Stocks Rally Following Janet Yellen’s Conference and Scotland’s Historic Referendum

Stocks Rally Following Janet Yellen’s Conference and Scotland’s Historic Referendum by Frank Holmes

CEO and Chief Investment Officer
U.S. Global Investors

Interest rates can’t stay zero forever, but for now it’s more of the same.

The Federal Reserve’s bond-buying program, enacted to spur growth, will indeed be winding down next month, as expected. But record-low interest rates will stay as they are for a “considerable time,” Fed Reserve Chairwoman Janet Yellen insisted during her Wednesday press conference.

It was “game on” for the stock market following Yellen’s speech. The Dow Jones Industrial Average closed at a new record high of 17,156, while the S&P 500 Index rose two points to close at 2,001, and the Nasdaq nine points to end at 4,562.

This news gives stocks reason to rally for a “considerable time,” or at least until the Fed gives us a more concrete timeframe for a rate hike.

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With interest rates very likely to rise sometime next year and at an indeterminate pace, you should consider being diversified with short-term bonds, as they’re less volatile to rate changes. Our Near-Term Tax Free Fund (NEARX), which invests in such bonds, recently received the coveted five-star rating from Morningstar for the three-year performance period.

This week in an interview with Marc Lichtenfield’s Oxford Club Radio, U.S. Global Investors Director of Research John Derrick highlighted some of the fundamentals of NEARX:

“Our average maturity’s around 2.75 years, so under three years right now… The overall fund structure is pretty conservative. [NEARX] really doesn’t move around that much. It’s a steady grinder.”

Rolling with the Punches

Chairwoman Yellen stated that the decision to raise rates was “highly conditional” and dependent on the Federal Open Market Committee’s (FOMC) assessment of the economy, which appears right now to be showing moderate or, in some sectors such as housing, faltering growth. Inflation has also fallen short of expectations.

But as always, we see opportunity.

The producer price index (PPI) numbers, released Monday by the U.S. Bureau of Labor Statistics (BLS), reveal that demand for goods such as gasoline and food dropped 0.3 percent while demand for services rose 0.3 percent, resulting in an unchanged final demand of 0.0 percent.

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Meanwhile, the consumer price index (CPI), which measures the cost of living, unexpectedly decreased 0.2 percent in August, the first time it’s done so since April of last year. The all-items index, however, has risen at a rate of 1.7 percent over the last 12 months.

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U.S. housing starts had a disappointing downturn last month, the Commerce Department reported, tumbling 14.4 percent to a seasonally-adjusted annual rate of 956,000 units. This decline is even lower than the projected -4.9 percent. Building permits fell 5.6 percent, below the -1.6 percent economists estimated.

Despite a decline in starts and permits from July, homebuilders’ confidence in the market soared to 59.0, according to the National Association of Home Builders/Wells Fargo builder sentiment index. This is the highest such reading since November 2005, before the housing bubble collapsed.

We might see stronger growth in the housing market very soon, as U.S. fixed mortgage rates had their biggest weekly jump of the year, following the increase in 10-year Treasury yields on the heels of Yellen’s press conference. This might help light a fire under hesitant homebuyers and encourage them to act. According to the Mortgage Bankers Association’s (MBA) weekly survey, mortgage applications rose 7.9 percent from a week earlier.

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Through the 12 months ended August 2014, the annual U.S. inflation rate is 1.7 percent, below many economists’ and Fed policymakers’ hopeful estimate of 2 percent.

Although lower-than-expected inflation might lead to less pain at the pump and checkout aisle, it can also sometimes lead to a sluggish economy. Debt financing becomes challenging. And as counterintuitive as it might seem, when prices are down, people tend to sit on their money and wait for even better prices to come along.

Rising prices, on the other hand, often prompt spending. For this reason, a little inflation is welcomed by some companies and their employees. Profits and wages can both increase, which stimulates borrowing and spending. The jump in mortgage rates is a perfect example.

As the U.S. Ends Quantitative Easing (QE), China and Europe Begin

With low inflation also comes the risk of dipping into deflation territory, which China is now facing. The country’s own PPI declined 1.2 percent in August, continuing a 30-month downtrend, while its CPI rose only 0.2 percent from July. Its purchasing managers index (PMI) also dropped last month, as did imports and manufacturing jobs.

To counteract this slowdown, China’s central bank injected $81 billion to five state-owned banks. So far the market seems to have liked the stimulus measure, as stocks in both the Hang Seng Index and Shanghai Composite Index have rallied, tracking positive stock performance on Wall Street. Only time will tell if the world’s second-largest economy is in a permanent recovery mode, but we’re optimistic.

