The Third Quarter Surprises Analysts — Again

The third quarter was another one full of surprises for those trying to anticipate the markets. Let’s take a look at what the major asset classes did during the quarter.

Despite a lot of negative headlines and pessimistic analysts, stocks had another good quarter across the globe. The S&P 500 rose 3.78% for the quarter, the Dow Jones Industrial Average gained 2.75% and the Russell 2000 handily beat both of those large stock indexes by rising 8.92%.

The emerging markets did even better, gaining 8.99%. Plus, the All-Country World Index increased 5.10%.

Bonds didn’t have such a good quarter. Long-term treasuries, which had wide swings, lost 0.46%. Investment-grade bonds gained 1.16%. Treasury Inflation-Protected Securities rose 1.05%, while high-yield bonds returned 4.42%. Plus, the dollar rose 0.64%.

Energy-based commodities gained 4.51% while broader-based commodities jumped 5.10% and gold rose 0.55%.

Central banks were the primary influences on the markets again, but not in the ways they anticipated. For example, the Fed tried to tighten monetary policy. A majority of voting U.S. central bank members were too concerned about the fragility of the global economy to raise rates, but they talked seriously about doing so.

The European Central Bank and Bank of Japan, on the other hand, increased their stimulus programs. Those programs were supposed to reduce the prices of their currencies against the dollar, cut domestic interest rates and stimulate stock markets. This was supposed to happen by having the central banks buy bonds while the sellers of those bonds invested the money in stocks or other risky assets. The actions also would lower interest rates and their currencies.

Instead, investors decided the European and Japanese markets were too risky. They also anticipated the expected currency declines. So, they invested the proceeds from the bond sales in U.S. assets, especially stocks. And they purchased currency hedges to neutralize any currency changes.

The result was that U.S. stocks and the dollar generally increased, along with the euro and yen. European and Japanese stocks had good runs early in the quarter but were flat after that.

This is an example of why we don’t invest based on forecasts. We look for margins of safety and try to be diversified and balanced. Also, if most analysts seem to agree on an outcome, we tend to think it already is priced into the markets and something else is likely to happen.

The Data

Household finances took a break in August. After four months of steady increases, Personal Income rose only 0.2%. Likewise, Consumer Spending was flat. The savings rate increased to 5.7%. High savings plus lower gas prices explain much of the flatness in consumer spending. Also, consumers were likely to slow down after several months of spending above expectations.

Inflation, as measured by the PCE Price Index, increased more than the previous month. That climb puts the 12-month increase for the core index at 1.7% and it continues to edge closer to the Fed’s target of 2%.

Consumer Sentiment, as measured by the University of Michigan, had a nice increase to 91.2. That’s one of the highest readings of the year and indicates consumers have confidence for the long term.

Manufacturing started to generate some positive reports after several months of negative surprises.

The Chicago PMI rose 3.7 points to 54.2. That puts the reading of Chicago-area business activity solidly into expansion territory.

The PMI Manufacturing Index declined a half point to 51.5. That still indicates growth. Businesses responding to the survey indicated that uncertainty over the presidential election is delaying customer decisions.

The ISM Manufacturing Index, on the other hand, reversed last month’s decline to below 50. The new reading is 51.5 and is a solid two point increase. Almost all components of the report were positive. The index is back to indicating modest growth in the manufacturing sector.

Perhaps the most significant manufacturing report of the week was Factory Orders. The headline number wasn’t much. Orders increased 0.2% after climbing 1.4% last month. But core capital goods orders increased 0.9% following 0.8% and 0.5% gains in the previous two months. This rise indicates that businesses finally might be investing in their operations and preparing for growth.

The broader economy continues to be looking good. The PMI Services Index rose to 52.3, after registering 51.0 last month. Even better, the ISM Non-Manufacturing Index soared to 57.1, after recording 51.4 last month. In addition, last month’s number was the low point for the index during this recovery. The components of the report were very strong throughout.

Tomorrow, the over-hyped Employment Situation reports will be issued. The lead-in, the ADP Employment Report, disappointed analysts by reporting only 154,000 new jobs. That’s a decent number, but it is below expectations and the last few months’ reports of 170,000 or more new jobs.

New unemployment claims declined by 5,000, and the four-week moving average is 253,500. The four-week average is the lowest since December 1973. The weekly number has been below 300,000 unemployment claims for 83 consecutive weeks, which is the longest streak since 1970. Both the weekly and four-week unemployment claims numbers remain near historic lows.

The Markets

The S&P 500 lost 0.47% in the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 0.24%. The Russell 2000 fell 0.59%. The All-Country World Index dipped 0.37% and the emerging market equities slipped 0.32%.

Bonds had a very bad week. Long-term treasuries slid 2.58%. Investment-grade bonds fell 1.07% and Treasury Inflation-Protected Securities (TIPS) dipped 0.76%. High-yield bonds rose 0.09%, while dollar climbed 0.81%.

Energy-based commodities gained 3.49%, while broad-based commodities increased 0.64%. Gold lost 4.23%.

Bob’s News & Updates

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Some Reading for You

There’s been a lot of concern about how the presidential election might affect stock prices. Here’s a good summary of the latest research.

If you’re among those worried about the future of western civilization, consider buying a luxury bunker.

High-yield bonds have done well this year when many people didn’t expect it. There are very large short sale positions in the high-yield bond ETFs.

I comment and link to these and other items on my public blog at http://www.bobcarlson.net.