Fool on the Hill
Which came first, the chicken or the egg? Does the market watch the Fed or is the Fed watching the market? Just looking at the comments from St. Louis Fed President Bullard on Oct. 9th he said that the Fed “should be willing to remove some accommodation.” On the 16th, after the Dow lost 1000 points (nearly 6%) he said “A logical policy response at this juncture is to delay the end of QE.” The Dow rallied 400 points thereafter. The economic data and earnings seem to be still supportive of modest growth. The worries of the markets center on global economic growth and fears of actual price declines or deflation. Tuesday, China releases their third quarter growth estimates, which is estimated around 7.2%. While the US would kill for that growth rate, China has been seeing slow and steady declines in their economic growth rates for the past two years. Earnings season is in full swing, so investors will have plenty to look at and analyze. Fed officials will be noticeably absent from the news threads next week, so the markets will be without the Fed dose of happy pills. The focus will likely be on China this week. The good news is that October is nearly over as are the election ads!
The tone of Wall Street has changed rather quickly in one week as it transitioned from the world is coming completely unglued to happy days are here again. What made the week interesting is though the averages were lower, more stocks rose on the week than fell. This was also the case mid-week, as small cap stocks had a dramatic turn higher. So now the question is: are we done? After a hair less than a 10% “normal” correction, the SP500 is poised to regain at least half of the decline over the coming weeks. What remains an open question will be whether stocks roll over and retest the lows of this week. What we described last week, a momentum bottom, followed by a rally and then a price bottom is the likely script here. This week should suffice as the momentum bottom. Given the decline was roughly two months in the making, the rally should last 3-5 weeks. While it is called a price low, it does not necessarily mean that prices decline below their momentum bottom. As a ball bounces, the initial decline has much more force than the second following the initial bounce. It is after that second bottom that we should be able to assess which sectors should be the new winners as we enter 2015.
As stocks rallied on the “Bullard bounce”, bond prices declined and yields rose. The signal from Bullard was that the Fed would be slow in changing monetary policy, once again hiding behind being “data dependant”. This meant that it would be OK to buy stocks and eschew bonds. An interesting scenario is that interest rates remain extremely low for the remainder of the decade. Debt continues to be an overhang and wage growth anemic. Economic growth is declining around the world and monetary policy initiatives over the past five years have done little to spur self-sustaining growth. The patient has built a resistance to the medicine. If/when/until debt is once again a much smaller portion of global economies, interest rates need to stay low for governments to pay the interest on the huge pile of debt they have built.
It should come as little surprise that utilities were among the best hiding places last week, but industrials and basic material sectors actually rose by more than 1% on the week. However, the two more cyclical sectors were among the hardest hit parts of the market coming into the week, so some investors were willing to bargain hunt at prices that had been marked down 10-15%. Energy has been the standout loser this quarter, falling over 15%. As oil prices declined by 20%, stocks dealing in oil also fell. Among the broader asset classes, as mentioned above, small cap stocks surged late in the week after falling nearly 15% this quarter as well. Investors may be tempted to buy some of the depressed parts of the markets, but we’ll wait a bit to see the dust settle before making a long-term commitment. For now, a little extra cash and some exposure to bonds will keep the portfolio much less volatile than the overall markets.
The snap back rally on the heels of Fed governor Bullard’s comments may carry a bit longer, but worries over economic slowing should once again move front and center in the weeks ahead. Large daily swings in the markets are likely to remain for much of the next two weeks, before investors make peace with current conditions. It is too early to be aggressively buying, but we’ll be watching the rotation in the various sectors to see what parts look best for the long-term. Bond investors may see some price declines in the weeks ahead, but it shouldn’t erase a very good year for fixed-income.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.