Like the People’s Bank of China, many central banks around the world continue or are implementing easing policies. The European Central Bank (ECB), for instance, will be buying close to $1.3 trillion in bonds to provide fresh capital to the Union’s depressed banking system. All of this global stimulation activity is good for global financial markets and specifically U.S. equities. We’ll be exploring this very topic in our October 2 webcast, “One World Market, Many Central Banks: How Will Your Investments Be Impacted?”

Scots Vote “Nay” in Historical Referendum

Speaking of one world market, it collectively breathed a sigh of relief Thursday when Scotland voted to stay in its long-term relationship with the United Kingdom. As a Canadian, I’m familiar with separatist movements. In Scotland, as it is with Quebec, there seems to be a disconnect between wanting to break up the government in order to obtain more government. At a time when there’s so much uncertainty in the world, when members of the eurozone are in the doldrums, when China is trying to jumpstart its economy, when Russia is rattling its saber and ISIS is spreading as quickly as the Ebola virus, the last thing we needed was a major restructuring of one of the globe’s most stable and reliable countries.

Once the votes were counted, stocks in London rose and the pound bounced up a quarter of a percent.

Below you can see the current gross domestic product (GDP) growth forecasts for the U.S., eurozone, U.K. and China. Had Scotland voted “yes” in the referendum, it’s possible that the increased uncertainty might have stalled growth among these powers and altered economists’ predictions.

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Granted, every people has the right to declare its independence for the right reasons. If that were not the case, America might today be in the same family as Scotland. University of Bath professor Chris Martin said it best when he wrote: “The desire for independence seems to be driven by romantic views of a separate Scottish identity and culture rather than by cold economic logic.”

Indeed, it’s important to realize that the U.S., E.U. and China—the world’s three greatest economic powers—all rely on one another and help drive the rest of the globe.

Even many Scots were apprehensive of the economic implications of leaving the U.K. and, by proxy, the E.U. According to the gold trading firm BullionVault, approximately 40 percent more Scots bought gold in September compared to last year, most likely as a hedge against an uncertain economic future.

Once again, who says gold isn’t currency?

Keep on Keepin’ On

Although the week began with speculation and uncertainty—would the Fed raise rates? would Scotland break up the U.K.?—we ended on more solid ground than some were expecting.

The bull market that we’ve seen this year has continued to charge forward, creating healthy intraday and closing market highs. We can relax for the moment knowing that the Fed isn’t undertaking any drastic measures. And easing around the world has improved liquidity, making it easier for companies and individuals to invest in their future.

These are all good reasons to stay calm and keep seeking and investing in quality equities.

Index Summary

• Major market indices finished higher this week.  The Dow Jones Industrial Average rose 1.72 percent. The S&P 500 Stock Index gained 1.25 percent, while the Nasdaq Composite advanced 0.27 percent. The Russell 2000 small capitalization index fell 1.18 percent this week.
• The Hang Seng Composite fell 1.18 percent; Taiwan gained 0.19 percent and the KOSPI rose 0.59 percent.
• The 10-year Treasury bond yield fell three basis points to 2.58 percent.

Domestic Equity Market

The S&P 500 Index set new highs this week as investors embraced the Federal Reserve’s more dovish comments that what had been expected. The much anticipated Alibaba initial public offering (IPO) finally priced this week and rose 38 percent on its first day of trading. Broadly speaking, interest rate sensitive areas of the market tended to outperform while cyclicals tended to underperform.

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Strengths

• The telecommunication services sector outperformed by a wide margin this week as all major wireless carriers posted strong performance on Apple’s iPhone 6 release. The phone officially went on sale Friday and pre-orders were very strong.
• The health care sector also outperformed as biotechnology stocks such as Amgen bounced back after giving up ground last week. Index heavyweights Pfizer and Johnson & Johnson also posted strong performance.
• Vertex Pharmaceuticals was the best performer in the S&P 500, rising 11.57 percent. The company rose sharply on Friday after a major sell-side research firm upped its target price.

Weaknesses

• In an otherwise solid week for the market, commodity-related names tended to underperform as the U.S. dollar remains very strong. This was true for coal, gold, aluminum and numerous energy industries.
• Small cap stocks continued their recent underperformance with the Russell 2000 falling 1.18 percent this week.
• Owen-Illinois was the worst performer in the S&P 500 this week, falling by 11.33 percent. The container and packaging firm significantly reduced third-quarter guidance, citing weak operation performance in North America.

