Looking Ahead to the Third Quarter of 2011
As market participants focus on the health of the economy and corporate earnings in the recently completed third quarter of 2010, Federal Reserve (Fed) policymakers are likely debating the outlook for the economy in the third quarter of 2011 and beyond.
This week, with a relatively light economic data calendar, the market’s focus may be on the third quarter earnings reports of S&P 500 companies, the Fed’s Beige Book and the full docket of Fed officials scheduled to make public appearances this week. Last week, data on merchandise trade, business shipments and inventories for August, retail sales, and consumer and producer prices for September helped to solidify the market’s view of real gross domestic product (GDP) growth in the third quarter of 2010.
Ben in Boston: Bernanke Makes His Case for More Quantitative Easing
In a speech in Boston on Friday, October 15, Federal Reserve Chairman Ben Bernanke laid out the case for the Fed to engage in another round of quantitative easing (QE). Citing weak economic growth, high unemployment and low and decelerating inflation, Bernanke made it clear that there is a “case for further action,” as the Fed tries to uphold its dual mandate from Congress “to foster maximum employment and price stability.”
Monetary policy, even dramatic and bold policy involving the purchase of large quantities of fixed income securities, in the open market intended to flood the system with cash works with a lag. These actions are intended to prompt interest rates to fall, businesses to borrow, hire and expand, and consumers to refinance debt and continue to repair their balance sheets. It takes a while (sometimes up to a year or more) for the stimulus to work its way through the system. As a result, there is obviously little that the Fed can do to affect the economy in the already completed third quarter. Any policy enacted by the Fed in the remainder of 2010 would only provide a small boost to growth in the fourth quarter. As a result, while Fed policymakers have some interest in the economic data referring to the third quarter of 2010, and the current fourth quarter, they are probably much more concerned with what economic conditions will be like looking out to the third quarter of 2011. Their hope is that by that time, their efforts will help to produce economic growth that will be above trend, pull down the unemployment rate, and modestly increase the pace of inflation.
Data for the Third and Fourth Quarters of 2010 Due This Week; Watch for Fed Dissenters
This week housing takes center stage with reports on homebuilder sentiment for October and housing starts and building permits for September due out. The health of the manufacturing sector as the fourth quarter of 2010 began will be assessed as the Philadelphia Fed Manufacturing Index for October is released later in the week. Finally, the index of leading economic indicators for September is due out in the back half of the week, as investors continue to get more comfortable with the “slow growth, but no double dip” view of the U.S. economy. As previously noted, the Fed’s Beige Book will get intense scrutiny when it is released (in preparation for the November 2-3 Federal Open Market Committee (FOMC)), as will the comments of the rather full slate of Federal Reserve officials scheduled to make public appearances this week.
In our view, with only a few weeks until the next FOMC meeting, there is not enough time for the incoming economic data to improve enough to deter the Fed from doing another round of QE. However, questions around the size, timing, composition, and efficacy of more QE will remain in the marketplace, and will likely be amplified by this week’s Fed speakers. Fed Chairman Bernanke certainly has more than enough votes on the FOMC, by our count, at least nine or ten out of the 12 current FOMC members have come out in favor of another round of QE. However, there are several Fed officials who would rather see the FOMC take a “wait-and-see” approach to more QE, while others are outright hostile to the idea altogether. Several of these officials who would prefer a “go-slow” or even a “no-go” approach to QE are scheduled to speak this week, so the financial press may be full of stories questioning whether QE will happen and whether it will work if it does happen. The only debate that matters on this issue is the one that will take place at the November 2-3 FOMC meeting, and the outcome of that debate is pretty much a foregone conclusion at this point.
A Look Back at Growth in the Third Quarter of 2010
Fed policymakers can do nothing to impact the pace of GDP growth in the recently completed third quarter, and have only limited influence over growth in the fourth quarter of 2010. Still, the Fed, market participants, and the financial media will be interested in the third quarter GDP release, which is due out on Friday, October 29. The third quarter will serve as a reference point for the Fed and for the markets, as they gauge the effectiveness of QE over the next several quarters. The data in hand thus far suggests that third quarter real GDP growth will come in at around 2.5–3.0%, with net exports, residential construction (housing), non-residential construction (businesses investments in office parks, malls and shopping centers), and state and local government spending exerting downward pressure on growth. The good news here is that while imports will exceed exports again in the third quarter, the gap is not likely to be as wide as it was in the second quarter. The data on housing and business investment in office parks, malls, etc. is likely to be bleak.
On the plus side, solid, but not spectacular consumer spending, which is likely to be slightly stronger in the third quarter than it was in the second quarter, solid business spending (although at a slower pace than in Q2), and most prominently, a big build in inventories will provide a lift to growth in the third quarter. Still, at right around the economy’s long-term average growth rate of 2.5%, growth in the third quarter is not swift enough to push the unemployment rate down or the inflation rate up. Thus, the third quarter GDP report, which is set to be released just a few days before the FOMC meeting, is likely to provide the Fed will plenty of reasons to do more to help stimulate the economy. However, the Fed is not so much concerned with growth in the third quarter of 2010 as it is with growth in the third quarter of 2011.
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IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Stock investing involves risk including loss of principal. Past performance is not a guarantee of future results. Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.
Philadelphia Federal Index is a regional federal-reserve-bank index measuring changes in business growth. The index is constructed from a survey of participants who voluntarily answer questions regarding the direction of change in their overall business activities. The survey is a measure of regional manufacturing growth. When the index is above 0 it indicates factory-sector growth, and when below 0 indicates contraction.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
This research material has been prepared by LPL Financial. The LPL Financial family of affiliated companies includes LPL Financial and UVEST Financial Services Group, Inc., each of which is a member of FINRA/SIPC. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.
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