Markets were generally flat last week, with the Dow Jones Industrial Average down fractionally to 11,118 and the S&P 500 Index unchanged at 1,183. The Nasdaq Composite did manage to make some gains, rising 1.1% to 2,507. The upcoming week is unusually packed with market-related events, including the US midterm elections tomorrow, the Federal Reserveās scheduled policy meeting on Wednesday and the monthly labor market report on Friday, so investors have much to pay attention to over the next few days.
In economic news, the preliminary third-quarter gross domestic product (GDP) report showed that the economy grew at an annualized rate of 2.0%, which was in line with expectations. The numbers show that the economy continues to slowly improve, but is hardly growing at a rapid pace. Looking ahead, we expect that the fourth quarter should see growth levels in a similar range of 2.0% to 2.5%. Beyond that point, easier financial conditions and what seems to be a sustained easing of bank lending standards could help provide a further boost in 2011. As has been the case for some time, the key variable remains the labor market, which has been slow to add a meaningful number of new jobs. On that front, initial jobless claims fell again last week and are now at their lowest level since August 2008, which may auger well for the future.
Despite the mixed economic backdrop, corporate earnings have remained surprisingly strong. At present, over 85% of companies that have reported third-quarter earnings have posted better-than-expected results.
Investors are eagerly awaiting this weekās Fed meeting, where it is expected that the central bank will roll out the long-anticipated next round of quantitative easing (known informally as āQE2ā). From an equity markets perspective, we would point out that markets have already climbed significantly since Fed Chairman Bernankeās August speech that kicked off the series of hints that QE2 was in the pipeline. This probably means that many of the potential benefits of QE2 may already have been discounted by the markets, and investors should not expect to see a major move higher in stock prices as a result of the new easing efforts. In any case, we do believe QE2 should be supportive of modestly improved economic growth by lowering interest rates, furthering the weakness of the US dollar, easing credit conditions and improving confidence levels.
Of all of these likely results of QE2, one that bears especially close watching is the currency issue. Many countries (the United States included) are eager to lower the value of their currencies to boost export levels. As we have discussed in prior weeks, such a scenario poses the risk of escalating into a currency and trade war as individual countries begin to adopt more protectionist measures. We are hopeful that cooler heads will prevail and that such a trade war does not come to pass, but such an outcome is clearly on the risk list.
