Fed Takes Action

As the economy has grown stronger, the Federal Reserve has been discussing when to reduce its bond and mortgage purchases. For about 15 months, the Fed has been purchasing about $85 billion each month and has acquired approximately $3 trillion in these investments. The purpose was to add liquidity to the economy, which resulted in lower mortgage interest rates, lower long-term bond interest rates and a booming stock market. The Fed indicated this afternoon that they will taper off these purchases by about $10 billion, bringing them down to about $75 billion monthly. Tapering will reduce the flow of cash from the Fed but will also allow them to adjust upward easily if the economy shows signs of souring. If tapering does not disturb the economy, it will likely be followed by additional cuts until all purchases are stopped. The long-term impact of this change will likely be an increase in longer-term interest rates and slowing of the rise in stock prices.  I had not personally expected the change until March of 2014, once Janet Yellen was in place as the new Fed Chairman. The change is likely to be the last major action by the current Fed Chief, Ben Bernanke. At the same time that they announced the tapering of purchases, the Fed also indicated that short-term rates would remain close to zero until after the unemployment rate goes below 6.5%.  This information means that short-term rates will be likely to stay at zero until late 2015 or early 2016.

Ed Mallon

Market Turning Down

During the past number of market sessions, we have seen some profit taking on stocks and repositioning of bonds, which has moved the stock market down. The result is confusion on the economic front. The good news, announced on Thursday, was that in the third quarter the economy grew at a rate of 3.6%, rather than the 2.8% originally reported. Business inventories, at $116.6 billion--the largest accumulation of inventories since the first quarter of 1998--accounted for most of the growth. This growth is in sharp contrast with domestic demand that rose only 1.8% rather than the expected 2.1%. As a subplot, consumer spending dropped to 1.4%, the lowest since the fourth quarter of 2009. Retail spending, so far in the fourth quarter, does not seem to be picking up as we go into the biggest shopping period of the year. Retailers may have to take major markdowns before the holiday season is over, to align inventories with consumer spending. Corporate profits, after tax for the third quarter, dropped to 2.6% from 3.5% in the second quarter. If heavy discounting of inventories takes place, corporate profits may drop further. Expectations of advancing corporate profits have kept the recent stock rally going. The reality of what might happen to corporate profits is setting in and moving the market downward.

All is not lost. It appears this will be a correction and not a bear market. One of my favorite indicators is the number of initial jobless claims. I have not reported on that in a while. Last week, jobless claims were at 298,000, the lowest number we have seen in years, and the third weekly drop, which is also impressive. Not long ago, I was wishing for the claims to drop below 400,000! With all of this information, I am maintaining my position that the Federal Reserve will not reduce bond purchases before March of 2014. The liquidity level of the economy should remain constant, which is good.  The economy surprised experts in the second quarter, growing more than 2% after original estimates of 1%. Again in the third quarter, the economy grew at 3.6% after the original estimate of 2.8%. Who knows? Perhaps it will do so again in the fourth quarter.

Ed Mallon