Schwab Market Perspective: So Now What?
Charles Schwab & Co. Inc.
Liz Ann Sonders
Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.,
Brad Sorensen
CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research, and
Michelle Gibley
CFA, Senior Market Analyst, Schwab Center for Financial Research
October 29, 2010
Key points
- The Federal Reserve and upcoming elections are in sharp focus and results and actions could to determine whether the momentum seen since September can continue.
- Earnings season was better than expected and the market reacted as such. But confidence remains a major issue, with brewing mortgage-related problems and continued uncertainty around tax policy causing consternation.
- Debt remains a major issue that's just now being addressed and protectionism still threatens economic expansion. China remains a bright spot for global growth.
Markets have been so focused on the potential for more Fed action and the outcome of the November 2 elections that the question becomes: What now? We believe we may start to see a shift in sentiment. During the past couple of months, stocks have rallied on somewhat weak economic data that was perceived as increasing the odds of another round of quantitative easing (the Fed injecting cash into the economy through the purchase of assets). Lately, the economic news has been at least marginally more positive.
Going forward, investors likely want to see fruit from any further Fed action and see more consistent improvement in economic data, especially jobs and housing. Similarly, markets were boosted heading into the elections on hopes that a new mix in Congress would lead to some tax and regulatory certainty—now it will be important to see that optimism fulfilled.
It will take some time to see the effects of these long-awaited events, and we believe some near-term consolidation in the stock markets is likely. We saw a hint of that following the very modest interest-rate increase out of China, but that was quickly reversed. As repeatedly noted, the market is a forward-looking mechanism, and we wouldn't be surprised to see some "buy the rumor, sell the news" action.
Investor sentiment has gotten a little stretched on the optimistic side (a contrarian indicator) and some technical indicators have reached levels that indicate stocks are somewhat overbought.
We again remind you to use this potential volatility to adjust your asset allocations as needed. Stocks should be viewed as a long-term investment (three to five years or longer) and short-term gyrations should be viewed as opportunities to align your investments with that in mind.
Economy back in focus
After a brief respite to focus on third-quarter earnings reports, full attention likely now turns back to the broader economy. After a couple of months of cheering tepid data due to its perceived influence on the Fed, more traction is likely needed to continue recent momentum.
The first read on third quarter GDP was in-line with expectations at 2%, up from 1.7% in the second quarter. Industrial production surprisingly declined 0.2% in September, while capacity utilization remained unchanged at 74.7%—5.9% below its 1972-2009 average, indicating continued cautiousness in the corporate sector. Companies have vast amounts of cash on their balance sheets. Unfortunately, for now, that money is largely just sitting on balance sheets.
Money Needs to Move
Click to enlarge
Source: FactSet, the U.S. Bureau of Economic Analysis, and the Federal Reserve, as of October 25, 2010.
*M2 velocity = GDP divided by M2 money supply.
We believe that cash will be soon put to work. With more certainty likely following early November's Fed meeting and elections, companies seem likely to look to deploy more of that capital.
