Despite early-in-the-quarter worries about possible “tapering” by the Federal Reserve and late-in-the-quarter fears of a federal government shut¬down, the markets performed well in the third quarter. U.S. stocks rose 5.2 percent, while international and emerging market stocks increased 11.6 percent and 5.9 percent respectively. Even bonds managed to squeeze out a small gain, rising 0.6 percent in the quarter. Real estate investment trusts (REITS) lost ground in the quarter, falling 2.6 percent.
Economic trends are supportive
Though still spotty, global economic activity is starting to confirm the stock market’s advance. As shown in this chart, manufacturing is improving in most major economic regions including the U.S., Europe, Japan and China. (The purchasing manager’s index is a diffusion index, so a reading greater than 50 indicates expansion while a reading below 50 indicates contraction.) In fact, of the 22 major economies surveyed, 15 now show expanding manufacturing, the highest proportion in over two years. The relatively low level of manufacturing and trade inventories means that increases in sales will translate directly into even further increases in manufacturing activity.
The U.S. employment situation is also improving. Unfortun¬ately, the October labor market report was cancelled because of the federal government shutdown, but the September report showed unemployment falling to 7.3 percent, the lowest level since December 2008 and well below the financial crisis peak of 10.0 percent in October 2009. Unemployment claims have dropped to levels last seen in 2007.
More good news comes from improvement in cyclical sectors such as automobile sales and orders for non-defense capital goods, both at their highest levels since early 2008.
The housing sector is also showing signs of life. As measured by the Case-Schiller index of 20 Metropolitan Areas, home prices are 22 percent higher than their lowest levels of the financial crisis and rate of growth has accelerated to more than a 12 percent annual rate since early spring. Housing starts, though still below average, are more than double the pace seen at the bottom of the financial crisis. The supply of homes for sale is around 2.3 million units, still one of the lowest levels we have seen since 2003. The low supply is helping to push home prices higher.
The President and the Republicans
Gilda Radner’s character Roseanne Roseannadanna used to say, “It’s always something. If it’s not one thing, it’s another.” That’s a pretty astute observation on life and the markets. Just as economic worries seem to be easing, domestic political concerns are mounting. After reviewing global economic and political developments, David Kelly, JP Morgan’s global market strategist, recently quipped: “It is hard to believe, but Italy now has a better political environment than the United States!”
He was referring, of course, to the ongoing shutdown of the federal government. House Republicans refuse to pass a continuing resolution to fund the government unless President Obama agrees to delay key aspects of the Affordable Care Act. From an economic perspective, this political gambit is a terrible thing. By shutting down the government and threatening to withhold action on the debt ceiling, Congress has dramatically increased the level of economic uncertainty right when we need greater clarity and confidence.
One commentator recently described the Washington situation as the classic paradox of an irresistible force pushing against an immoveable object. But I’m not sure the analogy holds. Very little about the Republican position is irresistible. They have staked out an untenable position.
Even if Republican concerns about the ACA are valid, there is little justification for disrupting or damaging the rest of the economy in an attempt to delay its implementation. Consequently, the Republican’s strategy lacks moral force—a reality not lost on the public at large. A recent Wall Street Journal/NBC poll showed that 53 percent of Americans blame the Republicans for the shutdown. Perhaps more damning, 70 percent think the Republicans are putting their political agenda ahead of what’s good for the country, compared to the President’s 51 percent. (see Wall Street Journal, 11 Oct. 2013, A5). If the Republicans want to become an “irresistible force,” they need to get busy crafting and communicating a more compelling vision of the future.
President Obama, on the other hand, really is immoveable—at least in terms of the ACA. Like most presidents, he lives with one eye focused on his place in history. That place, as he sees it, is inextricably linked to the Affordable Care Act. He is not going to cede it to what he sees as a group of conservative fire-eaters in Congress. Nor should he. Do we really want to live in a future in which Congresses think it is acceptable to exercise this kind of blunt force politics? Our system of government has more acceptable ways of dealing with controversial legislation. Let’s hope our political leaders rediscover those before they undermine our economy’s nascent recovery.