MarketView for November 1

 

 

Summary

 

Wall Street turned in a surprisingly positive day on Friday after manufacturing data overshadowed expectations that the Federal Reserve might reduce stimulus earlier than expected. The Dow Jones Industrial Average and the S&P 500 rose for the week as well, their fourth straight week of gains.

 

For the week, the Dow rose 0.3 percent and the S&P 500 gained 0.1 percent, while the Nasdaq slipped 0.5 percent.

 

Factory activity expanded around the world, several business surveys showed, with Chinese manufacturers reporting the fastest upturn in 18 months. The Institute for Supply Management (ISM) said on Friday its index of domestic factory activity hit a level of 56.4 in October, its best reading since April 2011.

 

While the news underscored views that the Federal Reserve may be considering scaling back its stimulus sooner than some market participants have been expecting, it also gave investors surprising evidence of the manufacturing sector's strength.

 

Boeing gained 1.9 percent to $133.03, a day after it said it would increase production of its 737 aircraft to 47 planes per month by 2017 from 38 now.

 

First Solar ended the day up 17.6 percent to close at $59.14 after the company exceeded expectations and raised its full-year earnings projection.

 

Meanwhile, Chevron ended the day down 1.6 percent to close at $118.01 after third-quarter revenue fell short of expectations.

 

American International Group closed down 6.5 percent to $48.28, a day after the insurer reported earnings that slightly exceeded expectations. However, the company benefited from a favorable tax rate this most recent quarter.

 

With about 74 percent of S&P 500 companies having reported results so far, 68.5 percent have exceeded Street expectations, above the long-term average of 63 percent, while just 53.3 percent have managed the same for revenue forecasts, below the 61 percent average since 2002, Thomson Reuters data showed.

 

Factory Growth Up Sharply

 

Manufacturing expanded at its fastest pace in more than two years in October, according to a report by the Institute for Supply Management, signaling a strong start to fourth-quarter factory activity despite a government shutdown during the first half of the month.

 

The ISM said on Friday its index of national factory activity rose to 56.4 in October, the best showing since April 2011, and far exceeding expectations of a slight slowdown in the growth rate. Last month was the fifth in a row of quicker growth in the goods-producing sector, according to ISM's data.

 

On the other hand, a separate reading from financial data firm Markit cast some doubt on the strength of factory activity growth. Markit said its final Manufacturing Purchasing Managers Index stood at 51.8 last month, exceeding the preliminary October reading but notching the worst final showing since October 2012.

 

The two surveys use several different methodologies, including one related to seasonal adjustment. Both figures indicated expansion in the manufacturing sector. The ISM's employment component did show some weakness as it slipped to 53.2 after hitting a 15-month high of 55.4 in September.

 

Job growth in the broader economy was tepid in September, and data polled by Reuters indicates that government reports due on November 8 will likely show hiring slowed further in October.

 

Friday's factory figures came a day after a report showed business activity in the U.S. Midwest surged past expectations in October as new orders hit their highest level since 2004. Weekly unemployment claims also fell, in welcome news for the nation's battered labor market.

 

Still, the mixed results in the two factory readings on Friday underscored lingering uncertainty over the state of the world's largest economy. Earlier this week the Federal Reserve suggested it still sees a need for stimulus and maintained its $85 billion per month bond-buying program to prop up the economy.

 

The Fed Continues to Disagree With Itself

 

Federal Reserve officials on Friday continued to show disagreement as to when a massive bond-buying program would be drawn down, with one saying they needed to wait for signs of rising inflation and two others reinforcing an argument the Fed has waited too long. The Fed opted this week to extend its policy support after a series of soft readings on the economy.

 

St. Louis Fed President James Bullard, who backed the decision, said the huge balance sheet has created risks of financial instability and stating that the Fed, “Would like to "get out of the uncharted territory if we can."

 

However, annual inflation, which was 1.2 percent in August according to the Fed's preferred measure of price pressures, remained too far beneath the central bank's self-imposed 2 percent medium-term goal, he said.

 

"I would like to see inflation coming back toward target before we make a decision to taper," said Bullard, who is generally viewed as a policy centrist. "If we could see it coming back, get some evidence that it was coming back toward target, I think that would be helpful if we wanted to make a decision."

 

Economists now think the Fed will wait until 2014 before starting to wind down asset purchases, although a clear improvement in economic indicators in the next two months could revive prospects for action at the Fed's December 17-18 meeting.

 

While the majority of Fed policymakers, including Chairman Ben Bernanke, are in Bullard's camp, a minority of them worry the costs of such unprecedented stimulus outweigh the benefits. These so-called hawks have long pushed for a reduction in QE.

 

"On a number of different dimensions for me personally it looks like labor force conditions have improved pretty significantly" since the latest bond-buying program was launched in September, 2012, said Richmond Fed President Jeffrey Lacker.

 

"The cumulative fall in the unemployment rate, the cumulative increase in employment are the key things," he added at a Philadelphia meeting of the Global Interdependence Center.

 

In deciding when to reduce the program, the Fed has said it will watch that economic data support its expectation for improvement in the labor markets and higher inflation.

 

Another senior policymaker, Philadelphia Fed chief Charles Plosser, told CNBC television that one way to exit from bond buying would be to adjust the open-ended nature of the program by announcing the total amount that would be bought.

 

"I'm actually leaning to believe that's a better way to get out of this," Plosser said, adding a cap on QE would allow the Fed to reassess the economy once it is done.

 

"It would be worthwhile for us to consider how we get out of this ... program in a sensible way without confusing it with our interest rate forward guidance."

 

Bullard said he did not support this approach, warning it would be impossible to know how the economy would be faring as buying came to an end, which would complicate communication. But he also stressed forward guidance.

 

The Fed has also promised to hold rates ultra-low at least until unemployment drops to 6.5 percent, provided the outlook for inflation remains under 2.5 percent. The U.S. jobless rate was 7.2 percent in September.

 

Addressing the low labor participation rate - Americans either with a job or actively searching for one - Lacker said it is likely due more to demographic factors, like an aging population, than to more cyclical factors that will eventually lead to a rebound.

 

"This sense that real GDP growth is going to pick up soon - I'm very skeptical about that," he said. "I see 2 percent growth ahead."

 

The Fed's policy-setting committee expects 2.9-3.1 percent growth next year, and 3.0-3.5 percent growth in 2015.

 

The committee argues reducing bond buying will not alter the commitment to keep rates near zero, and a majority of officials forecast the first rate hike will not happen until 2015. However, the financial markets have reacted sharply when the Fed has talked about changing the pace of buying, and Bullard said it was going to be challenging to sever the relationship.

 

"The Committee needs to either convince markets that the two tools are separate, or learn to live with the joint effects of tapering on both the pace of asset purchases and the perception of future policy rates," Bullard said.