MarketView for April 30

 

Summary

 

The Dow Jones Industrial Average closed at its first record high of 2014 on Wednesday after the Federal Reserve gave an upbeat view of the economy's prospects as it announced another cut to its massive bond-buying program. Stocks were near steady for most of the session, then slowly edged to session highs following the Fed announcement.

 

The Fed said in a statement it would reduce its monthly bond purchases to $45 billion from $55 billion, as expected. That will keep it on track to end the program as soon as October. That the Fed looked past a dismal reading on first-quarter growth reinforced the view that weather was to blame for the weakness.

 

For the month, the Dow and S&P 500 posted slight gains, while the Nasdaq fell 2 percent following weeks of heavy selling in tech and biotech "momentum" stocks. The Dow was up 0.7 percent in April; the S&P 500 was up 0.6 percent.

 

EBay was among the largest negative influences on both the S&P 500 and Nasdaq. Its shares fell 5 percent to $51.83, a day after it forecast lower-than-expected earnings this quarter. Twitter fell 8.6 percent to $38.97 and hit a record intraday low of $37.25, a day after posting lackluster user and usage growth.

 

Early in the session, data showed gross domestic product expanded at a 0.1 percent annual rate in the first quarter, the slowest since the fourth quarter of 2012, as exports and inventories weighed, but activity already appears to be bouncing back.

 

In another report, however, employers beat expectations by adding 220,000 workers in April, the most since November, and gains in the prior month were revised up.

 

After the bell, shares of Yelp, the operator of consumer review website Yelp.com, rose 4 percent to $60.67 as it reported a 66 percent rise in quarterly revenue.

 

Approximately 6.8 billion shares changed hands on the major equity exchanges, a number that was above the 6.6 billion share average during April, according to data from BATS Global Markets.

 

Economic Growth Slows to 0.1 Percent

 

The Commerce Department indicated on Wednesday that the economy’s growth slowed to a barely discernible 0.1 percent annual rate during the January-March quarter. That was the weakest pace since the end of 2012 and was down from a 2.6 percent growth rate in the October-December quarter.

 

Consumer spending grew at a 3 percent rate. However, that gain was dominated by a 4.4 percent rise in spending on services, reflecting higher utility bills. Spending on goods barely rose. Also dampening growth were a drop in business investment, a rise in the trade deficit and a fall in housing construction.

 

The scant 0.1 percent increase in the gross domestic product, the country’s total output of goods and services, was well below the 1.1 percent rise the Street had been expecting. The last time the quarterly growth rate was so slow was in the final three months of 2012, when it was also 0.1 percent.

 

A variety of factors held back growth. Business investment fell at a 2.1 percent rate, with spending on equipment plunging at a 5.5 percent annual rate. Residential construction fell at a 5.7 percent rate. Housing was hit by winter weather and by other factors such as higher home prices and a shortage of available houses.

 

A widening of the trade deficit, thanks to a sharp fall in exports, shaved growth by 0.8 percentage point in the first quarter. Businesses also slowed their restocking, with a slowdown in inventory rebuilding reducing growth by nearly 0.6 percentage point.

 

Also holding back growth was a cutback in spending by state and local governments. That pullback offset a rebound in federal activity after the 16-day partial government shutdown last year.

 

However, most of the factors that held back growth in the first quarter have already begun to reverse. Therefore, you should look for a strong rebound in growth during the April-June quarter. The consensus view is the economy will expand by 3 percent in the second quarter. And the stronger growth will endure through the rest of the year as the economy derives help from improved job growth, rising consumer spending and a rebound in business investment.

 

In fact, many believe 2014 will be the year the recovery from the Great Recession finally achieves the robust growth that’s needed to accelerate hiring and reduce still-high unemployment. Therefore it is no unreasonable to expect annual economic growth will remain around 3 percent for the rest of the year.

 

If that proves accurate, the economy will have produced the fastest annual expansion in the gross domestic product, the broadest gauge of the economy’s health, in nine years. The last time growth was so strong was in 2005, when GDP grew 3.4 percent, two years before the nation fell into the worst recession since the 1930s.

 

A group of economists surveyed this month by The Associated Press said they expected unemployment to fall to 6.2 percent by the end of this year from 6.7 percent in March.

