Update 6/20/14

The Federal Reserve won’t raise interest rates until 2015:

Federal Reserve Chairwoman Janet Yellen said this week that growth is bouncing back and the labor market is improving as it continued to reduce the pace of its monthly asset purchases.  In the post-meeting statement, the Fed said that economic activity rebounded since officials last met in April. Labor market indicators generally showed further improvement.  Household spending appears to be rising moderately and business fixed investment resumed its advance. While inflation has been running below the committee’s longer-run objective, longer-term inflation expectations have remained stable,” the statement said.

As expected, the central bank trimmed its bond buying program for the fifth consecutive meeting, keeping on track to wind down the program by the fall. The Fed cut the pace of monthly purchases by an additional $10 billion to $35 billion (i.e., $20 billion in Treasuries and $15 billion in mortgage-backed securities) and repeated that it is likely to “reduce the pace of asset purchases in further measured steps at future meetings.” The Fed also maintained its forward guidance on interest rates, once again stating that it’s likely to keep the benchmark Federal Funds Rate near zero for a “considerable time” after the bond purchases end and saying that it will consider a “wide range of information” in deciding when to raise rates.  In their updated economic and interest rate projections, Fed officials slashed their growth forecast for this year while expressing confidence that the recovery was largely on track and would allow it to begin raising rates in 2015. Fed officials cut their 2014 GDP forecast to 2.1% – 2.3% from their prior forecast of 2.9%, reflecting the impact of the harsh winter which caused the economy to contract 1% in the first quarter.

On the interest rate front, Fed officials still foresaw small rate hikes beginning next year. Fed policymakers lifted their interest rate forecasts for the next two years, predicting that the federal funds rate will be 1.13% by the end of 2015 and 2.50% by the end of 2016, up from their prior median forecasts of 1.00% and 2.25%. Fed members also lowered their projections for long-term interest rates, a potential sign of reduced confidence in the economy’s long-run potential. The median projection was for a long-term federal funds rate of around 3.75%, compared to around 4% in March.  U.S. interest rates are likely to remain steady during the remainder of the year in the aftermath of Yellen’s statements and the Federal Reserve’s reduced GDP forecast.  This sets the U.S. Economy on stable ground with the Federal Reserve keeping interest rates down for the remainder of the year.  This should help boost mortgage applications and real estate sales.  Business spending is picking up and mergers & acquisitions activity has been very strong.

U.S. Corporations share buybacks continue to increase:

Total share buybacks for the companies in the S&P 500 grew by 50% in Q1 to $154.2 billion, and amounted to the third largest quarterly total since 2005. The biggest contributor to the Q1 total was Apple’s record $18.6 billion in repurchases, but IBM also had an uncharacteristically active quarter with $8.3 billion in buybacks. In addition, five of the top ten companies by dollar-value buybacks in Q1 are traditionally not big spenders, and each spent more money on buybacks in Q1 than in any quarter in at least ten years. These companies included FedEx, Boeing, Abbott Laboratories, Corning, and eBay.  During the Q1 earnings call, Apple raised its share repurchase authorization from $60 billion (of which $14 billion remained) to $90 billion. This works out to $6.3 billion per quarter if Apple completes the program by its December 2015 time frame. IBM is also expected to reduce its per-quarter spending. CFO Martin Schroeter admitted that share repurchases were front-end loaded, and that full year spending on buybacks would be slightly less than 2013 ($14.0 billion). This would suggest quarterly spending will be less than $2 billion through the remainder of 2014.  Finally, IBM isn’t the only big spender that is expected to slow its pace of buybacks in 2014 relative to 2013. Of the top ten companies from 2013, Apple is the only stock that has picked up activity from the pace in 2013. General Electric disclosed that discretionary buybacks would be reduced, and Exxon Mobil, AT&T, Oracle, and Wal-Mart’s activity in Q1 was less than the average spending throughout 2013.  Obviously the historic increase in share repurchases cannot grow at the same percentage much longer, but the fact still remains that a record amount of money is being invested in U.S. equities each quarter which reduces the number of shares and increases EPS which should be a catalyst for stock prices for the next few years.

M&A:

Medtronic announced this week its plans to acquire global healthcare products company Covidien.   Through what is known as a tax inversion, Medtronic will shift their home tax base from Minnesota to Covidien’s base of Ireland.  This has become a popular topic of controversy as other U.S. multinational companies such as Apple and Pfizer have booked profits overseas to avoid repatriation of foreign earned income.  By doing so they have managed to avoid subjecting their income to U.S. corporate tax rates which are one of the highest among developed nations.   President Obama has thus far rejected a proposal from Republicans for a corporate tax repatriation holiday which would allow the companies to expose the profits to temporarily lower U.S. corporate tax rates.   It is estimated that over roughly 300 U.S. companies have a total of $1.95 trillion in accumulated profits held overseas.

Oil and Gold prices rise on the news of turmoil in Iraq:

The recent turmoil in Iraq has led to an increase in oil prices that has impacted the prices at the pump.  Concerns over the supply of oil resulted in nationwide wholesale gas prices rising by 5 percent over the last week.  Rising gas prices could reduce consumer household spending in an already struggling economic recovery.  This comes at a time when gas prices usually decline between Memorial Day and Fourth of July holiday.  The Obama Administration announced today that 300 Special Operations forces will be sent to Iraq as advisers to help the government forces.  We do not think this poses any major risk to the U.S. or global economy but it is a big risk for the 300 men and women that will be risking their lives in a very dangerous mission to stabilize Iraq.  It seems to be a no win situation in Iraq and our policy may be to control the damage that might come if left to unravel which could help the radical groups and Al-Qaeda grow into a real Army. 

 

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