As the sun begins to set on third quarter earnings season, investors are increasingly turning their attention back to the broader economy. With regard to key data, this week provided plenty to ponder. Mario Draghi’s surprising decision to cut short-term rates in Europe speaks to the European Central Bank’s concern about last week’s surprisingly low inflation reading, which has spawned talk about potential deflation on the Continent. And while the U.S. administration may not like the fact that Germany generates half its GDP from exports, the likes of BMW and Siemens must have been raising a toast to the resulting drop in the euro, which promises to make German exports that much more competitive. Only time will tell if more aggressive actions might be necessary in Europe, but from a monetary policy standpoint, the ECB retains more dry powder (reducing the rate that the central bank pays on excess bank reserves, quantitative easing, etc) than its U.S. counterpart, which has already spared no dollar in an attempt to stimulate the economy.
Less than Meets the Eye
As the Fed ponders its next move, investors got their first dose of the third quarter GDP data, which showed that the U.S. economy grew at a surprisingly robust 2.8 percent rate. Peeling back the onion, the underlying detail paints a less rosy picture—consumption spending up a lackluster 1.5 percent and reduced levels of capital spending more indicative of an economy growing at a slower pace. After subtracting a build-up of business inventories, real final sales rose by that not-so-magical number of 2 percent that investors have grown increasingly accustomed to seeing from the U.S. economy.
Juxtaposed against the uninspiring GDP data was Friday’s payroll report which was surprisingly robust. Despite the early October government shutdown, the economy added a net 204,000 jobs to nonfarm payrolls during the month, boosted by hiring in the manufacturing sector and better hiring trends in retail, leisure and hospitality. The response from financial markets was mostly predictable, as bonds fell, gold declined and the dollar strengthened—all in anticipation of the Fed tapering its program of quantitative easing sooner than otherwise expected. What is encouraging to us was the reaction by equity investors, who bid stocks higher to close the week. As we have indicated in past commentary, when the Fed does begin to taper, it will be for the right reasons.
Our Takeaways from the Week
- With nearly 90 percent of large U.S. companies having reported, an acceptable third quarter earnings season is drawing to a close
- Despite added volatility, stocks remain well bid in a rising interest rate environment