The first 6 months of the year is in the books, so it’s a perfect time to check in on the U.S. economy’s progress thus far, and to look ahead to the second-half of 2013. Economic growth: Recovery from the Great Recession has been sub-par (the post World War II growth rate for the U.S. is 3-3.5 percent), with growth averaging about 2 percent since 2010. Q1 growth was revised down to 1.8 percent from 2.4 percent and Q2 is expected to be similar to Q1, due to the lingering effects of sequestration. But economists believe that activity should pick up towards the end of the year and that total growth for 2013 will be between 2 and 2.5 percent. The pace of growth is due to accelerate to 3 percent next year, but this seems like a long way off.
Jobs: 5 months into the year job growth has been good, not great. The economy has added an average of 192,000 non-farm positions per month in 2013, ahead of the 175,000 monthly pace seen in the previous two years; and the unemployment rate has edged lower to 7.6 percent from 7.8 percent in December. Still, there are 11.8 million Americans out of work, 4.4 million of whom have been unemployed for more than 6 months. So while layoffs have tapered off, economic growth has been too weak to spur widespread hiring. Most economists predict that June job creation will be approximately 150,000 – 160,000, due to recent softness in manufacturing data.
Housing: Housing is finally recovering from the abyss. Sales have increased and prices have made great advances, though from low levels. The recent Case-Schiller house price index showed increases of 12 percent from a year ago, but housing experts note that double-digit advances are not sustainable, especially as mortgage rates have spiked and sellers will likely to return to the market in greater numbers. The slow down should not be read as another leg down in the housing market, but a new phase in which growth is normalized.
Consumers: The first half of the year has been pretty good for consumers. Americans' debt obligations have eased as a percentage of their disposable income, household net worth has surpassed its 2007 peak and consumer confidence shot up to the highest level since 2008. Still, incomes have remained mired at similar levels to where they were 10 years ago. But for tame inflation, stagnant wage growth would be a bigger concern.
Federal Reserve: We can divide Q2 into two periods: before May 22nd, which I propose we call “BB” or “Before Bernanke” and after May 22nd, which can be referred to “AB”, or “After Bernanke”.
- BB: From April to mid-May, stocks marched higher, due to the Fed’s easy monetary policies; a surprise announcement from the Bank of Japan about its own stimulus plans; better than expected corporate earnings; the continued recovery in housing; Europe stepping back from the precipice of disaster; and the much-feared hard landing in China never coming to fruition.
- B-Day (Bernanke Day): On May 22nd Fed Chairman Ben Bernanke testified before Congress and raised the prospect that the central bank could downshift from its accommodative policies (which were intended to drive down borrowing costs, push up asset prices and encourage more investment, spending and hiring in the broader economy) prior to Labor Day, if economic data were to improve. On that day, the Dow reached a fresh intra-day nominal high of 15,542. The bond market had already started to price in future Fed action, as the yield on the 10-year treasury spiked to 2.12 percent at the end of May, from 1.62 percent earlier in the month.
- AB/Stocks: The balance of the quarter was highlighted by huge gyrations in all markets, due to worries about when the Fed might pull back on its bond-buying. The height of the anxiety occurred after the June 19Fed Open Market Committee meeting. The S&P 500 index fell 7 percent from its intraday record high, before recouping some of those losses and finishing the quarter 3.8 percent below the record high. The AB period was marked by rampant volatility, with the Dow logging 16 triple-digit moves in June, the most in a month since Oct 2011.
- AB/Bonds: The 10-year bond yield climbed as high as 2.66 percent, before settling at 2.49 percent at the end of the quarter. . Treasury bonds handed investors a loss of 2 percent this quarter, the worst quarterly decline since the fourth quarter of 2010. While the jump in yields and drop in price has been sudden, 2.5 percent is still considered a low level.
More on bonds: Historically, the yield of the 10-year runs 1.5 to 2 percentage points higher than the inflation rate, which would suggest yields should be closer to 3 percent, even higher than the current 2.5 percent. While the move in bonds has probably been more violent than the Fed would have expected, the central bank would like to see both stocks and bonds return to more normal pricing. For those worried that the recent rise in long-term interest rates will derail the recovery, it is worth remembering that when the bond market plummeted in 1994 and yields surged, the subsequent five years saw unusually strong economic growth and large gains in stock markets.
What to expect in the second half of the year: Market volatility is likely to remain elevated, as each economic report will be parsed through the lens of “What will the Fed think about this report?” Global markets have become dependent on the Fed's unprecedented accommodative policy, including its monthly purchase of $85 billion worth of bonds (QE3). Due to the unusual nature of the Fed’s stimulus plans, it is difficult to draw on previous periods to help predict how the change in policy will impact the economy and markets. The very fact that we have not been here before is creating investor uncertainty, which is why the anticipated shift in Fed policy will likely remain the chief investment concern for the balance of the year.
Markets: June was the first losing month of the year for stocks, but all three major averages logged their third winning quarter in four and remain solidly ahead for the year. The Dow has seen its strongest first half of the year since 1999 and the S&P 500’s first half performance is its best since 1998. Volumes could be light this week due to the Independence Day holiday, but there will be plenty of action on the calendar, including policy committee meetings by the Bank of England and the European Central Bank, and the monthly jobs report in the U.S.
- DJIA: 14,909, up 0.8% on wk, down 1.4% on month, up 2.3% on quarter, up 13.8% YTD
- S&P 500: 1606, up 0.9% on wk, down 1.5% on month, up 2.3% on quarter, up 12.6% YTD
- NASDAQ: 3403, up 1.4% on wk, down 1.5% on month, up 4.1% on quarter, up 12.7% YTD
- 10-Year Treasury yield: 2.49% (from 2.514% a wk ago, biggest quarterly selloff since Q4 2010, worst first-half return (-2.1%) since 2009)
- Aug Crude Oil: $96.56, up 3% on week
- August Gold: $1223, down 5.3% on wk, down 23% on quarter (worst quarter since the start of modern gold trading in 1974), down 30% YTD)
- AAA Nat'l average price for gallon of regular Gas: $3.50
THE WEEK AHEAD:
8:58 PMI Manufacturing Index
10:00 ISM Mfg Index
10:00 Construction Spending
Motor Vehicle Sales
10:00 Factory Orders
7:30 Challenger Job-Cut Report
8:15 ADP Employment Report
8:30 International Trade
1:00 US markets close early for Independence Day
Thurs 7/4: US MARKETS CLOSED FOR INDEPENDENCE DAY
Bank of England and ECB rate decisions
8:30 Employment Report
8:30 Weekly Jobless Claims