Opportunities

• The Federal Reserve is not ready to shift gears just yet and was more dovish than expected with this week’s post-Federal Open Market Committee (FOMC) statement.
• The U.S. economy is currently a bright spot in the developed world, potentially allowing money to funnel back into the U.S. equity market. >
• The path of least resistance for the market appears higher as this “classic” bull market phase of grinding higher with lower volatility remains intact for now.

Threats

• Volatility has been remarkably low and this bull market has been an abnormally smooth ride. This calmness won’t last forever and late summer/early fall has traditionally been more volatile.
• With central banks and earnings off the agenda for next week, the focus will likely be on geopolitical risks.
• Geopolitical tensions remain high, and while the market has been able to shrug off these events so far, an escalation could be the catalyst for a long-awaited correction.

The Economy and Bond Market

Treasury yields were roughly unchanged for the week, although there was plenty of intraweek volatility. The FOMC kept its “considerable time” phrase when discussing when interest rates may be increased after the end of asset purchases. The Federal Reserve is likely to wind down its asset purchases at the end of October, while the markets interpret a considerable timeframe of roughly six months. So while the Fed appears unlikely to raise interest rates before mid-year 2015, the committee members expressed views of a Fed Funds rate at the end of 2015 of 1.375 percent. This dichotomy confused the market. Most investors are not expecting 125 basis points of interest rate increases in the second half of 2015. This news keeps pressure on the short end of the yield curve, pushing yields back to multi-year highs.

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Strengths

• The Federal Reserve came across more dovish than many had expected, and will likely be supportive for fixed income in the long run.
• China’s central bank injected $81 billion into several major banks in an attempt to spur economic growth.
• Both producer and consumer prices were very tame in August with both indicators solidly below 2 percent versus one year ago. This leaves the Fed plenty of room to maneuver.

Weaknesses

• August industrial production unexpectedly fell for the first time since January. Recent manufacturing indicators have been unusually strong, so this outlier reading is a potential warning flag.
• Housing starts fell 14.4 percent in August, while building permits dropped 5.6 percent. Housing continues to exhibit mixed results and can’t seem to maintain any positive momentum.
• Chinese economic data remains sluggish, with industrial production rising 6.9 percent, the weakest reading since the financial crisis.

Opportunities

• Bond yields in Europe remain low, with some short-term European bond yields trading in negative territory. U.S. fixed income yields look attractive and will likely bring money flows from overseas.
• The Fed and the Bank of England both came out this week indicating there is no rush to tighten, and that the status quo remains firmly entrenched.
• With key global central banks back into easy policy mode and inflation trending lower in many parts of the world, the path of least resistance for bond yields likely remains down.

Threats

• The U.S. economy has some positive momentum and appears poised to continue to build on that as we move into the fall. If the economy gains strength it could force the Fed’s hand.
• The geopolitical situation remains unsettled and a flare up could occur at any time.
• While not explicitly stated this week, several Fed speakers have recently become more vocal, indicating a potential shift in Fed thinking toward normalizing interest rates.

Gold Market

For the week, spot gold closed at $1,216.98 down $12.76 per ounce, or -1.04 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, fell 5.44 percent. The U.S. Trade-Weighted Dollar Index rose 0.63 percent for the week.

Date	Event	Survey	Actual	Prior
Sept 16	US PPI Final Demand YoY	1.8%	1.7%	1.7%
Sept 17	Eurozone CPI Core YoY	0.9%	0.9%	0.9%
Sept 17	US CPI YoY	1.9%	1.7%	2.0%
Sept 17	FOMC Rate Decision	0.25%	0.25%	0.25%
Sept 22	HSBC China Manufacturing PMI	50.0	—	50.2
Sept 24	US New Home Sales	430K	—	412K
Sept 25	US Initial Jobless Claims	300K	—	280K
Sept 25	US Durable Goods Orders	-17.8%	—	22.6%
Sept 26	GDP Annualized QoQ	4.6%	—	4.2%

Strengths

• China officially opened the Shanghai Free Gold Exchange on Thursday. By giving foreign investors direct access to its gold market for the first time, China is seeking to obtain more influence over prices while simultaneously boosting the global use of its currency, the yuan. In addition to the deregulation of the gold market in Shanghai, Hong Kong’s Chinese Gold and Silver Exchange Society was given permission to set up a precious metals vault in Shenzhen this week. The continued deregulation of the gold market by the world’s largest consumer is a huge boost to the precious metal.
• China is planning on boosting its gold reserves. The country’s reserves, a mere 1.1 percent of total reserves, have plenty of room to grow if when compared to nations such as the United States and Germany, which hold roughly 70 percent of their reserves as gold. The increase in gold demand from Chinese central bank purchases should place upward pressure on gold prices.
• In the first eight months of this year, Shanghai imported $15.98 billion of gold, a staggering indicator of demand in China. Furthermore, last Thursday, two tonnes of gold was imported into Shanghai, indicating that gold imports into the city are not slowing down.

