Stocks saw some relative calm this week. Through the Friday close, the Dow and S&P both gained 2.1% and the Nasdaq added 3.0%. Gold saw some weakness, off 1.5%. Oil stayed in a pretty small range to close off 3.1% to $44.03 per barrel. The international Brent oil, used to make much of our gas here in the east, closed down to $49.92 per barrel.
Source: Google Finance
The holiday-shortened week was a rather uneventful one. There were a few economic reports and some news out of Asia, but the focus was really on the Fed meeting coming next week.
We opened the week with a solid gain on good news out of Asia. Well, the news was good for the market, anyway. The poor economy in China and Japan has caused government officials to indicate more stimulus may be on the way. Remember, stimulus is good for the market as the new money flows into stocks, but the results show it does little to help the economy.
This leads to the other factor moving the market this week – the Fed and their stimulus. They are holding a policy meeting next week where they are expected to announce a decision on the level of interest rates.
Why is this so important? As mentioned above, these stimulus programs are great for the market. For example, the image below shows the market rising in lockstep with a Fed stimulus program. The blue line represents the money printed by the Fed in their QE program and the red line indicates the stock market (the S&P 500). If the Fed announces a reduction in stimulus, stocks are widely expected to fall.
We opened the week with a solid gain on good news out of Asia. Well, the news was good for the market, anyway. The poor economy in China and Japan has caused government officials to indicate more stimulus may be on the way. Remember, stimulus is good for the market as the new money flows into stocks, but the results show it does little to help the economy.
This leads to the other factor moving the market this week – the Fed and their stimulus. They are holding a policy meeting next week where they are expected to announce a decision on the level of interest rates.
Why is this so important? As mentioned above, these stimulus programs are great for the market. For example, the image below shows the market rising in lockstep with a Fed stimulus program. The blue line represents the money printed by the Fed in their QE program and the red line indicates the stock market (the S&P 500). If the Fed announces a reduction in stimulus, stocks are widely expected to fall.
With the Fed relying on economic data to make this decision, the market has reacted strongly to recent economic reports.
An employment report (the JOLTs report) showed job openings at a record high level. This positive report saw stocks immediately move lower, since it increased the odds of a reduction in stimulus.
A higher-than-expected inflation level in the PPI report also pressured stocks, since the Fed is looking for higher inflation before raising interest rates. The inflation rate is still below their target, however, so this may give them some pause before raising rates.
It is frustrating that the market is so dependent on the Fed for direction, but that is one of the consequences of their intervention in the market. The volatility in the market we are seeing shows just how hard it will be for the Fed to eventually get out.
Next Week
All eyes will be on the Fed next week. We’ll see a few economic reports, like retail sales, inflation at the consumer level, and housing stats. However, they are unlikely to have as much impact on the market as the Fed will have.
If the Fed does announce an increase in interest rates, we believe stocks will fall. Conversely, they will probably rise if rates are held unchanged. We suspect it won’t be that cut-and-dry though. We wouldn’t be surprised to see some sort of offsetting comments designed to confuse the market, probably because the Fed is confused what to do, too.
On a positive note, next week has been the best week of the year over the past 10 years according to market strategist Ryan Detrick. Unfortunately, the following three weeks are the worst of the year. We’ll see if that is the case again this year.
Investment Strategy
No change here. It’s not bad to do some nibbling on these down markets. However, it’s all about the Fed now more than ever. The direction of the market hinges on their stimulus policy and without a clear idea of what they will do, it is difficult to tell where the market will move in the short run.
In the longer run, we think some of our long-run fears are being realized with the recent market action. The distortions created in the market by the Fed’s stimulus program will cause large downturns when the stimulus comes off.
Looking at longer term fundamentals, we are concerned over the lack of companies reinvesting their earnings into their business. Money has instead flowed into stock buybacks and dividends, not reinvested back in the company. This signals lower corporate growth down the road.
Bonds didn’t fare well this week as money left bonds and moved into stocks (so prices fell and yields rose). Prices are still on the high end of the range we have seen, which makes them an expensive hedge at this point. Cash may be a better option and we would avoid longer-term bonds.
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. They have not done well recently as a record supply has kept prices low. Therefore, we keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical issues and when more stimulus looks likely and falling on the opposite.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets. However, the stimulus programs in Europe and Japan do make for interesting investments, as long as the currency effects are hedged.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
An employment report (the JOLTs report) showed job openings at a record high level. This positive report saw stocks immediately move lower, since it increased the odds of a reduction in stimulus.
A higher-than-expected inflation level in the PPI report also pressured stocks, since the Fed is looking for higher inflation before raising interest rates. The inflation rate is still below their target, however, so this may give them some pause before raising rates.
It is frustrating that the market is so dependent on the Fed for direction, but that is one of the consequences of their intervention in the market. The volatility in the market we are seeing shows just how hard it will be for the Fed to eventually get out.
Next Week
All eyes will be on the Fed next week. We’ll see a few economic reports, like retail sales, inflation at the consumer level, and housing stats. However, they are unlikely to have as much impact on the market as the Fed will have.
If the Fed does announce an increase in interest rates, we believe stocks will fall. Conversely, they will probably rise if rates are held unchanged. We suspect it won’t be that cut-and-dry though. We wouldn’t be surprised to see some sort of offsetting comments designed to confuse the market, probably because the Fed is confused what to do, too.
On a positive note, next week has been the best week of the year over the past 10 years according to market strategist Ryan Detrick. Unfortunately, the following three weeks are the worst of the year. We’ll see if that is the case again this year.
Investment Strategy
No change here. It’s not bad to do some nibbling on these down markets. However, it’s all about the Fed now more than ever. The direction of the market hinges on their stimulus policy and without a clear idea of what they will do, it is difficult to tell where the market will move in the short run.
In the longer run, we think some of our long-run fears are being realized with the recent market action. The distortions created in the market by the Fed’s stimulus program will cause large downturns when the stimulus comes off.
Looking at longer term fundamentals, we are concerned over the lack of companies reinvesting their earnings into their business. Money has instead flowed into stock buybacks and dividends, not reinvested back in the company. This signals lower corporate growth down the road.
Bonds didn’t fare well this week as money left bonds and moved into stocks (so prices fell and yields rose). Prices are still on the high end of the range we have seen, which makes them an expensive hedge at this point. Cash may be a better option and we would avoid longer-term bonds.
Bonds to protect against inflation, or TIPs, remain a good long term hedge for inflation. Floating-rate bonds will do well if interest rates eventually do rise.
Some municipal bonds look attractive for the right client, too. We like buying individual, insured names for these bonds, avoiding muni index bonds if possible. They have not done well recently as a record supply has kept prices low. Therefore, we keep a longer term focus with these investments.
Gold is another good hedge for the portfolio. It is only a hedge at this point – rising on geopolitical issues and when more stimulus looks likely and falling on the opposite.
Finally, in international stocks, we see weakness around the globe and favor neither the developed or emerging markets. However, the stimulus programs in Europe and Japan do make for interesting investments, as long as the currency effects are hedged.
Please note, these day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
