MarketView for December 20

 

 

Summary  

Gross domestic product grew at an annual rate of 4.1 percent in the third quarter, the fastest pace in almost two years, and exceeding the 3.6 percent pace reported earlier this month. Business spending was also stronger than previously estimated. As a result, both the Dow Jones Industrial Average and the S&P 500 indexes finished Friday's session at record closing highs. This marked the Dow's third record closing high in a row. Earlier in Friday's session, the Dow set an all-time intraday high at 16,287.84.

 

For the week, the Dow rose 3 percent, its best week since September, and the S&P 500 gained 2.4 percent, its best week since July. The Nasdaq advanced 2.6 percent. Indexes pared their gains going into the close because of "quadruple witching," which marked the quarterly expiration and settlement of December contracts for stock options, stock index options, stock index futures and single stock futures. In addition, most index funds adjusted their portfolios as a result of quarterly rebalancing by index providers. The resulting volatility affected a number of notable names, including FedEx  and Electronics Arts , in the final minutes of trading.

 

Nonetheless,  S&P 500 index has is up more than 27 percent this year and is on track for its best year since 1997. The Fed's aggressive economic stimulus program has been the major catalyst for this year's rally.

 

Red Hat rose 14.5 percent to $56.10 and was the S&P 500's best percentage gainer after the world's largest commercial distributor of the Linux operating system reported third-quarter results above analysts' estimates and raised its full-year forecast. Blackberry reported a massive quarterly loss on Friday due to an inventory write down and asset-impairment charges. Still, BlackBerry's shares ended the day up 15.5 percent to close at $7.22.

 

Walgreen rose 3.7 percent to $59.04 after reporting higher first-quarter sales. Oracle fell 0.6 percent to $36.37 after the company said it would acquire Responsys in a deal valued at $1.5 billion. In contrast, Responsys ended the day up 40.3 percent to close at $27.40. Jones Group was up 5.2 percent to end the day at $14.87.

Approximately 6.47 billion shares changed hands on the major equity exchanges, according to BATS exchange data, a rate that was far higher than the previous sessions this week.

 

GDP Exceeds Expectations

 The Commerce Department reported Friday morning that the economy grew at its fastest pace in almost two years during the third quarter after an upward revision of business and consumer spending. The broad revisions hinted at some underlying strength, which could help the economy better absorb the blow from an anticipated cutback in inventory accumulation this quarter.

 

According to the Commerce Department, gross domestic product grew at a 4.1 percent annual rate instead of the 3.6 percent pace reported earlier this month. This is the Department’s third estimate. The increase in growth rate made it the quickest pace of growth since the fourth quarter of 2011 and was an accelerated rated from the April-June quarter's growth of a 2.5 percent.

 

Looking at some details, business spending increased at a 4.8 percent rate instead of the 3.5 percent pace reported early this month. That reflected stronger growth in intellectual property products such as software, research and development, and entertainment.

 

There were also upward revisions to consumption. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, was raised 0.6 percentage point to a 2.0 percent rate. The revisions reflected higher spending on both goods and services than previously estimated.

 

Revisions to spending on gasoline and other energy goods accounted for part of the upward revision to spending on goods, while spending on healthcare and other services also was higher than previously estimated.

 

Consumer spending grew at a 1.8 percent rate in the second quarter. Business spending on equipment was revised up to a 0.2 percent pace. It had previously been reported as being flat.

 

That left domestic demand rising at a 2.3 percent rate, instead of the 1.8 percent pace the government reported earlier this month.

 

Export growth was also raised up by two tenths of a percentage point to a 3.9 percent pace. Spending on residential construction was lowered by 2.7 percentage points to a 10.3 percent rate in the third quarter.

 

A large build-up of stocks still accounted for much of the increase in GDP growth in the July-September quarter. That has left economists anticipating a slowdown in the pace of inventory accumulation, which would hurt fourth-quarter growth.

 

Businesses accumulated $115.7 billion worth of inventories. That compared to prior estimates of $116.5 billion. So far there is little sign that businesses are pulling back, with stocks at retailers, auto dealerships and wholesalers increasing solidly in October.

 

Bernanke May Have Done Yellen a Favor

 

By ensuring the Federal Reserve begins trimming its massive bond-buying stimulus before a more hawkish contingent of voters comes on board next year, Fed Chairman Ben Bernanke may have done a favor for his successor, Janet Yellen.

 

The Fed's decision on Wednesday to begin to reduce its monthly purchases by $10 billion, to $75 billion, gave the Fed's bond-buying skeptics what they wanted: a roadmap out of a policy they felt risked fueling future inflation.

 

Barring an unexpected downturn, Bernanke told reporters at his last news conference as chairman that the central bank would likely end the bond-buying by late 2014. The change in policy effectively shifts the Fed from an era of extraordinary stimulus to one of slowing the money presses and eventually starting to shrink the central bank's nearly $4 trillion balance sheet.

 

For Yellen, it could neutralize potential opposition from regional Fed presidents who opposed the stimulus program and who rotate into voting spots on the Fed's policy panel next year, giving her some breathing room to acclimatize.

