In Japan We Trust

Earnings, Policy Drives Markets Higher

Equity markets continued to climb higher last week, propelled by good corporate results and a deal in Congress to suspend the debt ceiling. The S&P 500 rose 2.1% while the Dow Jones Industrial Average gained 2.2%. Both markets are trading at five-year highs following seven consecutive days of gains.

On Wednesday, the House of Representatives passed a resolution suspending the debt ceiling until May 19, avoiding a potential repeat of August 2011’s showdown. The measure technically does not

raise the limit, but rather suspends it. The bill does require the Senate to approve a budget by mid-April. Failure to do so will result in the suspension of lawmakers’ pay.

The Senate is scheduled to vote on the resolution next week, with Senate Majority Leader Harry Reid announcing that his party would support the bill without amendments. The White House has also stated it would not stand in the way of the deal. The Treasury Department has already technically breached the debt ceiling limit, although a series of short-term measures have allowed the government to continue paying its bills until mid-February.

The apparent agreement is a sharp departure from recent negotiations, in which lawmakers have refused to compromise until the eleventh hour (and sometimes later). Some see the move as a capitulation by House Republicans, but the measure no doubt sets up expectations for more spending concessions from Democrats in the late-February sequester discussions.

On the corporate front, fourth quarter earnings reports suggest a sector on the mend following a disappointing third quarter. Through Friday, 69% of companies have reported earnings above their mean estimates, and 64% have reported revenues above estimates, according to data from FactSet. Last quarter, the revenue beat rate sank into the 40% range, substantially below long-term averages.

The aggregate growth rate thus far, with about a quarter of companies in the S&P 500 reporting, is 2.3%. This is an improvement from the prior quarter when earnings growth fell to virtually zero, the lowest in three years. Financials and materials companies are propelling that growth, with companies such as Goldman Sachs and Morgan Stanley posting large upside surprises.

Apple reported earnings per share of $13.81 last week, above consensus estimates of EPS of $13.48. Revenues, however, came in below expectations, sparking concerns that the company’s run of dominance is tapering off. The stock sold off more than 15% last week, the bulk of that occurring Thursday and Friday following Apple’s afterhours report on Wednesday.

In a limited week of economic data, there were a few notable reports.

On Tuesday, the National Association of Realtors (NAR) reported that existing home sales declined 1.0% in December from one month prior. However, December’s figure was 12.8% higher than year-ago levels, and 2012 experienced the most aggregate home sales in five years.

Lawrence Yun, NAR’s Chief Economist, noted that tight inventory levels and tighter credit standards from lenders were impacting sales. The current 4.4 months of supply is the lowest since May 2005 – near the peak of the last housing market. Mr. Yun noted that buyers “started entering the market early last year as their financial ability and confidence steadily grew, along with home prices. Likely job creation and household formation will continue to fuel that growth. Both sales and prices will again be higher in 2013."

On Thursday, the Labor Department reported that initial jobless claims remained subdued, clocking in at 330,000. This was somewhat surprising following last week’s sub-340K reading. While a volatile series, the weekly jobless claim series has plummeted since mid November when it temporarily spiked above 400,000. The four-week moving average is down to 351,000, the lowest level of the economic recovery.

Finally, the Census Bureau reported new home sales slipped to 369,000 in December. This followed a surprising upward revision in November of 22,000 to 398,000. That marks the highest rate of sales since the stimulus-fueled jump in 2010.

Sales prices advanced in December, increasing 1.3% during the month to $248,900. According to Econoday, this is the highest median price in more than five years.

In Japan We Trust

In fewer than 60 days, one country has made a splash larger than all the others. No, we are not referring to the US, where Barack Obama was re-elected to a second term. Nor are we referring to China’s recent transition of power. Instead, the country we reference is Japan. After decades of malaise, Japanese officials moved to embrace policies previously only accepted by Western officials.

On December 16, the Liberal Democratic Party (LDP) won control of the lower house of parliament in Japan. Only three short years prior, the LDP was voted out of office following a multi-decade rule. As a result of December’s election, Shinzo Abe returned to power as Prime Minister of Japan. Mr. Abe has been a loud-spoken advocate of aggressive stimulus and easing to jumpstart his nation’s economy.

After receiving pressure from the new political leadership, the Bank of Japan (BoJ) decided to pursue a course navigated by Western central banks. The BoJ announced last week a 2% inflation target, up from 1%, and stated the central bank will begin an “open-ended” asset purchase program in 2014.

The announcements were clearly perceived as a dramatic shift by markets, but last month’s elections foreshadowed a more aggressive Japan. Beginning in mid-December, the Japanese yen began trading lower against most of its major trading partners. In the last three months, the yen is down anywhere from 11% to 16% against major currencies such as the euro, US dollar, and British sterling.

Source: Financial Times

Investors felt the obvious beneficiary of such policies would be stocks, as Japan’s Nikkei index is up more than 21% in the same time.

During the World Economic Forum in Davos, Switzerland, Japan’s economic minister assured other central bankers that currency devaluation was not a central policy goal. Currency traders clearly beg to differ.

Despite the recent changes, Japan continues to face a steep uphill battle. Japan’s debt-to-GDP ratio is in excess of 220%, well beyond levels in countries such as Greece, Portugal, or the US. Japan can shoulder this massive burden due to its demographics: nearly one quarter of the Japanese population is over the age of 65 and those investors have long supported the government. Domestic investors own 95% of Japanese debt. Unfortunately, this demographic profile also makes it very difficult for Japan to grow its way out of the problem.

Government Debt/GDP

Source: The Economist

Japan has long been the bane of many international investors’ existence, offering false hope time and again. It finally seems that Japanese officials are serious about reviving their stagnant economy, but it will force them to lurch further into previously unseen debt territory. The long-term implications are a scary unknown at the moment.

the week ahead

Economic data picks up next week with a spate of reports, highlighted by the first estimate of fourth quarter GDP and January nonfarm payrolls. The slate also includes durable goods, the Case-Shiller Home Price index, personal spending, and the ISM Manufacturing index.

Corporate results continue to come in, with more notable results expected from Caterpillar, Monsanto,, Eli Lilly, Ford Motor, Pfizer, T. Rowe Price, Tyco International, US Steel, Yahoo!, Boeing, ConocoPhillips, Facebook, Colgate-Palmolive, Dow Chemical, MasterCard, ExxonMobil, Merck & Co, and Chevron. A number of foreign companies are also scheduled to report.

The Federal Open Market Committee (FOMC) meets this week to determine monetary policy. Little changes are expected. Other central banks meeting this week include Colombia, Israel, India, Hungary, New Zealand, Egypt, Malaysia, and Russia. Hungary, India, and Colombia are expected to ease.

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