You may recall the FOMC meeting of three weeks ago as the one that had little or no anticipation before the event, a non-surprising conclusion of no policy changes, and little press coverage afterward. However, analysts have been awaiting the minutes to see what was going on behind those closed doors, and today, the Federal Reserve released them.
The Fed revised its forecast for near-term GDP growth downward, primarily due to the partial government shutdown and softening in consumer spending. However, it revised medium-term GDP growth upward based on slower increases for the value of the dollar and long-term interest rates combined with higher projections for equity prices and home values. The Fed believes real GDP will accelerate in 2014 and 2015 and then begin to slow a little in 2016. It also expects the unemployment rate to continue its gradual decline.
Risks in the forecast include the uncertain effects and future course of fiscal policy, which is the Fed’s polite way of saying the budget problems in Washington. Other risks include a possible slowdown in consumer spending growth and the potential for increasing mortgage rates to affect residential construction activity. Inflation is expected to remain below 2% through 2016.
Regarding the unemployment rate, the Fed appears to agree with our assessment, namely “the drop in the unemployment rate over the past year, while welcome and significant, could overstate the degree of improvement in labor market conditions, in part because of the decline in the labor force participation rate.”
However, the inevitable tapering of the asset purchase plan is of primary interest to most market watchers. In that regard, “all members but one again judged that it would be appropriate for the Committee to await more evidence that progress toward its economic objectives would be sustained before adjusting the pace of asset purchases.” Members discussed whether the initial reductions should target Treasury or MBS assets, or both equally.
The timing is not clear, but the Committee expects economic data to be consistent with its forecast, which “would thus warrant trimming the pace of purchases in coming months.” Some participants want to extend the program because more time was needed to assess economic conditions, while noting the Fed’s balance sheet had ample capacity versus foreign comparisons given the scale of the U.S. economy.
One thing all participants seemed to agree on was the need for making the Committee’s communications as simple, clear, and consistent as possible. Examples include continued emphasis that the program was data dependent, along with a reminder that any reduction would depend on both the cumulative progress and outlook for improvements in labor markets. Given that, we expect the commencement of tapering to be well-telegraphed so as to avoid a repeat of the September meeting, when analysts were surprised by the lack of action taken.
Sectors
Industrials kept its top ranking on strength in the aerospace industry. Consumer Discretionary moved up to second place as homebuilders posted a good week. Health Care’s recent ascent continued, this week climbing two positions to third while Materials held steady at fourth. Technology took a drop, sliding from second to fifth primarily due to setbacks in semiconductor and solar technology stocks. Consumer Staples and Energy held their ground near the middle of the pack. Financials was the top performing sector the past week but only managed to climb one spot in the rankings. Utilities and Real Estate posted small improvements in momentum but not enough to change the big picture. Real Estate is the only category currently in a negative trend.
Styles
The transition in leadership from Small Caps to Large Caps is now essentially complete. Relative strength aligned with inverse market capitalization was the predominant pattern just a few weeks ago. Today, Mega Cap and the three Large Cap categories are on top, Micro Cap and the three Small Cap categories are on bottom, while the three Mid Caps are wedged in the middle. Given the tight compression across the momentum scores, the differences are subtle yet consistent enough to produce a discernible pattern. Growth and Value are mixed, and they take a back seat to capitalization size at this time.
Global
After two months on top, Europe has now been unseated. Last week, we mentioned how the U.S. had climbed in the rankings and was poised to challenge Europe for the leadership position. However, both categories were handed a surprise as China surged from tenth place a week ago all the way to the top today. In a week where the U.S. and Europe posted modest gains, a better than 6% jump in Chinese stocks was enough to upset the status quo. Europe and the U.S. each moved down a notch as a result. World Equity and EAFE held their ground while Japan had an above-average week, allowing it to climb two places to sixth. The U.K. suffered the largest drop in the rankings, sliding from third to eighth. However, it posted a positive return and increased momentum. It’s just that other regions were even stronger. China’s surge rubbed off on Emerging Markets and Latin America enough to propel them out of their negative trends but not enough to change their relative positions.