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Market Update

Easy Money: Central Banks’ Dovish Policies Intensify Search for Yield

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September 23, 2016

(Friday Market Open) The central banks have spoken, and the message appears to be more easy money for a longer period. As rate hike threats ebb, investors search for yield opportunity, and that’s what seems to be driving the recent stock market rally.

The announcements this week by the U.S. Fed and the Bank of Japan led to a flattening of the interest rate yield curve, with the long end of the curve down significantly. So the search for yield continues, and some of the better yield opportunities continue to be in the stock market, which rallied sharply in the wake of the banks’ decisions.

Nasdaq posted back-to-back record days on Wednesday and Thursday, and all 11 sectors of the S&P 500 were in the green two days in a row. That isn’t something we see very often. So far today, it looks like the markets may be taking a breather, with some profit taking coming in, but it’s a bit early to tell how long that trend might last.

The Fed’s decision to leave rates alone helped keep the market humming Thursday, as the S&P 500 Index (SPX) rallied to its highest close since the first week of the month, led by real estate, the new sector on the block. The telecommunication services and consumer staples sectors also made big gains, helped in part by the Fed. But overseas markets fell early Friday, with European markets burdened by weak manufacturing data. The tepid data led some analysts to predict more stimulus from the European Central Bank in coming months.

With the Fed meeting over and the start of earnings season still a couple weeks out, it could be quiet ahead of the weekend. But not completely quiet. On the docket today are some Fed speakers, including Philadelphia Fed President Patrick Harker, Atlanta Fed President Dennis Lockhart and Cleveland Fed President Loretta Mester, all of whom are scheduled to speak at noon ET in Philadelphia on a panel about the Fed's role in communities. Dallas Fed Robert Kaplan is scheduled to speak at 12:30 p.m. ET at the Texas Oil & Gas Association Lone Star Energy Forum. It remains to be seen what, if anything, any of the speakers might say about the economy and the Fed’s rate policy, but stay tuned, because Fed speakers can sometimes move the market.

There is one economic report today. The September release of Markit’s purchasing managers index for manufacturing comes out this morning, and Wall Street analysts’ consensus forecast is for a reading of 52, Marketwatch reported.

Economic data released Thursday didn’t exactly indicate a booming economy, though the markets rallied anyway off the Fed. Existing home sales reached a seasonally-adjusted level of 5.33 million in August, down from the previous month’s 5.38 million and below the Wall Street consensus for 5.5 million. This came as total inventories fell and prices rose, and economists say those two factors likely led to the slipping sales. The median existing home price rose more than 5% year-over-year to $240,200, marking the 54th consecutive month of year-over-year increases.

And leading indicators fell 0.2% in August, compared with consensus for a 0.1% drop, marking the second month in the last four to see a decline. Weekly manufacturing hours and ISM new orders both fell. This follows sluggish industrial production and business inventory numbers reported by the government earlier this month, and looks like another in a series of signals that the economy isn’t necessarily firing on all cylinders.

From a technical perspective, it was interesting to see the SPX close Thursday right at 2177, a technical resistance point going into the session. If the SPX can break solidly above this level, there’s more psychological resistance up around the all-time high of 2193 set last month. The index had tested that level several times in late August.

When the market approaches highs, as it’s doing now, it’s a good idea to exercise caution and avoid going “all in.” Valuations aren’t extraordinarily high, but remain well above average, something to keep in mind.

Oil prices sizzled again on Thursday, as they have most of the week thanks in part to an unanticipated hefty drop in U.S. stockpiles, as well as dollar weakness. Even with this week’s supply drop, however, U.S. supplies are 11% above year-ago levels. It’s unclear what led to the sharp recent decrease in oil stockpiles, analysts said. There aren’t any major weather events, and this time of year normally is when gasoline demand starts to fall from summer highs. Keep an eye on the weekly rig count at 1 p.m. ET today to see if the recent trend toward increased drilling continues. And early Friday, Reuters reported that Iran and Saudi Arabia may be nearing an output agreement, so that might bear watching if the two adversaries can actually work together on something.

S&P 500

FIGURE 1: BULL'S-EYE!

The S&P 500 (SPX), plotted through Thursday's close on the TD Ameritrade thinkorswim® platform, closed right at a significant area of resistance marked by the 2177 level. A move above this could be a positive technical sign, and the SPX is now less than 1% below its all-time high of 2193.81. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Let the Debate Watch Begin: With the Fed decision out of the way, attention now shifts to the next event: This coming Monday night’s Presidential debate. In fact, one could argue that the election, just over six weeks away, is becoming “item one” for the stock market, with the Fed pushed back to being “item 1A.” There is a Fed meeting right before the election, but the futures market puts very little probability on any interest rate moves at that time, meaning the election could continue to outweigh the Fed as a factor for some weeks to come. Those watching the debate might want to keep an eye on the stock futures market at the same time, as futures prices could give immediate feedback on market reaction as the two nominees battle it out on stage. It used to be that investors had to wait until the morning after to get investors’ take on a debate, but now the futures market can react in real time.

Oil Rally Helps Fuel Stock Market: The correlation between oil and stocks isn’t what it was earlier this year, but there’s still a connection, and recently, both have shown signs of moving together. For instance, between Aug. 25 and Sept. 9, a period in which oil prices fell 3.6%, the SPX declined about 2%. But since last Friday, nearby U.S. crude futures are up about 6% and the SPX is up as well, climbing 1.7%. Various other fundamental and technical factors play into these price movements, of course, so it’s best not to rely too much on these sorts of correlations. But if one looks farther back, say, to early this year, the pattern continues. When the SPX hit its low point for the year of around 1810 on Feb. 11, nearby crude was also at its low, near $26 a barrel. Since then, the SPX is up 20% and nearby crude futures are up about 77%.

Déjà vu Part Deuce: On Fed Day, we talked about how it seemed like “déjà vu all over again,” to quote Yankee great Yogi Berra, as the Fed once more declined to raise rates. Now déjà vu returns, with bond yields and volatility moving back to where they were in late summer. The bond market, which spent the last week building a “just in case” type of scenario ahead of the Fed meeting, rallied sharply with the meeting behind, sending 10-year Treasury yields all the way back below 1.62% by end of day Thursday, down from three-month peaks near 1.75% posted last week. In fact, yields are nearly back to the range they held most of the summer, at extremely low levels of between 1.5% and 1.6%. It’s worth watching to see if yields fall back into that area in the coming days.

Meanwhile, market volatility has collapsed. The VIX index, which many consider the best tracker of market fear, fell nearly 10% Thursday to 12.02, and is down around 40% from highs above 20 reached just 10 days ago. All of a sudden, September seems a lot less scary, at least judging from VIX levels. What would it take to bring some fear back into the market? Well, Halloween isn’t too far away.

Good Trading,
JJ
@TDAJJKinahan

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