Dawn of a New Era
Amid heightened turbulence in the global economy and capital markets, Janet Yellen was sworn into service as the Federal Reserve’s first chairwoman this week. Although she has a dovish reputation as an economist focused on the labor market implications of monetary policy, she ascends to a position requiring the optimization of full employment and low inflation. In this spirit, and acknowledging the faster pace of U.S. economic expansion at present, we do not expect this morning’s surprisingly weak payroll report to throw the Yellen Fed off its course of continuing to taper QE3. The headline number of 113,000 net new jobs created in January is anemic but, like December’s similarly weak number, unusually severe winter weather could be at play. More importantly, the underlying detail is encouraging – more private sector hiring and less competition from the government, which continues to shed jobs. After retreating nearly 6 percent year to date, blue chip U.S. equities shook off the weak payroll headlines and rallied back into positive territory for the week.
While retailers cut back following a choppy Christmas selling season, construction and factory jobs surged in January, providing more anecdotal evidence of a renaissance in U.S. manufacturing. Combine that with the surge in U.S. energy production and low inflation, and what we see is a relatively healthy domestic economy that appears able to withstand an increasingly uneven outlook internationally. The global purchasing manager surveys out this week demonstrate that economic activity globally is far from the synchronized global expansion that some would claim. Consider China, where the manufacturing sector is teetering on the edge of contraction, and contrast it with Europe, where despite 12 percent unemployment, factory output is growing at a faster clip. While China is still growing, its rate of expansion has slowed, taking the punch out of commodity prices and serving to help developed nations worldwide, whose lower bills for gasoline and agricultural commodities are helping boost consumers’ disposable personal income.
Emerging Market Contagion?
With the sun beginning to set on another reasonably constructive earnings season, we observe corporate earnings for the fourth quarter of 2013 that in the aggregate appear to have risen by about 8 percent. But with emerging equities already down as much as 11 percent year to date, investors are concerned that the relatively modest pullback U.S. stocks have already experienced could turn into something more sinister. So far, the interest rate hikes in nations like India, South Africa, and Turkey that are being used to help stem currency weakness and capital outflows appear localized to such economies disadvantaged by current account deficits that are driving up inflation. In contrast to the late 1990’s when currency devaluations in countries like Thailand were exacerbated by foreign currency debt obligations (making those obligations more expensive to repay), emerging market challenges today center around the more common but less pernicious problem of stagflation, a combination of slowing economic growth and rising inflation. As emerging market countries adjust to higher interest rates, we expect their growth to slow and in turn, dampen the level of global economic growth. But just as it did against a strong domestic backdrop amid the Asian Financial Crisis, we expect the U.S. economy and capital markets will weather the storm. Acknowledging the near-term challenges presented by emerging markets, we recently reduced our allocation to this equity style.
Our Takeaways from the Week
- Janet Yellen became the Fed’s first Chairwoman, amid an increasingly turbulent global economy
- Stocks bounced back, defying disappointing headlines on the jobs front and mixed manufacturing data