It’s been a week since the FOMC meeting concluded, yet many analysts and investors are still mulling over the Fed’s lack of action regarding the tapering of its bond purchases. Many believe they were misled and are essentially accusing the Fed of reneging on its promise. A small few called it correctly, claiming the economy is still too weak. We were part of the majority consensus, thinking the Fed would commence with a token amount of tapering. Still, we hedged our forecast two weeks ago in a client communication stating, “A reduction in the bond-buying program at the conclusion of next week’s FOMC meeting is no longer a given, and if it does occur, then it could be just a token amount.”
Although we were part of the incorrect consensus thinking, we did not let it bother us. Furthermore, we are not in the camp that believes the Fed led us astray. All along, the Fed made it clear a reduction in the monthly purchases was dependent on the continuation of good economic data and there was no set timetable. Our investment models generally fared better than the S&P 500 since noon of last Wednesday, so maybe that is playing a part in our non-accusatory thinking.
Debt ceiling discussions are moving back to center stage. You can expect a great deal of rhetoric from both sides of the aisle. However, we recommend you do not become emotionally involved. It is key to understand that a government shutdown and a government default are two very different events, with two very different consequences. A shutdown has much higher probability but much lower impact on the market. The U.S. government shut down 17 times between 1976 and 1996. Presidents Carter and Reagan encountered six shutdowns each. The last shutdown lasted three weeks, from December 15, 1995 to January 6, 1996. The S&P 500 ironically advanced a small 0.3% during that period, and then it fell 3.2% in the two days following the government’s reopening.
A U.S. government default on its debt obligations is much more serious. Financial markets would likely take a huge hit, U.S. Treasury securities would plunge in price, and the phrase “backed by the full faith and credit of the U.S.” would lose its significance. This is unlikely to happen, as no elected official wants that scenario to play out while they are in office. Still, it is a huge tool for politicians who enjoy making negotiations a game of brinkmanship, so we are likely to hear this threat many times in the weeks ahead.
Industrials claimed the Sector leadership position for the second week in a row. Consumer Discretionary moved from third to second despite the wide price swings among homebuilders and retailers. Technology climbed two steps to third as Apple’s (AAPL) apparent success with its new phone launch translated to higher share prices. Materials held steady at fourth, although it has given back all post-FOMC meeting gains. Health Care encountered weakness, falling from second to fifth. ObamaCare funding has become a political football, and the associated uncertainty is bringing pressure to Health Care stocks. The Financials sector posted the largest price declines this past week and slipped below Consumer Staples in the rankings. It’s too early to call a top, but Financials has been unable to surpass its July peak in the September rally. Yield regained some importance after the Fed decided to hold off on tapering, and that reinvigorated the Utilities sector, allowing it to shed its negative trend. Real Estate is now the only category not in an intermediate-term positive trend.
Strength was concentrated at the bottom of the Style Box matrix this week, and the eleven Style categories did not move in unison. Micro Cap posted the largest momentum increase with Small Cap Value, Small Cap Blend, and Small Cap Growth following. Large Cap Value, Large Cap Blend, and Mid Cap Growth had the largest decreases in momentum. This created some shifts in the overall rankings. Small Cap Growth remained on top while Micro Cap moved up to second place and pushed Mid Cap Growth from second down to fourth. Small Cap Value jumped two spots to seventh place and is now challenging Mid Cap Blend for sixth. Large Cap Value replaced Mega Cap at the bottom.
The Global rankings are compressing. Europe edged ahead of China to reclaim first place after a three-week hiatus, although its margin is quite slim. EAFE jumped two places to third as Emerging Markets held steady in fourth. The U.K. dropped three places to sixth and is now essentially in a three-way tie with Japan and Latin America. Latin America, as you may recall, has been stuck at the bottom of the rankings for months, and this week it finally makes a clean break. World Equity dropped a few notches to land below Latin America. North America’s constituents are now at the bottom of the heap. The U.S. currently has a slight edge over Canada, but both are severely trailing the rest of the world.
“In short, the Affordable Care Act is well insulated from annual appropriations and the implications from an appropriation lapse.”
Gordon Gray, director of fiscal policy for the American Action Forum
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