Fed Still at Full Throttle
World financial markets finished 2010 on a high note and started 2011 the same way. Risk assets (growth equities and commodities) are staying strong as defensive categories like Treasury bonds and income stocks lag. Not coincidentally, the Federal Reserve still has the money-creation engine running at full throttle and shows no signs of slowing down.
Economic data released so far this year has been encouraging. The ISM Non-Manufacturing Index came out stronger than expected today. More impressively, the ADP Employer Services report suggests private nonfarm job growth was well above expectations in December. Official numbers from the Labor Department come out this Friday. We are not as comforted by the ADP report as some seem to be; the employment hole is so deep that any semblance of normalcy is still years away even in the optimistic scenarios. Demand for temporary workers is still very strong and hiring plans remain subdued. Employers are still in no mood to increase payrolls just yet.
This being the case, the Fed seems likely to stay accommodative for the foreseeable future. This, in turn, causes an increase in inflation expectations, which may be why commodities are climbing and bonds are sinking. The ten-year Treasury yield ended the year at 3.3%, right about the midpoint of the 2010 range of 2.3% to 4.0%. Gold closed out 2010 near an all-time high. Crude oil and other commodities are also showing strength.
One place where the prospect of higher inflation does not seem to be helping is residential real estate. The robo-signed foreclosure scandal that erupted last fall appears close to a resolution that will be favorable for banks, letting them resume the unloading of foreclosed properties at fire-sale prices. Housing prices are likely to stay soft until this excess inventory is worked off, which could take years.
The 112th Congress convened today with a large cohort of new members eager to make their mark. The U.S. government is approaching its statutory debt ceiling and will probably reach it sometime in March. The machinations surrounding this vote will be interesting to watch. The stakes are very high, and it is hard to see how either side can back down gracefully. The new year is bringing new political risks on top of the normal financial ones.
Our Sector rankings kicked off 2011 with more of the same: Materials, Energy and Industrials still top the list. The combination of these three sectors indicates that commodity demand is strong and economic activity may be improving. Other factors are no doubt at work as well, so we hesitate to read too much into this pattern just yet. The big sector gainer was Telecommunications, which moved up from #7 to #5. The Financials had a strong week, but not strong enough to improve their relative position. The defensive sectors are still on the bottom.
The Style rankings showed little change from last week’s perfect alignment, though Large Cap Value and Large Cap Growth did manage to swap places. This was related to the sector strength in Financials and Telecom, both of which have significant weightings in the Large Cap Value benchmark. Otherwise, Growth remains dominant over Value. The inverse cap-weight pattern continues with Micro Caps on top and Mega Caps at the bottom.
Japan and the U.S. have been alternating leadership of our Global rankings, and this week is Japan’s turn. While the Yen has been weak relative to the greenback, ETFs tracking Japan have remained quite strong. This suggests Japan may be able to hold the lead longer this time. China’s stock market started off 2011 on a strong note, posting significant gains already. Chinese equities retreated in the last two months of 2010 as the government sought to cool an overheating economy. We are watching closely to see if the early action in 2011 is the beginning of a turnaround or just a bounce within a downtrend.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“Measures of house prices declined recently, and households’ concerns that home values might continue to fall, their pessimism about the outlook for employment and income, and the tight standards faced by many mortgage borrowers appeared to be weighing on demand.”
FOMC Minutes, December 14, 2010
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