Weaknesses

• Gold traders have become the most bearish in three months, according to a survey from Bloomberg. The poor market sentiment is the result of the Federal Reserve lifting its median estimate for the Federal Funds rate by the end of 2015.
• Despite historically being the best month for gold, September has shown nothing but declining gold prices. The typical increase in demand from India due to the festival season appears to be overshadowed by the extraordinary strength of the U.S. dollar and its negative effect on gold prices.
• The ratio between gold prices and global equities, as measured by the MSCI ACWI, has declined to its lowest level since September 2008. The low point is due to the unusual headwinds for gold as of late and the continued strength of equities. It will be interesting to see if the strength in equities continues in the near future.

Opportunities

• Despite overall market sentiment favoring equities, George Soros has decided to bet on gold. Soros increased his bearish position in equities by 605 percent last quarter. The world famous investor did double down his position on gold mining ETFs, while also adding many gold companies.

• Klondex Mines remains significantly undervalued relative to its peers. Despite its higher profit margins and similar revenue production, the company’s enterprise value is much lower than that of its peers. This undervaluation creates a significant opportunity for those seeking to take advantage of cheap and high-quality gold companies. In addition to the company’s superior margins, Klondex recently identified a third mineralized structure at its Fire Creek mine, with grades exceeding one ounce per tonne.  A new resource estimate for Fire Creek will certainly add to the company’s resource base at year end. The success of Klondex has been noticed by some, as it is to be officially included in the S&P/TSX SmallCap Index, which will serve to boost demand for the stock.

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• Teranga Gold reported that the first ore obtained from Masato confirms high-grade mineralization, a sign of the project’s increasing profitability. Furthermore, insiders at Teranga Gold, including the company’s chairman, recently purchased more than 600,000 shares. Insider buying typically foreshadows an expected increase in stock prices.  Teranga was also added to the Market Vectors Junior Gold Miners Index as of close on Friday.

Threats

• The recent record performance of the S&P 500 is painting an incomplete picture of current market conditions. Roughly 47 percent and 40 percent of stocks in the Nasdaq Composite (CCMP) Index and the Russell 2000 Index, respectively, are experiencing a bear market. The divergence between large-cap and small-cap stocks points out significant threats in the market, painting a much darker picture for future performance.
• Deutsche Bank notes that, due to the recent poor performance of gold, households in India will begin to move toward financial investments and away from physical investments. The bank sees the attractiveness of financial savings through bank deposits, mutual funds and insurance increasing in the future.
• Higher bond yields and the continued strength of the dollar, continue to create headwinds for gold. Although the dollar is in store for a reversal soon, higher yields could persist as investors continue to consider the coming rate rises.

Energy and Natural Resources Market

Strengths

• Railroad stocks continue to impress despite declining global growth and weak commodity prices. Even more impressive is that rail stocks have increased by a whopping 630 percent since 2003, a much larger increase than the 120-percent gain by the S&P 500 Index. Union Pacific rose 2.20 percent this week.

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• Chemical stocks outperformed this week as natural gas prices continue to decline. Westlake Chemical was up 2.21 percent on the week.
• Oil and gas refining stocks weathered the storm caused by talk of the U.S. permitting oil exports. The S&P Supercomposite Oil & Gas Refining and Marketing Index was up 1.65 percent this week. Marathon Petroleum rallied 2.05 percent this week.

Weaknesses

• Gold stocks continue to be depressed as the dollar remains strong. Furthermore, lower-than-expected consumer price index (CPI) data out of the United States this week contributed to the headwinds gold is currently facing. The NYSE Gold Miners Index fell 5.46 percent this week, its third-straight weekly decline.
• Continuing their downward trend, oil and gas drilling stocks suffered this week on the back of weak global growth and a stronger dollar. The S&P Supercomposite Oil and Gas Drilling Index declined 2.75 percent this week.
• Base metals, particularly copper, continue to be depressed as weak industrial output data was released this week by China. Year-over-year industrial production in August came in at a disappointing 6.9 percent, compared to 9.0 percent in the prior month.

