw09192014While the sun may have set long ago on the British Empire, the United Kingdom lives on as it avoided a very messy and public breakup this week by a margin of 383,937 votes. The referendum on Scottish independence ended up being not as close as the polls were predicting (45% “Yes” for independence and 55% “No” to stay in the union), but it certainly was a remarkable showing for the democratic process. In the lead up to the vote a staggering 97% of the eligible voting population had registered to cast a ballot and when all was said and done a record 84% turned out at the polls. For comparison, in the last U.S. presidential election 65% of the eligible population was registered and just over 56% actually voted. Equity markets had a relatively muted reaction to the vote, with the British FTSE 100 rising less than 1% on the news. For the week pound Sterling was little changed against the U.S. Dollar.

The political fallout from the vote has already resulted in the leader of the Scottish National Party resigning, and Scotland seems intent on holding London to its promise for greater autonomy that was made just days before the referendum. At some level this appears to have been a political game of chicken, and it still remains to be seen who won. The allure of independence will likely trouble Europe for some time as the continent struggles with high unemployment a low economic growth. Catalonia, a region in northwestern Spain, has long sought to be an independent nation, and the region’s parliament is set to allow a non-binding vote on the issue to take place in November. The federal government in Spain considers such an action illegal and will likely challenge the attempt in court.

If you weren’t paying attention you could have easily missed it, but sometime between Thursday night and midday Friday $65 billion was magically created as a result of the IPO by Chinese e-commerce giant Alibaba. Shares were priced in the offering at $68, but by the time they opened for secondary trading on the NYSE the price had skyrocketed to over $94. For those unfamiliar with the company, Alibaba is the go to website for everything from t-shirts to industrial water treatment systems in China. Think of it as a mix between Amazon and eBay, but on an even larger scale. The company operates multiple sites which facilitate $296 billion in annual merchandise transactions among 231 million active buyers. The company certainly has a compelling story for future growth, as only half of the 618 million internet users in China currently buy stuff online. Furthermore, another 700 million Chinese don’t even have access to the internet, but that is bound to change in the future. However for now that is just a story, and the hype surrounding the IPO is likely getting a bit excessive.

 

Nicholas Case
Senior Investment Analyst

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