sono Dally Agenda: Bank of England Stays the Course rstiitonal Investor
Plast tional
nvestor
Daily Agenda: Bank of England Stays the
Course
09 OCT 2014 - ANDREW BARBER
After a week that saw a bearish shift in sentiment among many market strategists and
pundits, U.S. equities rebounded sharply yesterday, as the Standard & Poor's 500
Index gained nearly 1.8 percent. While language in the notes from the Federal Open
Market Committee's September meeting released yesterday suggest that the Federal
Reserve won't be raising interest rates anytime soon, a positive for stock investors, the
market's sudden, large upward move appeared outsized to many observers. For now,
it seems that U.S. investors have yet to make up their minds about the balance
between good news domestically and grim news abroad. Corporate earnings appear
likely to be a deciding factor for investors as many large-cap companies announce
third quarter results in the coming weeks.
Bank of England stays the course. As most market watchers had expected, Britain's
central bank voted today to keep its benchmark interest rate at 0.5 percent. At the
same time, the Bank of England announced that it is leaving its asset-buying program
at £375 billion ($607 billion). Bank of England governor Mark Carey has recently
expressed concern over the economic impact of the steep rise in U.K. housing prices
and household debt over the past year.
More bad news for Europe. German trade data for August released today by the
Federal Statistics Office added to the gloom hanging over the European Union's
largest economy, with exports registering a 5.8 percent contraction. This constitutes
the largest single month drop in exports since 2009 and was well below consensus
forecasts. In the wake of yesterday's announcement that the International Monetary
Fund (IMF) had reduced GDP projections for Germany in 2014 and 2015, political
debate over economic policy in Berlin is beginning to pick up steam
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Machinery orders in Japan show improvement. After a string of disappointing data
releases for Japan in recent weeks, a positive development arrived this morning
August machinery orders registered a 4.7 percent month-over-month expansion and a
year-over-year contraction that was shallower than forecast. Machinery orders are
considered a significant indicator for the overall production levels, suggesting that
factory activity may have found a bottom in September. The encouraging industrial
numbers, however, are unlikely to dispel larger concerns regarding the health of
recovery, as extraordinary easing measures by the Bank of Japan have failed to offset
the impact of increased consumption taxes on overall economic activity.
Today's U.S. data unlikely to move markets. In the U.S. initial jobless claims and
August wholesale inventories will be released today with no expectations of a
significant market impact from either number. Consensus forecasts are for a marginal
uptick in the ranks of newly jobless after last week's surprising drop of 8,000. Last
week's continuing claims figures reached a recovery low of 2.398 million. Meanwhile,
wholesale inventories have risen modestly in August after a surprise reduction in July
largely driven by a decrease in farm and computer equipment.
Earnings season takes center stage in the U.S. After aluminum maker Alcoa's
profits beat forecasts yesterday, eamings season is now in full swing. Companies
reporting today include retailers Gap and Sears Holdings Corp. Shares of Sears
tumbled yesterday on reports that a significant vendor had ceased to ship to the
beleaguered department store chain and discount retailer on concerns over credit
worthiness. Gap shares were down 10 percent in premarket trading after the San
Francisco-based retailer announced that CEO Glenn Murphy would be stepping down
in February and be replaced by Art Peck, president of its growth, innovation and digital
division
Portfolio Perspective: Small- and Mid-Cap Stocks Are Due for a Fall — Nicholas
Ragone, Villicus Capital Group
The most important technical indicators are screaming that small- and mid-cap stocks
are bound for bigger losses. The small-cap iShares Russell 2000 Index ETF (IWM) and
SPDR S&P MidCap 400 ETF (MDY) have both broken below their key 50-, 150- and
200-day moving averages, as well as below a trend line going back to 2012. The small-
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cap index has formed a bearish head-and-shoulders chart pattern, indicative of market
tops, while the mid-cap benchmark has formed an equally bearish double-top pattern
If the two indexes fail to find support at current levels, the next level of chart support is
at the 2013 September low — about 10 percent below current levels.
The combination of weakness in small- and mid-cap stocks and strength in large-cap
stocks means that institutional investors and hedge funds — the bull market's primary
drivers since 2009 — are lowering their exposure to the more speculative areas of the
stock market and gravitating to less volatile, more liquid stocks.
The first phase of the Federal Reserve's plan to scale back quantitative easing is
nearly done. With QE being eliminated, hedge funds and institutional investors will
have less access to cheap money and therefore less firepower to push stocks higher.
The iShares Russell 2000 Index ETF has returned an average of 7.8 percent annually
the past ten years, according to Morningstar. But over the past three years, it has
gained a whopping 19.3 percent a year. This outsized divergence from the historical
average is unsustainable, suggesting that the small-cap index has to underperform for
the next few years to revert to the mean. The same holds true for the SPDR S&P
MidCap 400. Its three-year average return is about double the ten-year average.
Nicholas Ragone is founder and portfolio manager of Villicus Capital Group, a Melville,
New York-based alternative investment management firm catering to institutional and
high-net-worth clients.
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