Opportunities

• Weather forecasters are predicting below-average temperatures throughout the U.S. this winter. Lower-than-expected temperatures could eat up much of the stored gas supply.
• India’s Deputy Trade Minister Bayu Krisnamurthi said that Indonesia is considering a request from China to remove a duty on palm oil exports. Reducing the trade barriers should be positive for domestic producers.

Threats

• A survey from Bloomberg shows that gold traders are the most bearish in three months. The results counted six bullish traders and 13 bearish traders. The negative outlook comes from the Federal Reserve lifting its rate forecast this week.
• Copper traders continue to be bearish for a third week now. Concerns are mounting over weaker demand from China, which is the largest industrial metal consumer.
• The dollar continues to rise, placing pressure on commodity prices. While there is no sign of an immediate turnaround in the strength of the dollar, a correction is well over due.

Emerging Markets

Strengths

• As a response to weaker foreign direct investment and industrial production data, China has provided $81.4 billion of liquidity to the country’s five biggest banks. Chinese markets rallied on the move, which signaled the country’s willingness to take necessary steps in maintaining its desired level of growth.
• Indian stocks gained for the sixth-straight week, making this the longest weekly rally since 2012. On Thursday, Chinese President Xi Jinping said China will invest $20 billion in India over five years. Similarly, Japanese Prime Minister Shinzo Abe has offered $460 million in infrastructure loans to India, as well as other investment and financing over the next five years.
• Alibaba Group, the Chinese e-commerce giant, started trading on Friday after raising $21.8 billion in its initial public offering. This makes Alibaba the largest public company offering in U.S. history. The stock closed up 38.07 percent at $93.89, giving a huge boost to market sentiment.

Weaknesses

• The Russian ruble and the Micex Index continue to take blows for many reasons. First and most obvious are the further economic sanctions that were placed on Russia over increasing geopolitical tensions. Second, weak Brent prices continue to detract from Russia’s oil revenue, a significant part of the government’s budget. Third, 10-year yields rose on government bonds remaining at unacceptably high levels, strangling the financing abilities of many Russian companies. Finally, Russia risks losing half of its wealth fund, the National Wellbeing Fund, in order to help finance many of its sanctioned companies.
• Brazilian equities continue to be volatile amid election speculations. Furthermore, Brazil, which officially went into recession last quarter, may have to raise rates in order to combat rising consumer prices that are weighing down the economy.

• Turkish stocks were hit this week after the Federal Reserve increased its median estimate for where the Federal Funds rate will be at the end of next year. Very sensitive to capital outflows, Turkey is concerned that sooner- or higher-than-expected rate increases by the U.S. may lead to unwanted rate increases domestically. The Borsa Istanbul 100 Index sold off 1.16 percent this week.

Opportunities

• Indonesia’s new government announced this week that it is aware of the problems impeding foreign investment. The government singled out its current ban on ore exports as a problem, implying that it may adjust the policy to boost inflows. Lifting the obstructive ban would be a positive move for Indonesia as a whole.
• With the weak data out of China this week, in addition to last week’s sluggish growth in M2 money supply, it appears that Chinese monetary stimulus will be at the forefront of economic policy moving forward. The stimulus measures enacted have already served to boost surrounding Asian economies. Thus, future stimulus measures should be positive for the region as a whole.

Threats

• According to an official at the Ministry of Development, Turkey may cut its economic growth targets for 2014 and 2015. The government attributes the revision to rising geopolitical risk from Iraq and Syria as well as the possibility of future rate increases to combat rising inflation.
• In an effort to increase the fiscal budget, the incoming government in Indonesia plans to reduce fuel subsidies by another 1,500 rupiah by the end of 2014. Higher oil prices would serve as a headwind for most Indonesian companies.
• The Greek finance ministry reported that pledges made by Alexis Tsipras, the leader of the main opposition Syriza party, will increase the budget deficit by 9 percent of GDP. The current fiscal situation has a budget surplus of 1.5 percent of GDP. Moving back into a deficit would reignite many of the pressures that plagued the Greek economy in the recent past, prompting capital outflows and financial instability.

Leaders and Laggards

The tables show the weekly, monthly and quarterly performance statistics of major equity and commodity market benchmarks of our family of funds.