Equity markets have breezed through two of what are historically the most tumultuous months for stock investors – September and October. Stocks held in October and continue to climb the wall of worry, moving up to “lofty” levels not seen since October of a year ago. The Dow Jones Industrial Average eclipsed the 10,000 point mark during the month, before slipping back below that milestone as the month came to a close. The tone of the move through the 10,000 level on the DJIA is far more positive this year compared to last, when markets were heading lower and the 10,000 mark was eclipsed on the down side. Despite sitting at roughly the same level from October 2008 to this October, investors know that the equity markets have been anything but flat during the past 12 to 13 months.
Guarded optimism is reigning supreme for many economists, and Wall Street employed investment strategists. Our unscientific poll suggests most are expecting a strengthening of the economy over the next several quarters. Many of the leading economic indicators are showing positive trends, which will hopefully be confirmed by economic strength in the months to come. Manufacturing, industrial production and productivity are all pointing to accelerated economic activity over the near term. The preliminary 3rd quarter GDP report indicates the economy grew by 3.5%, with most forecasting further economic growth over the next several quarters.
The number of jobs created by the economy is still the most widely followed indicator by the general public and is often the chosen barometer for economic performance. The much publicized jobs number reports have been abysmal as the U.S. economy has shed over 7 million jobs since January 2008. There are some signs of improvement as the rate of job losses is slowing considerably in recent months, which is consistent with a slowing of weekly initial jobless claims. But make no mistake – those seeking employment are finding the worst job market since the early 1980’s.
The most recent employment report showed that the economy lost another 190,000 jobs during the month of October, while the unemployment rate reached 10.2%, the highest since 1983. Amazingly, the recent employment reports are indicating improvement, as the trajectory suggests the economy may again start producing jobs sometime in the next few months. Some analysts are even suggesting job growth as early as December. Yet, it is likely that the unemployment rate will continue to tick higher for some time as new entrants joining (or rejoining) the job market exceed the number of new jobs created.
In addition to the poor – but improving – jobs situation, the other overhang in the recent optimism has been the falling U.S. dollar. Despite the impression of many casual observers, the U.S. dollar has done little when you analyze the change over the past 17 months. However, the ride has been anything but flat for an index of dollar denominated currencies. The dollar actually soared as the financial crisis hit its zenith and has been falling back to the pre-crisis levels. In fact, a close look at the dollar chart reveals steady weakening against a basket of world currencies since 2002, with sporadic counter trend strength, particularly during the recent financial crisis.
We have opined that the falling dollar has benefits as well as detriments. The largest beneficiary of a falling dollar would be U.S. exporters and U.S.-based multinational firms that do a significant portion of their business overseas. A falling dollar will inflate foreign income earned by U.S. multinationals and also makes U.S. goods less expensive to foreign buyers. While commodities priced in U.S. dollars, like oil and foreign made products, are consequently more expensive for U.S. consumers. Given the persistent trade imbalance, some would argue that suppressing imports and encouraging exports is good economic policy.
For the month of October, the Equity indices were moderately lower, but the gains for the year are holding steady. The S&P 500, NASDAQ, and the Russell 2000 were all lower for the month of October at -1.9%, -3.6% and -6.8%, respectively. The Dow Industrial Average bucked the negative trend and eked out a small gain of 0.2% for October. For the year, all of the major averages remain in positive territory with the widely followed S&P 500 gaining 17.0% for the year through October 31, 2009.
Commodities were some of the strongest performers during the month of October as oil gained 9.5% for the month and gold added 3.8% for the month of October. Oil has more than doubled from its $37.87 price on December 31, 2008, while holding an investment in gold has produced a comparatively modest 20% return since the beginning of 2009. The well documented negative correlation between these commodities and the U.S. dollar held in tact as the U.S. dollar index was down slightly in October.
International stocks were also lower in October, but have generally outperformed the U.S. markets over the first ten months of 2009. Emerging market stocks have surged nearly 60% for the year, while the developed international stocks have added 21% though October 31, 2009.
Consumer stocks were positive standouts during the month of October as retailers, consumer staples and energy stocks produced positive returns for the month. Financials and REITs were notable losers for the month as each sector gave back nearly 5% for the month. Technology, natural resources and consumer discretionary stocks have outperformed for the year to date. Utilities, Health Care, and industrial stocks have produced positive returns for investors, but have significantly underperformed the broader indices this year.
While there are certainly some headwinds for the economy, we remain cautiously optimistic. Stocks may be the best indicator of future economic conditions. The continuing rally is indicating that significant strengthening in the general economy is likely. In addition, recent housing price reports have even shown that home prices have not only stopped falling, but are starting to move higher.
The poor employment data steals most of the economic headlines, as many investors follow the jobs benchmark as a gauge for general economic strength. Historically, the unemployment rate continues to rise even as the economy transitions from recession into expansion. In fact, it would be consistent with past recessions if unemployment were to rise for at least six months after the recession has ended. Employers are always reluctant to hire additional workers until an economic recovery is well under way and the current employees reach their productivity limit.
