Kristina Hooper, CFP®, CIMA® is head of investment and client strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
There is so much uncertainty facing investors right now, and so many unanswered questions. Chief among them is, “How healthy is the US economy?” With such an acute focus on monetary policy, the answer isn’t so easy. Indeed, striking the right balance between Fed intervention and economic expansion will be crucial to the investor psyche. To that end, bearish sentiment on gold may be giving us a glimpse into the future.
Intuitively, a selloff in gold could be forecasting better days for the economy. The price of gold dropped more than 2% on Friday extending its month-long losing streak. Indeed, the yellow metal has fallen 5.5% since the beginning of October. The recent skid in gold prices may come as a surprise to market observers given that central banks around the world have been printing money and promoting looser monetary policy. However, some pundits have suggested that the reason for the drop in gold is that there is growing optimism that the US economy is improving and that Federal Reserve Chairman Ben Bernanke may soon put an end to QE3.
A clue can also be found in the stock market, which dropped nearly 1% on Friday despite a better-than-expected jobs report. Non-farm payrolls showed the economy added 171,000 new jobs, well above the 125,000 jobs economists were expecting. However, the number of new jobs created is still not sufficient for the economy to grow at a meaningful clip. The unemployment rate rose to 7.9%, in line with estimates, but remained under the psychologically important 8% threshold.
While seemingly counterintuitive, it’s possible that stocks dropped because of the positive jobs report. That’s because investors seem to have become far too dependent upon monetary easing—to the extent that it is often determining the direction of the market. And if the economy, particularly jobs, show enough improvement, then investors may become fearful that the Fed will halt its aggressive monetary policy measures. Consider the stock rally we saw this summer, which was widely believed to have been based on expectations that the Fed would launch QE3. Keep in mind that this move upward occurred despite deteriorating earnings expectations.
In the Fed We Trust
Central bank dependence can be almost as problematic as drug dependence in that governments have come to rely on central bankers to provide a cure-all for economic troubles. Similarly, investors have come to rely on central bankers to prop up the stock market. The Bank of Japan, for example, announced an expansion of its asset-purchase program for the second time in two months. The BOJ will also offer unlimited loans to banks to boost credit demand. The move comes on the heels of data showing a considerable decline in industrial output—the largest drop since Japan suffered a massive earthquake in February 2011.
By contrast, the US employment situation appears to be improving, albeit slowly and unevenly. Since the beginning of the year, non-farm job growth (private and public) has averaged 157,000 per month, versus an average monthly gain of 153,000 in 2011. And things look even better in the private sector: Since reaching an employment trough in February 2010, the US economy has added five million private-sector jobs. October’s higher-than-expected job growth may have been cause for dismay because investors are uncertain of how the Fed will respond to improving economic conditions. Specifically, the job market, an area where it has a laser-like focus, would be on top of the list.
Of course, jobs have a long way to go in terms of recovery. Realistically, at least 200,000 new jobs per month are needed before the Fed would even consider a change in monetary policy.
But jobs aren’t the only area of the economy showing signs of life. Housing has been steadily improving over the past 18 months. The Case-Shiller 20-City Home Price index rose 2% in August, beating expectations of 1.7%. We’re also seeing some improvement in manufacturing. At 51.7, the ISM Manufacturing Index showed continued expansion in the month of October. And while manufacturing is still technically in contraction territory, both the Dallas Fed manufacturing index and Chicago PMI rose in October.
Investors have sufficient evidence to believe the economy is improving. However, it is unlikely the Fed will put an end to quantitative easing any time soon given the need for more jobs and other headwinds for the economy, including earnings weakness and election uncertainty. Not only are third-quarter earnings showing anemic top-line growth, but also fourth-quarter guidance has been gloomy. Through Nov. 2, 56 companies have issued negative earnings guidance and 18 companies have issued positive earnings guidance.
Throw in a dogfight of an election and how the fiscal cliff will take shape post-election and it seems unlikely that the Fed will be prompted to turn off the monetary tap any time soon. Brace yourselves for a wild week.
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