All Quiet on the Washington Front

Posted on October 2, 2013 by David Laidlaw

For the first two and one-half months of the quarter, the financial markets had been focused on whether or not the Federal Reserve would reduce its bond-purchasing program. On September 18th, the Fed decided not to taper its purchases since it concluded the underlying economy was too weak to remove the stimulus.

This news was greeted enthusiastically by both the equity and fixed-income markets. Interest rates declined and the stock market rallied with the expectation of continued monetary stimulus. Over the last week or so, this enthusiasm waned and the market began to sell-off in anticipation of another fiscal crisis orchestrated by our dysfunctional politics.

As of this writing, Congress suspended many governmental activities by refusing to fund its operations through the Continuing Resolution. Since 2010, these battles over spending and the scope of the government appear to be fought as trench warfare. One side may advance a few yards; however, nothing is definitively resolved and the casualties are high.

Outside of the Beltway, the economy is growing, but at an anemic pace. The economy grew at an annualized pace of 2.5% during the second quarter and is expected to have slowed over the summer. Similarly, housing activity has also trailed off as higher interest rates have decreased demand from prospective buyers. The economy is creating jobs, but not quickly enough to reduce unemployment.

After the slight pullback in equity prices over the past couple of weeks, the S&P 500 is still up over 19% year-to-date. These gains follow last year’s rally of 16% even though revenue and earnings growth has been far less impressive over this period. The S&P 500 now trades for 16.3 times what it earned over the last year. At this same point in time last year, the index traded for 14.5 times prior year earnings. We believe there are still pockets of reasonably valued companies with strong prospects, but this universe is getting smaller as stock prices have risen.