Market Continues Its Recent Advance Ahead of the Fed Tapering Decision

After putting in its worst monthly performance since May 2012 in August, the market last week continued to make amends by advancing for the second straight week in September, and in the process the S&P has now gained 3.4 percent so far this month after losing 3.1 percent last month.

The real hero last week was the Dow Jones Industrials, which rose by 3 percent, its second-best weekly showing this year and the best since the first week of the year in early January. It might have been helped by the announcement that its three lowest-price members are going to be removed at the end of this week and be replaced by three higher-priced stocks that are perhaps more reflective of the current economy.

The three that are going to be shown the door are AA, BAC and HPQ, all of which are trading at fractions of where they were before the financial crisis five years ago, despite the fact that the latter two are actually the two best Dow performers this year, having improved from extremely low levels last year. AA remains the worst Dow performer this year and the only one stuck in single-digits.

Two of the three new members are trading in triple-digits and since the Dow is a price-weighted index, their movements will have more of an impact on the average than the three that are being removed. New members GS and V will now compete with IBM for the honor of being the most influential stocks in this venerable index because of their price levels, almost the same as Big Blue; and the third new member, NKE, has been one of the fastest-growing consumer stocks over the past several years.

Another factor responsible for the solid upward market move this past week has been a defusing of the Syrian crisis that had caused stocks to sell off in late August. It was apparent that the president did not have the support of either Congress or the American public for further military ventures in the Middle East. In his speech last Tuesday night, he pledged to explore a diplomatic plan from Russia to take away Syria’s chemical weapons, but voiced skepticism about it and urged the public to support his threat to use military force if needed. But facing the reality of the opposition to the use of force against Syria, he said that the Russian offer to pressure the Assad government to place its chemical weapons under international control raised the chances of putting off the limited military strike that he was considering. Therefore, he asked Congress to put off a vote on his request to authorize the use of force in order to let diplomacy play out.

And sure enough, over the weekend the U.S. and Russia reached an agreement that called for Syria’s arsenal of chemical weapons to be removed or destroyed by the middle of 2014, and thus indefinitely stalled the potential for an American airstrike. Although the agreement specifically includes the U.N. Security Council for the first time in deciding potential international military action against Syria, Russia has still maintained its opposition to any military action against its client state, to which it is the largest arms supplier.

This calming of the Syrian situation for the time being and the upcoming announcement from the Federal Reserve this Wednesday about the start of its scaling back of the current $85 billion a month of bond purchases will now become the items that will have the greatest influence on stock prices. The bond market obviously believes that some sort of tapering is in the offing, as the 10-year Treasury yield has already risen from 1.6 percent in May to its current level of just under 3 percent, and this is certainly much more of a gain than has been the pace of economic improvement.

But there is good evidence for some tapering to begin, as since the Fed began buying $45 billion of Treasuries and $40 billion of mortgage securities every month, the unemployment rate has declined from 8.1 percent to its current level of 7.3 percent and 2.2 million jobs have been created. This progress toward the Fed’s ultimate objective of a 6.5 percent unemployment rate most likely means that the central bank will not want to inflate any further, and therefore a tapering in the order of $10 to $15 billion a month is now widely anticipated by investors. Any reduction by larger amounts would probably be construed as negative for stocks and no tapering at all would most likely send stocks moving further to the upside.

Stocks have probably been moving higher as economic growth has been moderate enough to not warrant a greater tapering, as for instance this past week it was reported that August retail sales rose by only 0.2 percent, the fifth consecutive month of gains but also the slowest rate of increase in four months, the preliminary September U. of Michigan Consumer Sentiment Survey declined to its lowest level since April, and weekly jobless claims fell to their lowest level since April 2006.

One stock that has gone contrary to the rest of the generally upward move of the market lately has been none other than the most highly capitalized company of all, namely AAPL. It is a historical fact that whenever they introduce a new product, like they did last week, the stock tends to decline, but last week’s 6.7 percent plunge seemed excessive. It would now seem that the only thing that is going to cause another upside turnaround is if the company can announce a deal with China Mobile Ltd., which has a customer base more than twice the size of the U.S. population at 700 million subscribers. So far the new 5S and 5C iPhone models are being released for the networks of China Unicom, based in Hong Kong and China Telecom Corp. These are the second- and third-largest carriers in that country, but both are dwarfed by China Mobile. As far as the new phones themselves are concerned, the rap against them is that they are lacking in new features and low enough prices to attract a large enough population of first-time users. This is despite the fact that the billionaire activist investor has declared that the stock is “extremely undervalued” and a “no-brainer” at current price levels.


 

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.
If you have any questions, contact dselkin@nationalsecurities.com.