Weekly Update-10/31/2014

Macro Commentary 

10.31Party like it’s 1999!  Well, at least the S&P 500 index price looks likely to close well above this level after a surprise announcement from the Bank of Japan (BoJ) that they are expanding their quantitative easing program.  After weakening inflation data and a decline in household spending, BoJ Governor Haruhiko Kuroda surprised markets by raising the annual target for increasing the monetary based by 23% to the equivalent of around $724 billion at today’s exchange rates.  It seems the implicit message from the US Federal Reserve this week that they will not be the world’s central banker was heard loud and clear in Japan.  Kuroda may also be trying to give some cover to Prime Minister Shinzo Abe who is facing the decision of whether to again increase the sales tax rate in 2015.  The first increase that occurred earlier this year led to a significant step backward in the sustainability of the Japanese recovery.  Monetary policy is only able to buy time for structural reform and, given the relative size of Japan’s actions relative to others like the US or the UK, the amount of time available to buy is growing short.

We think the Fed took the right action this week in closing out their bond purchases.  Despite earlier comments by St. Louis Fed President James Bullard suggesting that the FOMC use the potential message of delaying the last step as a way to show that the Fed truly is data dependent in their decision making would have been a trap of moral hazard.  What data would the Fed have been looking at to make such a decision?  Yes, inflation expectations have been weakening at the margin but that is during a drought of positive sentiment and concerns on growth primarily from Europe.  Advance Q3 GDP data in the US was 3.5%, losing some of the bounce back from Q1 but strong.  While many of us feel the Fed looks at financial markets, it would not have been wise to react to the relatively modest S&P 500 downdraft.  If they did not stop the bond buying now, then when?  We appreciate that that good ol’ fashioned earnings caused the turnaround in the US equity market – over 80% of the S&P 500 companies that have reported beat earnings estimates and over 60% beat sales estimates.  That is much better long-term support than another liquidity rush.

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