MarketView for October 29

Summary 

If you expected the markets to do anything spectacular ahead of the upcoming election on Tuesday, and the close of the Federal Reserve Open Market Committee meeting on Wednesday, it just was not about to happen as stocks ended on a flat note on Friday. Nonetheless, it was the last trading day of October and it was another strong month driven by expectations that the Fed will take matters into its own hands, given the lack of additional fiscal stimulus on the part of Congress, as it will likely attempt to increase the economy’s rate of growth with a large amount of monetary stimulus.

Although earnings season has taken a back seat to macroeconomic data, Microsoft did see a nice 1.5 percent gain in its share price, with the shares closing out the day at $$26.67 a day after its earnings exceeded estimates on higher sales of its flagship software.

Meanwhile, there is an excellent likelihood that market volatility will increase, possibly substantially, after Tuesday's midterm elections and Wednesday's announcement by the Fed. To that end, the CBOE Volatility Index .VIX climbed about 13 percent this week, even as stocks rose marginally.

Looking at some of the day’s trading activity, Chevron and Merck saw their share price fall after they posted their quarterly results. Chevron closed down 2.2 percent to close at $82.61, while Merck chalked up a loss of 1.8 percent to close at $36.28.

For the week, the Dow was down 0.1 percent, while the S&P 500 managed a gain of only 0.02 percent and the Nasdaq added 1.1 percent. For the month of October, though, it was a solid upswing, with the S&P 500 gaining 3.7 percent, while the Dow advanced 3.1 percent and the Nasdaq jumped 5.9 percent.

U.S. economic growth edged up as predicted in the third quarter, but not enough to chip away at high unemployment or change expectations of more monetary easing from the Federal Reserve next week. In another snapshot of the economy, the Thomson Reuters/University of Michigan's survey showed that consumer sentiment weakened slightly in October, dropping to its lowest level in almost a year.

The week of November 1 marks the final peak week of the third-quarter earnings season, as 94 S&P 500 companies and two Dow components are expected to report. With 335 S&P 500 companies having reported so far, some 77 percent have beaten earnings estimates. That is just shy of the record beat rate of 79 percent in the third quarter of 2009, according to Thomson Reuter’s data.

GDP Up 2 Percent

Economic growth increased in the third quarter, as expected, but the level of growth was not enough to make a serious dent in the high unemployment rate or change expectations of more monetary easing from the Federal Reserve next week. GDP chalked up a 2.0 percent annual rate as consumer spending rose at its fastest pace in four years, the Commerce Department said on Friday.

While the level of consumer spending rose and business investment continued to expand, much of the increase in demand was met by overseas production and domestic goods continued to pile up in warehouses, suggesting tepid growth in the fourth quarter.

Details of the report, which showed core inflation running at its second-lowest level since 1962, reinforced expectations the Fed will pump more money into the economy at its November 2-3 meeting to push interest rates down further and ward off deflationary pressures.

The anemic level of economic growth, combined with  the prospect of an easing of monetary policy, resulted in a rally in the Treasury markets, while the dollar fell to what was nearly a 15-year low against the yen. The economy exited recession in June 2009 but growth braked abruptly in the second quarter of this year, coming in at a meager 1.7 percent rate.

With unemployment at 9.6 percent, there will likely be a shift in the political landscape on Tuesday. The question that has yet to be answered, although speculation runs wild, is how big a shift and exactly what does that portend for the country. A report to be released next Friday by the Labor Department is expected to show U.S. employment grew in October for the first time in four months, but at a pace way too sluggish to register for the 14.8 million unemployed.

The bottom line is that an economic growth rate of at least 3.5 percent over several quarters, driven by solid domestic demand and exports, is needed to bring down high unemployment.

An increase in consumer spending gave the economy a lift in the third quarter. Consumer spending, which accounts for 70 percent of U.S. economic activity, increased at a 2.6 percent rate after rising 2.2 percent in the prior period. The third-quarter gain was the largest since the fourth quarter of 2006 and added 1.79 percentage points to GDP growth. Consumer spending, however, could soften. A separate report showed consumer sentiment weakened a touch in October, dropping to its lowest level in nearly a year.

Output in the third quarter was also supported by a big rise in business inventories. Excluding inventories, the economy expanded at a 0.6 percent pace, slowing from 0.9 percent in the second quarter. The rise in inventories against the backdrop of high unemployment raises the possibility that companies are restocking shelves more quickly than consumers are willing to empty them, which could limit fourth-quarter growth.

Although the build-up in inventories suggests slower production ahead, a report on manufacturing activity in the Midwest region showed production rising. The GDP report also indicated that business spending continued to rise in the July-September quarter, but the pace slowed from the prior period, with notable moderation in investment in equipment and software after three quarters of robust growth.

Growth was held back by the surge in imports that certainly outpaced exports. However, the trade gap narrowed somewhat during the quarter, weighing less heavily on the economy than in the prior three months. Residential construction was also a drag on output in the third quarter as a tax credit for home buyers ended, while government spending made a modest contribution.

The report showed the Fed's preferred inflation measure, the personal consumption expenditures price index, excluding food and energy, rose at an annual rate of 0.8 percent in the third quarter.

That was the smallest increase since the fourth quarter of 2008 and the second-lowest reading since the fourth quarter of 1962. Fed officials have signaled concern that low inflation could ultimately turn into pernicious deflation if the recovery does not strengthen.