AN ECONOMIC UPDATE

Last week’s big news for the financial markets came in the form of the employment report on Friday.

The unemployment rate unexpectedly dipped down from 4.6% to 4.4%. Job growth for October was reported at just 92,000, but the job numbers for the prior two months were revised upward substantially. In spite of the fact that the employment numbers have been notoriously unreliable and subject to frequent revision lately, when you look at the overall employment picture over the past year, it is clear that new jobs are being created and the unemployment rate has been dropping.

It would be natural to suppose that the financial markets would have reacted positively to the good news.

But, as with a lot of things in the markets, the connection is not quite that simple, direct or intuitive. The bond market is intensely concerned about whether inflation is peaking or just beginning its climb. Bond, stock and real estate investors have all pinned their hopes on the idea that the Federal Reserve will start cutting short term interest rates next spring to avert recession. But with employment going strong, that hope is dancing further and further out of reach. You may remember that a strong employment report in March 2004 set the stage for the 17 consecutive rate hikes we saw over the following 2 1/2 years.

Large-company stocks, represented by the S&P 500, fell 0.95% for the week.
The technology and small-cap oriented NASDAQ fell 0.84%, while non-US stocks fell 0.62% in US dollar terms. Treasury notes and mortgage-backed securities fell by more than 0.25% in price. Real estate investment trusts, an asset class widely believed to be overvalued in the first place, fell by 3% for the week.

The coming week has a relatively light calendar of economic releases, so the news will likely revolve around politics: the election and its aftermath.

However, it’s not clear that the election will have much impact on the markets either way. The conventional wisdom used to be that the financial markets prefer Republicans in power rather than Democrats, since Republicans are perceived as more pro-business. However, the waters have been muddied in recent years. The markets also seem to follow Thomas Jefferson’s adage, "That government is best which governs least." Through most of the 1990’s, we had divided government, with the Presidency held by one party and one or both houses of Congress held by the other. That led to political gridlock, and the markets and the economy thrived under a government that had its hands tied most of the time. The markets’ response to any of the more likely election outcomes this week will probably be muted, as the net impact, to the extent that it can be anticipated, has already been taken into account in securities prices.

Courtesy of Richard M. Crouse, Capital Markets and Louis Rose, ELB Mortgage Brokers