Could it be, could it possibly be — the major averages actually had the nerve to reverse their almost inexorable climb higher this year after the release of the minutes of the latest F.O.M.C. meeting last Wednesday afternoon turned what had been new all-time intraday highs for most of the major averages into closing declines for the day. This not only led to dramatic intraday downside reversals, as for instance the Dow had been 155 points higher and ended with a closing decline of 80, but also to lower closes for the week. This meant that the four-week winning streak for the major averages had finally come to an end.
This little hiccup occurred in light of what had been gains of 18 percent for both the Dow and S&P in less than the first five months of 2013, which is around double the annual percentage gains that these two indexes have averaged over their history, and it was obvious that this upside pace could not continue unabated without the market taking some sort of a breather. And what finally caused this cooling off was a series of contradictory statements from various Fed officials as to the timing and extent of any pullback from the quantitative easing programs that have been largely responsible for providing the underpinning to propel the stock market to the record highs it has achieved this year.
In last week’s column, I alluded to recent comments from the presidents of the Dallas, Philadelphia and San Francisco Fed saying that these stimulus programs should be reined in sooner rather than later. On the other hand, the New York and St. Louis Fed president argued for continuing these measures as long as the jobless rate stayed below the Fed’s target of 6.5 percent and inflation remained below the 2 percent level as well, and both of these conditions currently exist.
These contradictory statements were reflected last Wednesday in Chairman Bernanke’s congressional testimony that the Federal Reserve’s monetary stimulus programs are helping the U.S. economy to recover and that the central bank still needs to see additional signs of a continuation of this recovery before taking its foot off the accelerator. His testimony offered few signs of a retreat from the current bond-buying program as he pointed out the high costs of unemployment and inflation that continue to be below the Fed targets as mentioned.
“Monetary policy is providing significant benefits,” he pointed out and cited strong consumer spending on automobiles and housing, as well as increases in household wealth. He added that “monetary policy has also helped offset incipient deflationary pressures and kept inflation from falling even further below the Fed’s longer-term objective.”
But then he commented that the central bank could decide to scale back the $85 billion in monthly bond purchases at one of its “next few meetings” if the economic recovery looked set to continue its current forward pace.
The first of these two statements had driven both the Dow and S&P toward what have now been their best-ever intraday levels at 15,542 and 1687 respectively before the latter statement pushed those averages off their highs. The selling intensified at the 2 p.m. release time of the minutes from the last Fed meeting which revealed that “[s]ome members were willing to taper bond buying as early as the next meeting on June 17–18 if economic reports show evidence of sufficiently strong and sustained growth.”
To confuse things further, the minutes revealed that “[m]ost members observed that the outlook for the labor market had shown progress” since the bond- buying program began last September, “but many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate.”
If these statements were not contradictory enough to confuse investors, the markets were also rocked by a report that China’s manufacturing contracted in May for the first time in seven months as their Purchasing Managers’ Index fell to 49.6 compared to the 50.4 reading last month and anything above 50 shows expansion while readings below 50 indicate contraction. Then the Japanese stock market, which had been ahead by over 30 percent this year, plunged by 7 percent in the largest decline since the 2011 tsunami and nuclear disaster and Japanese bond yields rose to 1 percent for the first time in a year.
Ironically adding to the downside pressure were three economic releases that came in better than expected as both April new home sales and durable goods orders rose by more than forecast and weekly jobless claims declined by more than projected, and the market initially reacted very negatively to both on the old “good news is bad news” syndrome, meaning that if the economy is continuing to show improvement, then the Fed will start to ease off its stimulus programs sooner rather than later.
Despite the end of the market’s latest four-week winning streak, the Dow has now had its longest period in history of not having declined for three days in a row, as this has lasted for 100 days. In addition, the S&P has now gone 130 sessions without a 5 percent decline, and the last one of this magnitude or greater was the 7.7 percent setback from last September 14 to November 15, and this has been the longest such streak since there were 173 days that ended on February 20, 2007.
What last week’s Fed-induced change in market sentiment means is that trading going forward is likely to get a bit more volatile than it has been as worries about the Fed reducing its stimulus programs will be in the back of investors’ minds. As a sign of this anxiety, the yield on the U.S. 10-year Treasury note rose above 2 percent to a 10-week high. The VIX, or volatility index rose by 13 percent in the past few days although it remains at historically low levels, but this may change depending on future comments and potential policy moves by the Fed.
Since its November lows, the S&P has advanced by almost 25 percent and during that time any downside corrections have been brief, with the largest being a 3.8 percent decline last month. It will now be up to the bullish contingent to keep that streak going despite all of the Fed-induced turmoil of last week.