The major averages have continued their recovery from the February 3 bottom and have done so well up until Monday of this week that the Dow Jones Industrial Average is on track to put in its best monthly showing since November, the S&P has undergone its best monthly gain since October and the Nasdaq has had its best monthly performance since September. And all of this came about after that 5.8 percent correction from the all-time S&P high that closed out 2013.
Now we hardly hear a peep about the items that ostensibly caused investors to get so bent out of shape earlier in the year, namely the slowing economic growth in China and the emerging market currency debacles in such far-flung countries as Turkey, South Africa, Argentina, Russia and the Ukraine. In fact, the S&P has now rallied by 6.1 percent since that early in the month bottom and is just about unchanged for the year.
Federal Reserve policy has certainly been a major contributor to the bounce-back in equities, as the minutes of the January meeting showed that their $85 billion a month in bond-buying stimulus would be cut back in predictable $10 billion-a-month steps unless there is some sort of major unforeseen economic surprise this year. They confirmed this with the statement that “in the absence of an appreciable change in the economic outlook, there should be a clear presumption in favor of continuing to reduce the pace of purchases by a total of $10 billion at each policy meeting.”
In addition, the Fed did not make any changes to its other main policy agenda, which is its pledge to keep interest rates low for the foreseeable future. They have promised to keep rates near zero until well after the unemployment rate, presently at 6.6 percent, declines under 6.5 percent, especially if inflation remains below their 2 percent target. The minutes of this meeting showed that they expect to change this guidance shortly considering how close the current jobless rate is to the 6.5 percent rate-hike threshold, but it also appears as if there is really not the desire to simply lower the threshold.
At the present time, the consensus thinking is that the Fed will keep rates near zero until the third quarter of next year and their biggest challenge in this regard is to adjust its forward guidance without causing a panic in the bond market.
Another factor in pushing stocks higher lately is that fund investors worldwide have been putting money back into equity-related products, as for instance $13.4 billion entered stock funds two weeks ago. This inflow was the largest in 12 weeks as investors had previously pulled $45 billion out of extremely low-yielding money market funds, the largest such withdrawal since October. This moving of money into equity funds was the third straight week of such activity.
Equity Exchange Traded Funds (ETFs) had witnessed a $36 billion withdrawal during the first five weeks of 2014, which partly explains why the market did so poorly during this time, as mentioned above. But since then there has now been a total of $18 billion put back into these instruments. This type of activity highlights investor appetite for riskier assets amid confidence that stock markets around the world could continue to gain.
This confidence in equities was once again illustrated by the continued ignoring of economic reports that have come in weaker than expected, as January housing starts declined by 16 percent, which was the largest such drop since February 2011, the February Philadelphia Fed Manufacturing Index went from positive to negative and January existing home sales fell by 5.1 percent, their largest decline in over a year. And once again, the mantra of investors was to give these reports the benefit of the doubt, as old man winter was assumed to have held large parts of the economy in his icy and snowy hands due to the miserable weather conditions that have disrupted various forms of activity these past several weeks.
Better than expected earnings for the fourth quarter have also helped in the sense that as with 450 of the 500 members of the S&P having already reported, the projection is for profits to have advanced by 8.6 percent and this figure has steadily grown as the reporting season enters the home stretch. Revenues are expected to have advanced by 2.9 percent. Sixty-eight percent of companies have beaten profit projections versus the traditional 63 percent that surpass expectations and 65 percent have surpassed revenue expectations versus the 61 percent that usually beat in this area.
The main event this week will be Fed Chairman Janet Yellen’s return trip to Capitol Hill, when she goes before the Senate Banking Committee to complete her semi-annual testimony about monetary policy tomorrow. Investors will certainly be paying close attention to her answers to questions about how much she thinks the weather has impacted economic activity and how much attention the central bank will pay to that. In addition, market participants will want to divine the tea leaves for any sign regarding the Fed’s plans as the ongoing tapering of the stimulus program moves forward and as the unemployment rate gets closer to that 6.5 percent target.
Friday will see the next revision of economic growth during the final three months of 2013 and it is expected to show a slowdown to an annualized rate of 2.5 percent, lower than the previous reading of 3.2 percent. This will be crucial, as it now appears that the first quarter is currently tracking less than the fourth quarter.
Despite all these tribulations, the S&P did manage to make a new all-time intraday high on Monday as it broke through what had been formidable resistance at the 1850 level, reaching as high as 1858.71 before setting back to close just shy of its best-ever closing level of 1848.38 with a reading of 1847.61. One has to assume that the major focus for the rest of the week will be whether investors can finally push the S&P above this 1850 level on a closing basis to hopefully establish a new higher beachhead from which a continuation of the bull market can take place. Stay tuned.
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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