 

One reason for the optimism is that a drag on growth last year from higher taxes and deep federal spending cuts has been diminishing. A congressional budget truce has also lifted any imminent threat of another government shutdown. As a result, businesses may find it easier to commit to investments to modernize and expand production facilities and boost hiring. State and local governments, which have benefited from a rebound in tax revenue, are hiring again as well.

 

Labor Cost Increases Remain Low

 

The Labor Department reported on Wednesday that labor costs increased at their slowest pace in more than two years in the first quarter, suggesting that slack in the jobs market continues to keep wage inflation subdued.

 

The Employment Cost Index, the broadest measure of labor costs, rose 0.3 percent after gaining 0.5 percent in the fourth quarter. That was the smallest gain since the third quarter of 2011. In the 12 months through March, costs rose 1.8 percent, the smallest since the second quarter of 2012. They had advanced 2.0 percent in the 12 months through December.

 

While the index continues to show little sign of wage inflation it could garner more attention in the quarters ahead as pockets of upward wage pressure start to emerge in areas where employers cannot find qualified workers to fill positions.

 

The lack of wage inflation is keeping overall price pressures in the economy benign, giving the Federal Reserve latitude to keep benchmark interest rates near zero for a while.

 

Wages and salaries, which account for 70 percent of employment costs, also increased 0.3 percent in the first quarter. That followed a 0.5 percent rise in the fourth quarter.

 

Wages and salaries were up 1.6 percent in the 12 months through March. Benefit costs rose 0.4 percent in the January-March period after rising 0.6 percent in the prior quarter.

In the 12 months through March, benefit costs increased 2.1 percent.

 

The Fed Keeps the Faith

 

The Federal Reserve on Wednesday looked past a dismal reading on first quarter U.S. growth and gave a mostly upbeat assessment of the economy's prospects as it announced another cut in its massive bond-buying stimulus.

 

Recent information "indicates that growth in economic activity has picked up ... after having slowed sharply during the winter in part because of adverse weather conditions," the central bank said in a statement after a two-day meeting.

 

"Household spending appears to be rising more quickly," it added, although it said business investment "edged down."

 

The Fed said it would reduce its monthly bond purchases to $45 billion from $55 billion, a widely expected decision that keeps it on track to end the program as soon as October. The decision was unanimous.

 

In fact, its statement was more upbeat than the one it issued after its last policy meeting on March 19. At that time, it noted that activity had slowed, although it said harsh winter weather was at play.

 

The Fed has now reduced its monthly bond purchases by a cumulative $40 billion in four steady steps. The gradual tapering seeks to close an era in which the central bank's balance sheet quadrupled to more than $4.2 trillion through three separate purchase programs launched to battle the financial crisis and the recession and slow growth that followed.

 

The projected end of the program sets the stage for a series of policy decisions expected next year on when and how to reduce the balance sheet to more usual levels, and, most notably, when to move the target interest rate above the near zero level maintained since late 2008.

 

The Fed disclosed that its board of governors met on Tuesday to discuss "medium-term monetary policy issues," the type of session that in the past has preceded important policy changes.

 

But Janet Yellen's second meeting as Fed chair offered no specific new guidance on rates or other core questions the Fed must answer in coming months. The Fed's policy panel said in its statement that it will keep the overnight target rate between 0 and 0.25 percent "for a considerable time" after the bond buying ends - the same formulation it used after its March meeting. Outside of its discussion on the economy, the Fed's statement was little changed from last month.

 

Going forward, the bond purchases will be split between $25 billion of Treasuries and $20 billion of mortgage-backed securities, a cut of $5 billion a month to each.

 

Analysts expected little out of this session as the Fed enters what may prove a sort of holding pattern as it closes out the bond purchases and debates when an initial interest rate increase may be warranted. Investors currently expect the first rate rise around the middle of next year.

 

With little sign of inflation and unemployment at a still-elevated 6.7 percent, Yellen has said there is plenty of "slack" in the economy. In its statement, the Fed noted that unemployment "remains elevated" and that continued improvement required "appropriate policy accommodation" in the form of continued low borrowing rates.

 

While the GDP report did not throw the Fed off course, it could influence the discussion going forward. The 0.1 percent annual growth rate was far below expectations. It will also focus attention on the next round of data on jobs and inflation as signs of whether what the Fed analyzed as a winter lull was in fact nothing more than that.