Amid Government Dysfunction, Yellen Tapped to Lead Fed

by Shawn Narancich, CFA Senior Vice President of Research

More Than Just Political Theatre

A rollercoaster week in financial markets came to a favorable end for stock investors, who are beginning to equate a resumption of budget negotiations with a potential deal to end the government shutdown and raise the U.S. Treasury’s borrowing authority. The emergence of political comity in D.C. is being forced upon both political parties as poll numbers show Americans’ increased frustration with Beltway gridlock. As well, eleven days of partial government shutdown is taking its toll on the economy: a lack of FDA inspectors causing delays in reviewing key drugs for approval; small businesses unable to obtain SBA financing because of staff furloughs; and a lack of customs inspectors to approve a variety of imported and exported goods. Dislocations began to show up in weekly unemployment claims, which surged by over 20 percent as furloughed workers applied for benefits. Against this backdrop, economists are cutting their estimates of fourth quarter GDP, with projected economic growth once again settling near a lackluster 2 percent rate. At the Fed, policymakers are lacking key economic data such as the latest payroll report, retail sales and inflation statistics necessary for informing their latest evaluation of proper monetary policy.

It’s All Over But the Yellen

While the Fed at present may be flying blind to a certain extent, investors learned this week who will be piloting the plane. As expected, current Fed Vice Chair Janet Yellen received the nod to become the Federal Reserve’s next leader, set to replace a retiring Ben Bernanke. If confirmed by the Senate as we expect, she will become the first female Chair in the institution’s 100 year history. Our expectation is for a seamless transition of leadership, but Yellen’s policy making is thought to be somewhat less collaborative than Bernanke’s and more influenced by the Keynesian school of economic thought. Despite some concern that Yellen leans dovish, we believe she will keep policymakers focused on the Fed’s dual mandate supporting both full employment and low inflation.

A Slow Start to Earnings Season

With metals producer Alcoa one of the few names to rally following its third quarter numbers, earnings reporting appears to be off to a lackluster start. Of eight key earnings reports that we reviewed this week, only Alcoa and Wells Fargo reported ahead of consensus expectations, and Wells did so despite a disappointing top line that was burdened by a dramatic pullback in mortgage underwriting. Chevron pre-announced disappointing numbers citing weaker refining margins, fast food operator YUM Brands was burdened again by a hangover from its chicken supplier issue at its KFC business in China and JP Morgan’s legal tangles with the federal government caused it to report its first ever loss under chief executive Jamie Dimon’s leadership. Despite the week’s plurality of discouraging news from corporate America, investors should realize that earnings season has just begun, so it’s too early to pass judgment. Earnings season kicks into high gear next week, when investors will digest financial results from an increasing number of big banks, including Citigroup, Bank of America, Goldman Sachs and Morgan Stanley. Earnings reports are also on tap from the likes of GE and Google. For large cap stocks in aggregate, we expect a quarter of low single-digit revenue growth accompanied by a mid-to-high single-digit increase in earnings.

Our Takeaways from the Week

  • Stocks rose for the week amid investor optimism about budget negotiations in Washington
  • Although it is very early days, third quarter earnings season is off to a somewhat discouraging start