Kristina Hooper, CFP®, CIMA® is head of portfolio 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.
Two trouble spots for the economy—the job market and housing—generated some good vibes amid gloom over no action from central banks and manufacturing weakness. Unfortunately, it wasn’t enough to push the stock market into positive territory for the week. But looking through a longer-term lens, stocks have been resilient since last year’s debt-ceiling drama and Standard & Poor’s downgrade of U.S. debt.
On the positive side, the U.S. nonfarm payrolls report exceeded expectations with 163,000 jobs added, well ahead of the 95,000 jobs economists forecasted. We also saw the continuation of a positive trend: the number of new jobs created all came from the private sector while public- sector jobs fell slightly. While unemployment rose to 8.3%, the added jobs reversed an anemic growth rate in the second quarter. And housing showed more signs of recovery with the release of the S&P/Case-Shiller 20-city home price composite, which rose 2.2% in May. All 20 cities in the index saw some advance in home prices for the month.
This kind of progress might have been cheered by investors had there not been substantial negative news for the week. Manufacturing proved disappointing. The ISM Manufacturing Index remained below the key 50 mark for a second straight month, continuing to suggest contraction in the sector. Lackluster growth was confirmed by factory orders, which fell 0.5%. However, the decline was surprising because Chicago PMI climbed to 53.7 in July from 52.9% in June. The gain ended a three-month skid on the strength of order backlogs. In addition, some of the disappointment over the ISM Manufacturing Index was alleviated by improvement in the ISM Non-Manufacturing Index, which comprises roughly 70% of the economy and stayed well above the 50 level.
It’s possible that events in Europe are eroding U.S. consumer confidence, which, in turn, is dragging down business confidence and causing manufacturing activity to slow. But consumer confidence made some strides in July, stretching to 65.9 from 62.7 in June.
Dry Powder
More importantly, central banks sat on their hands last week, disappointing investors who had anticipated some form of action. In the Federal Open Market Committee’s press release last week, the Fed stuck to a familiar message, reiterating its commitment to hold rates extremely low through at least the end of 2014. The Fed also said it would continue its work to extend the average maturity of its bond holdings and to invest principal payments in agency mortgage-backed securities. In short, it would continue to monitor data closely and promised to “provide additional accommodation as needed.”
Similarly, the European Central Bank announced last week that it stands ready to bring down “excessive” risk premia in select euro-zone bond markets—Spain and Italy—by buying bonds concentrated at the front end of yield curves. To the market’s dismay, there were no immediate measures being taken such as interest-rate cuts, another long-term refinancing option (LTRO), restructuring of debt or immediate bond buying. In addition, the strict conditions and lack of clarity on many details was not encouraging.
However, the Allianz Global Investors Economics and Strategy Group believes the market had somewhat unrealistic expectations and is more positive on the ECB announcement since the central bank is already preparing to tackle key issues such as bond seniority. Despite investors’ initial disappointment, the subsequent reaction in short-term bond yields in Spain and Italy is encouraging and reflects renewed confidence in the ECB.
There’s no question that investors are anxious—and they have every right to be. They continue to be buffeted with conflicting news, which stirs up uncertainty and confusion. Every step forward seems to be followed by a step backward, or worse. It seems that when you need intestinal fortitude most, it is hardest to find.
Still, it’s important to maintain perspective in the face of heightened volatility. It was just one year ago on August 5, 2011 that Standard & Poor’s downgraded the United States, stripping it of its coveted AAA rating. Headlines screamed the news and many investors panicked. Investors viewed this as a strong signal to leave risk assets. But calamity did not ensue. In fact, the S&P 500 has returned nearly 13% since the downgrade. Benjamin Graham was right: In the short run, the market is a voting machine, largely reflecting emotions, but in the long run it is a weighing machine, largely reflecting fundamentals.
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