 

Financial markets, ever sensitive to the utterances of the Fed chief, could be especially jittery as the Street becomes acquainted with Yellen's style of leadership and communication. However, to complicate matters, at least three seats at the seven-member Fed board will need to be filled in the New Year, presuming Bernanke steps down when his chairmanship ends, as is widely expected.

 

Back in May, the mere hint from Bernanke that the central bank could soon start to slow its bond buying sent bonds and stocks into a tailspin. Long-term borrowing costs rose so quickly that the Fed had to put its plan on hold and redouble efforts to convince markets that interest rates would stay low for a long while even if the purchase pace slowed. This week's decision reduced such headaches.

 

Nonetheless, Dallas Fed President Richard Fisher and Philadelphia Fed chief Charles Plosser rotate into voting slots on the policy-setting Federal Open Market Committee next year. Both have been vocal opponents of the bond-buying program, and both have a record of expressing their opposition to policies in the form of dissent.

 

In addition, Cleveland Fed President Sandra Pianalto, who is usually seen as a centrist but who wanted the Fed to scale back its purchases earlier this year, also takes a voting spot. While she has announced plans to step down early in 2014, she has said she will serve until a successor is named.

 

On the other side of the coin, Esther George of the Kansas City Fed, a hawk, loses her vote and is replaced by dovish Narayana Kocherlakota of the Minneapolis Fed. However, taken as a whole, the ranks of officials who would prefer to normalize policy sooner rather than later will have their hands strengthened. As such, they can be counted on to keep the pressure on Yellen to stick to the timetable Bernanke laid out. As long as she does, outright dissent is unlikely.

 

At his news conference, Bernanke emphasized that the decision on bond buying does not mean the Fed is getting close to raising benchmark overnight rates, which it has held near zero since late 2008. He said the Fed would hold them steady until well after the unemployment rate falls to 6.5 percent. It stood at 7 percent last month. That is especially so, he said, if inflation remains below the Fed's 2 percent target.

 

Futures traders took Bernanke at his word, betting there would be no rate hike until the second half of 2015. It's a message that Yellen will continue to hammer home.

 

The Fed's decision to taper has already muted hawkish sentiment, with Kansas City's George supporting the Fed's decision after a string of dissents at every other policy meeting this year.

 

Yellen Almost Home

 

Janet Yellen saw her nomination clear a Senate procedural hurdle on Friday. The Senate voted 59-34 to move forward with the nomination, indicating ample support for her confirmation. A final vote is set for January 6 when the Senate returns after a holiday break. If approved the Fed's current vice chair would succeed Ben Bernanke, whose second four-year term as chairman expires on January 31. Yellen's main task would likely be unwinding the extraordinary stimulus the Fed has put in place during Bernanke's watch.

 

In the test vote, she won unanimous support from Democrats, but all but five Republicans on hand voted against taking up the nomination - a sign anger at a recent Senate rule change that made it easier for majority Democrats to end filibusters.

 

Yellen has been a strong supporter of the monetary policies that Bernanke brought forth to spur investment, hiring and economic growth. As a result, the Fed cut overnight interest rates to near zero in late-2008 and has quadrupled its balance sheet to about $4 trillion through a series of massive bond purchase programs meant to push down longer-term borrowing costs.

 

A strong believer that monetary policy can help get more Americans back to work, Yellen told a Senate hearing last month that efforts to boost hiring were an "imperative" for the central bank. However, with the unemployment rate having fallen to a five-year low of 7 percent last month, her main task is likely to be unwinding the stimulus program the Fed put in place in response to the 2007-2009 recession.

 

The central bank gave her a road map of sorts on Wednesday with a decision to trim its monthly bond purchases by $10 billion in January, dropping them to $75 billion. Bernanke said it would likely end the asset purchases by late 2014, and that Yellen fully supported the decision to start winding them down.

 

Now Yellen will have to end the purchases without rattling Wall Street or disrupting the ongoing economic. To soothe investors, the Fed accompanied its plan to reduce its bond buying with a strengthened pledge to keep benchmark overnight interest rates low for a long time to come, a policy that analysts see in keeping with Yellen's stated commitment to foster a stronger jobs recovery.

 

Yellen brings to the job a wealth of experience at the top ranks of economic policy-making. She ran the San Francisco Federal Reserve Bank for more than five years before becoming the central bank's vice chair in 2010. She had previously served on the Fed's board in the 1990s and as a top economic adviser to President Bill Clinton.

 

A highly acclaimed economist, Yellen has taught at the London School of Economics, Harvard and the University of California, Berkeley, and has written on a diverse range of topics from single mothers and youth gangs to wage inflation.

 

As Vice Chair, she has played a lead role in refining the central bank's communications strategy, spearheading its adoption nearly two years ago of a 2 percent inflation target. She is a proponent of the forward guidance the Fed has used to shape market expectations about the path of interest rates.

 

Yellen has long argued that the Fed should tolerate slightly higher inflation if that is the cost of fighting high unemployment and has never dissented on a Fed policy decision. At the same time, she has not shied away from advocating rate increases when she felt the situation called for it.