Monday, January 27, 2014

Future U.S. Stocks Fall From Record Before Fed Stimulus Decision- Discussion Topic 2013/10/31


  1. Market outlook:
    1. Fed stimulus impacts the stock market in following ways: Firstly, by maintaining stable bond purchase, the money supply gradually increases, which according to the neoclassical theory will increase the price level (inflation). The current 10 year T-bond rate is 2.65% ( and Fed has an 2% inflation objective. Investor are likely to pressure for a higher real interest rate in the near term. (Real GDP growth rates is an approximation for it). Secondly, the Fed can change the long term interest rate, since the T-bill rate is used as a risk free rate benchmark, a higher WACC will lower companies's valuation.
    2. Currently, the S&P index is trading at 4 year high at a P/E ratio of 16. According to the DDM model, it implies that the S&P should be able to grow at 16% annually to make the P/E valuation stable. Nevertheless, the average of 300 reported companies' earnings are growing at 5% and sales at 2.9%. Although, factors other than growth ratios matter in making investment decisions, those figures show that the investors are being too optimistic.

    Fed will have to reduce the monetary stimulus some time in the future, because the implied risk free rate is too lower. The low interest rate stimulates companies to invest in capital and labor, but the growth rate fall short of market valuations. Therefore, S&P stock index will drop to adjust its P/E ratio closer to implied growth rate.

  2. Generally, U.S economy is still growing but the whole economy is still down like job markets lost its momentum so the government still will maintain its monetary stimulus and want to see more evidence of economy grow.
    Since S&p 500 stocks fell and consumer confidence declines stoked, Fed will maintain its bond purchase. So far, though the Fed stimulus helped propel the stock more than 160 percent from 12-year low in 2009, that's still below the multiples at the markets two previous peaks.

    Job markets lost momentum and the partial government shutdown will reduce economic growth by 0.3 percent this quarter.

    Inflation is below the Fed’s 2 percent expectation, giving policy makers room to maintain monetary stimulus.

    Conclusion: In the next quarter, the Fed will still maintain its monetary stimulus since the job market doesn't have a lot of job openings though financial markets make gains.

  3. I think the key determinants for the equity market in the past weeks have been (1) corporate earnings; (2) Federal Reserve’s open market operations and the speculation towards it.
    As the CIO of PIMCO El-Erian mentioned in his interview with Bloomberg, CEOs have to make multi-year decisions, which requires clarity on some basic issues, such as tax regime, government spending and financial regulations. As these things become less clear, companies hold back hiring because they are making multi-year commitments that are very difficult to change. I suspect that the market at this point has NOT fully taken into consideration the potential higher unemployment that is yet to be reported by the labor department this Friday.
    Now for the macro-economy, I would suggest keeping an eye on the following indicators.
    Tuesday ICSC-Goldman Sachs Chain Store Sales Index
    ISM Non-Manufacturing Report on Business (Oct)
    Wednesday Leading Indicators
    EIA Weekly Petroleum Status Report
    Thursday Advance GDP 3Q
    EIA Weekly Natural Gas Storage Report
    Friday U.S. Employment Report (Oct)

    Post updates
    From my observation…
    Based on what is suggested in the article, the increase in the equity market in the past three years largely results from Federal Reserve’s stimulus. Now we have heard the central bank said there were signs of “underlying strength” in the economy, and the market translates this into speculation that the Fed may begin to slow the pace of stimulus in coming months. With that being said, the speculation was offset by better-than-estimated corporate earnings, especially those in the consumer cyclical and healthcare sectors.