Northwestern Mutual

Financial Markets Commentary For the week of Oct. 17, 2016

The three major stock indexes fell for the second week in a row as investors were kept off balance by some mixed third-quarter earnings news and some purely contentious politics.

But while the elections will be behind us in less than a month, the question of when the Federal Reserve will raise its benchmark rate is not likely to be decided until the mid-December meeting, which could lead to another two months of investor uncertainty about both stocks and the yields on Treasurys, which rose once again last week.

Stocks began the week on a strong note as crude oil hit its highest point since July 2015 after Russia’s President Vladimir Putin said he’d support the Organization of the Petroleum Exporting Countries recently announced production cuts. In addition, Apple’s stock soared in the wake of Samsung’s Galaxy 7 woes, and Mylan’s shares surged after it reached a settlement with the government for overcharging for its EpiPen. On Tuesday, Alcoa and Illumina kicked off the earnings season with weak reports – the former’s stock dipped 11.4% and the latter’s 24.8% – and the Dow Jones Industrial Average shed 200 points. The market fell again on Thursday when China reported that its exports had tumbled 10% (in dollar terms) in September from a year earlier, the biggest drop since February. Stocks rebounded slightly at week’s end after JPMorgan Chase and Citibank announced better-than-expected earnings, but it wasn’t enough to pull the major indexes out of the red for the week.

The Fed

The Fed released the minutes for its September meeting last week and they indicated that the committee was ready to raise its rate “relatively soon” as long as economic developments unfolded as the committee expected. However, some members were concerned that the statement might be misinterpreted to mean the passage of time, rather than the accumulation of evidence, would be the key factor, and noted that inflation was still below the Fed’s target of 2%. Nonetheless, the minutes also stated that “a reasonable argument could be made for an increase at this meeting,” and that the decision to leave the rate unchanged was a “close call” despite the 7-3 vote. Though the Fed meets next on Nov. 1 and 2, it isn’t expected to act that close to Election Day, and Patrick Harker, president of the Federal Reserve Bank of Philadelphia (a non-voting committee member) said last week, “It may be prudent to wait until we have resolved some of that uncertainty.” As for the meeting on Dec. 13 and 14, which will be followed by a press conference with Chairwoman Janet Yellen, Eric Rosengren, president of the Federal Reserve Bank of Boston (and a voting member), told CNBC on Friday that the market’s anticipation of a hike at that session “seems quite appropriate.”

The deficit

The federal deficit for the fiscal year that ended on Sept. 30 was $587 billion, as predicted by the government because of the renewal of tax breaks in December, but nonetheless the first increase after six straight decreases; the deficit for the previous fiscal year was $438 billion. Furthermore, the latest deficit added up to 3.2% of gross domestic product compared to 2.5% the year before. Because of the aging American population, the costs of Medicare and Social Security are expected to continue to drive up the deficit for years to come.

Puerto Rico

Striking an ominous note, Puerto Rico’s Governor Alejandro García Padilla told the new oversight board created to manage the island’s $74 billion debt that, even if creditors agreed to reduce debt payments, Puerto Rico will “still need the assistance of the federal government to bring this economic and humanitarian crisis to an end.”

The Brexit

The precipitous dip in the pound against the dollar is seen as having buffered the impact of the Brexit by increasing Britain’s lower-priced exports to partially offset reduced consumer spending at home. Even so, the International Monetary Fund reported that Great Britain had dropped behind France and was now the world’s sixth largest economy because of the Brexit. And on Thursday, following up on remarks she made in the wake of the Brexit vote, Scotland’s First Minister Nicola Sturgeon said, “I am determined that Scotland will have the ability to reconsider the question of independence, and to do so before the U.K. leaves the EU, if that is necessary to protect our country’s interests."

Retail sales rebound

Retail sales beat expectations, rising 0.6% in September from August, and were up 2.7% from a year earlier. In other economic news, and in another sign of the impact of the upcoming election, the University of Michigan’s Consumer Confidence Index fell to a 13-month low of 87.9 in October. The National Federation of Independent Business Optimism Index dipped 0.3 points in September from the month before to 94.1. The number of job openings decreased to 5.4 million on the last business day of August, the government reported, while hires and separations were little changed at 5.2 million and 5.0 million, respectively. The Producer Price Index (PPI) was up 0.3% in September from August and rose 0.7% from a year earlier; core PPI, less food and energy, increased 0.2% from the month before and climbed 1.2% over the past 12 months. Business inventories were up 0.2% in August from July. For the week ending Oct. 8, first-time jobless claims were unchanged at 246,000, the four-week moving average for the week ending Oct. 1 fell 3,500 to 249,250, its lowest level since 1973. Lastly, giving in to the withering criticism that has come his way, John Stumpf stepped down as the chief executive officer of Wells Fargo, which has been embroiled in a controversy over phantom customer accounts being created on his watch.

A look ahead

This week’s releases will include the latest on industrial production and capacity utilization, the Consumer Price Index, housing starts, building permits, existing home sales and the Fed’s Beige Book report, as well as more third-quarter earnings news.