Let us go over what has transpired in the equity markets since the last time that this column appeared three weeks ago. At that time, stocks had undergone what turned out to be their largest downside correction of the year, with both the Dow and S&P falling 5.8% from previous record-high closes on May 21. The next day, confusing and contradictory statements and testimony from Fed Chairman Bernanke as to the timing of the tapering of the current $85 billion monthly stimulus package resulted in a market collapse after the major averages made further all-time highs in the early going. This downside reversal resulted from investor reaction to the confusion contained in the chairman’s statements, as he first said that the Fed would increase or reduce the rate of purchases depending on the outlook for the job market and inflation and then contradicted himself by adding that “the committee anticipates that it would be appropriate to moderate the pace of purchases later this year.”
Since the bottom of the correction on June 24, the markets have once again turned right around to the upside and put in their best first-half-of-the-year performance since 1998 for the S&P with a gain of 13 percent while the Dow had its best first-half start since 1999 with a 14 percent advance. On the other hand, things did cool off in the second-quarter as the bulk of the gains were achieved in the first three months of the year.
But as if to make up for lost time, the major market averages have begun the third-quarter this month with their best monthly showings since January as the Dow has now achieved 26 record-high closes this year, the S&P has reached new heights on 20 occasions, the Russell 2000 Index of small stocks has been the best performer of all and the Nasdaq has achieved levels not seen since September 2000 when it was coming off its all-time highs reached in March of that year at the height of the internet bubble frenzy.
Naturally the question becomes — what caused the renewal of the uptrend that has been in effect since the start of the year after that late May to late June hiccup as mentioned above? And the answer is that a combination of factors has once again emboldened investors to push the major averages even higher than the levels previously achieved on May 21.
The first was a dramatic development on July 4 when markets here were closed for the Independence Day holiday. On that day the E.C.B. and the Bank of England did something neither had ever done before, which was to commit themselves to keeping interest rates at record low levels indefinitely. In addition, they did not promise to start a gradual withdrawal of stimulus, as our Federal Reserve has already indicated. The E.C.B. President added that the two central banks were signaling a “downward bias” in interest rate policy, which meant that further cuts were possible or even likely.
This dramatic policy announcement from Europe was followed the next day by the U.S. June non-farm payrolls report, which showed that 195,000 jobs were added, significantly above the 165,000 official estimate and there was an upward revision to the April and May numbers as well to the tune of an additional 70,000 positions. This now meant that the average number of jobs created during the first half of the year has been 202,000.
The huge market gains on that day assured that the major averages would now end higher for the second week in a row, and this followed the market’s ability to advance during the final week of June despite having made its correction low on Monday, June 24. This type of market action is known as a “key reversal,” which means that the selling pressure exhausts itself and new buyers are able to enter at lower prices to push things above the previous week’s close, indicating a change in short-term direction, which had been lower into that week.
Just to keep the good times rolling, last week the major averages put in their second-best weekly performance of the year and their third straight week of advances, motivated to the upside as Chairman Bernanke said in a speech that “highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy” because there is low inflation and higher unemployment than what the Fed would like to see.
This statement also reversed the steady rise in interest rates from a low in May of 1.61 percent for the 10-year Treasury note to as high as 2.75 percent after the better-than-expected June jobs report as mentioned above. What was a bit disturbing about this increase in yields was that they caused the rate for a 30-year fixed mortgage to rise from a record low level of 3.3 percent in May to as high as 4.3 percent in early July and this has to be of concern because the recovery in the housing market has been one of the mainstays of the overall economic rebound over the past four years. This latest cooling off of bond yields once again pushed mortgage rates a little lower than the early month’s highs.
This past Monday saw the major averages once again push to their best-ever levels before taking a bit of a breather on Tuesday ahead of Mr. Bernanke’s semi-annual Congressional testimony to the House on Wednesday and to the Senate on Thursday and the market’s reaction to what he said will be discussed in next week’s column.
Aside from what the chairman has to say, the major focus for the next few weeks will be the second-quarter earnings reports, and expectations are for a 2.8 percent profit gain with revenue gains of 1.5 percent. This is down from an 8 percent profit projection in April and makes the market susceptible to upside surprises from lowered expectations. On the other hand, those companies that do not meet lowered expectations or that warn of slower profit or revenue growth in upcoming quarters will be punished, and we have already seen that in the shares of Dow component KO, in addition to important stocks like GS, SCHW and UPS. On the more optimistic side, banking giants C and WFC have done well after their numbers were released.
Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media.
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