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End of the Quarter: Steady As We Go

The Week Ahead: the market is twitchy with bad bank stories. But the broader economy is about to bounce.

Your commentator was out for a couple of weeks (although checking markets daily). It seemed busy but in the final month of the quarter, U.S. stocks moved less than 0.01%, Treasuries traded in a near 15bp band and ended at 1.6%. Europe had another tough month. Japan led the Asian markets with a 2% return, which had everything to do with the Bank of Japan (BofJ) buying domestic stock ETFs and nothing to do with real progress.

It all seems busy. Central banks met, created some chatter, headline politics bounced around and two global leading banks made an idiot of themselves. Oh, and OPEC met and came to a deal for the first time since 2014. But market reaction was quiet. Here are a few things that caught our eye.


1.Central Banks: The Fed met, held rates but made hawkish noises. Three Governors dissented. A split Fed is never a good thing…markets would rather see unanimity. But the Committee changes in 2017 and becomes substantially more dovish. It’s likely we’ll see a return to consensus. Mind you, we have a tough time seeing any conditions that warrant a rate rise. On Friday, we saw Personal Consumption Expenditures (PCE). This is what they look like: The PCE is the number the Fed targets at 2%. Over on the right the latest number is just under 1% and the core (so strip out food and energy) at 1.7%. Earlier in the week we saw some better numbers on consumer confidence but these have yet to transfer into higher consumption. So a mixed bag.

In other central bank news, the BofJ proved that no, they are not out of ammo. In an extraordinary move, they announced they would target the 10-Year yield on government bonds. This is a big deal because Central Banks cannot control long-term rates. They can set an overnight rate, which is what the Fed does with the Fed Funds rate, and they can sell bonds at specific coupons. But they cannot manage or control long-term rates. The market does that. So for the BofJ to target the 10-year rate at 0% means they have to manage every rate from overnight to 10-Years. Or the entire yield curve. It may work but the market’s initial reaction was to bid up bonds and trade up equities. So no change.

2. Oil:The spot price bounced over 10% on the back of the new OPEC agreement. Energy stocks rose by less but they’re up 36% this year. Now, there are lots of moving parts on the oil outlook. On the supply side we have producers’ revenue needs (high), debt financed companies, new flow (Iran).  On the demand side, we have higher efficiency (think Prius), substitution (think Tesla) and the general GDP impact (think slower Emerging Markets). We don't expect much movement on the oil price. For what it's worth, the consensus is $50 for the next few years. We take solace on our low conviction with the words of Exxon Chairman Rex Tillerson:

“We’ve never been any good at predicting these [price] cycles, neither when they occur nor their duration. We don’t spend a lot of time even trying.”

Meanwhile, expect a rebound in Q3 GDP partly because of this:


There was a massive plunge in drilling cap ex in the last year. The latest numbers point to a 100% (yes) increase in rig counts in Q3, which will drive up the investment component of GDP.

3.Deutsche Bank in 140 characters: Deutsche Bank has lost 90% of its value since the financial crisis and 50% this       year. It’s down to the usual suspects of bad management, inadequate capital and overreach. A government bail out was in     the wind in late Friday session. Meanwhile Twitter, which has never made money and lost its shareholders $2.2bn in five       years, kind of put itself up for sale. Google could buy both for cash and have $40bn left over. That's the great thing about      capitalism. It tells you when it’s time to fold.


Bottom Line:  Investors made good money in the third quarter. Typically some large institutions start to play safe for the rest of the year. This week has more economic data and earnings season will start up. Remember the bar from a year ago, when earnings fell 7%, is low so there will some flattering comps.


Guide to thinking about Fed Meetings

Harvard students mad at endowment guys

Hedge fund activism may not work, or it might

--Christian Thwaites, Brouwer & Janachowski, LLC

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