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Over the past few months Fed Chairman Ben Bernanke and his colleagues implied they’d like to reduce the central bank’s purchases of bonds but said that this ‘tapering’ would always be ‘data dependent.’ Since economic numbers had been getting better, almost all market players assumed some schedule to wind down these purchases coming from the Fed’s Open Market Committee 2-day meeting September 17-18th. Those bets were cancelled when Bernanke & Co. shocked the markets by maintaining the status quo. Stocks immediately reversed course, heading higher on this renewed stimulus while gold prices had the biggest move, going from an intra-day loss of US$10 per ounce to a gain of over US$50. Looking back, perhaps it shouldn’t have come as a surprise. Interest-sensitive stock as well as bond prices had moved sharply lower from May to late August in anticipation of this tapering. The 10-year Treasury yield had almost doubled to 3%, while the S&P Homebuilding Index had slid by a third. But the Fed had not wanted to see rates rise to a level where they would impact economic activity. Bernanke, a student of the Depression, would rather be three months too late than one month too early.
However, over the next few days both the stock and gold markets gave back all those gains as investors recognized that the Fed had just ‘kicked the can down the road’ and would still have to remove this stimulus at some point. What now seems clear is that it’s going to be a lot harder than most thought for the Fed to remove its stimulus without seeing some major side effects in the markets. The timing of this removal has always been deemed to be ‘data dependent’, so once again we need to focus on the trends in global growth in order to be able to predict any moves from the world’s most important central bank. On that subject we continue to see a trend to stronger global growth, even if the U.S. is not accelerating or providing the bulk of that growth, as it has been for the past two years.
The chart below shows Global Export Volumes (solid blue line) and the survey data from the Euro Purchasing Managers Index (black dotted line). There has been a clear, close relationship between the two measures over the past 15 years. The pick-up in the Euro PMI over the past few months bodes well for increased global trade, particularly since the Euro-Zone has a substantial trade flow with China. This fits in with our thesis that the global economy is entering a period of synchronous growth as Europe, China and Japan are all expanding while the U.S. maintains a moderate growth rate.
This also supports our view that cyclical stock groups such as industrials, technology, basic materials and energy are in the process of taking over the stock market leadership from the defensive consumer, health care, telecom and retail stocks that had lead over the past two years. Further evidence of this pick-up in global growth can be seen in the ISI Company Surveys. The chart below shows the survey data for manufacturers in the U.S. for foreign sales (red line) versus domestic sales (blue line). While the domestic data has been improving since the economy came out of the recession in 2009, the foreign sales had been trending down since 2011, as the recession in Europe and a slowdown in China negatively impacted the data. But we can see that the surveys on foreign sales have improved in the past few months and are starting to close the gap with the domestic sales. This explains some of the recent weakness in the U.S. dollar as well as the strength in overseas stock markets.