07/09/14   Quantitative Easing To End

Editor’s Corner

Ron Rowland

Quantitative easing, the Federal Reserve’s bold experiment in central banking policy, is now set to end before October.  The Fed has been tapering back its monthly purchases of mortgage-backed and Treasury securities by $10 billion per month since early this year, with July purchases targeted at $35 billion.  Today, the Fed released its minutes of the June FOMC meeting, which contained a discussion of whether the final reduction should be bumped up to $15 billion, or if they should maintain the $10 billion a month pace of reductions, leaving just $5 billion for the final step.  Members agreed on the $15 billion plan.  Therefore, if the economy continues to improve as expected, then asset purchases should total $25 billion in August, $15 billion in September, and be completed before the calendar turns over to October.

This will end the growth of the Fed’s balance sheet, but monetary policy will still be far from normal.  Topics such as when and how the Fed might begin reducing its balance sheet remain unclear.  For now, maturing bonds will be rolled over and therefore will not result in decreased holdings.  On the subject of monetary policy normalization, the meeting minutes contained much discussion on whether an overnight reverse purchase agreement (ON RRP) facility or interest on excess reserves (IOER) would be the better policy tool.  Fed wonks may want to watch this debate going forward, but for now, most of us will be satisfied in the knowledge that the Fed intends to keep rates low for an extended period.

Earnings season is underway, and Alcoa (AA) started things off by reporting a 157% surge in profits.  Granted, with prior period profits of just 7 cents a share, the improvement to 18 cents does not seem such a huge success.  Still, analysts were only expecting 12 cents, so this is indeed an upside surprise.  Retailers are issuing warnings though, so no one is expecting all the 2Q results to be as good as Alcoa’s.  However, with a nice positive number for second quarter GDP already a foregone conclusion, many market watchers will assume most earnings reports to be rosy.

In the good news is bad news category, the June jobs reports were better than expected and even skeptics had to concede the employment picture seems to be improving.  Employers added 288,000 new jobs and revisions brought the May figure above 300,000.  The official unemployment rate dropped from 6.3% to 6.1%.  Unlike most other recent drops, this one was not immediately attributable to people leaving the labor force.  Although the labor participation rate didn’t budge off its 36-year low of 62.8%, the improvement in the unemployment rate was the result of 407,000 landing a job.  On Monday and Tuesday, the market had its worst two-day tumble in months.

Investor Heat Map: 7/9/14


Energy extended its reign over the sector categories to five weeks and shows no sign of relinquishing its position.  Technology climbed a notch to second place, but it came under pressure in the early part of this week and will have to work hard to be here again next week.  Health Care moved up to third despite posting a loss in momentum.  Real Estate and Consumer Discretionary are now tied for fifth place.  Real Estate has been hanging out in that neighborhood for a few weeks, while Consumer Discretionary climbed up from last place over the past two weeks.  Consumer Staples was the only sector to improve its momentum reading since our last update, which is not too surprising for a defensive category given the market’s decline this week.  However, Utilities, another defensive sector, took a different path.  It posted the largest decline in value, lost the most momentum, and plunged from second to tenth in the rankings.  Industrials resides at the bottom for a second week.


Whereas the sector rankings failed to reveal a strong rotation into defensive sectors, the style rankings are exhibiting a noticeable shift in that direction.  Mid Cap Value managed to hang on to its top spot, but the next five positions were all replaced by larger capitalization categories.  In times of uncertainty and outright selloffs, larger cap stocks typically perform better than small caps and hence carry a defensive label.  That was certainly evident this past week as Large Cap Value, Large Cap Blend, and Large Cap Growth all moved ahead five slots to form a three-way tie for second place.  Mid Cap Blend held its decline to just two spots, while Mega Cap jumped from last place to sixth.  The three Small Cap categories had been climbing the past few weeks, but they were all knocked down to the bottom this week.  Micro Cap, the smallest of the small, now sits in last place.


Canada sits atop the rankings for a second week thanks to its large weighting in the strong Energy sector.  China has been exhibiting volatile behavior recently, and this week it was to the upside.  This allowed China to jump from sixth to second place and pushed Japan down to third.  Emerging Markets held steady in fourth, while the U.S. slipped a couple of spots to fifth.  Most of the lower-ranked regions have momentum readings that are relatively compressed and are therefore subject to large shifts in relative order despite similar performance.  This week, strength in Pacific ex-Japan had the largest affect, allowing it to climb three spots.  Europe was relatively weak and was already in last place, but its poor showing pulled EAFE down three spots to tenth.


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.


“It would be useful for the Committee to develop and communicate its plans to the public later this year, well before the first steps in normalizing policy become appropriate.”

June 18, 2014 FOMC Minutes


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