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Thanks, Fed! Markets Rally After Yellen and Crew Deliver As Anticipated

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September 22, 2016

(Thursday Market Open) No surprises. That’s the main takeaway from this week’s Fed meeting, and investors seem happy with the results.

One could argue that yesterday’s Fed decision and announcement were exactly what the market needed to hear. The broad-based rally that followed and appears likely continue on Thursday reflects in part the market’s relief that the Fed stayed patient and kept rates unchanged.

Going into “Fed Day,” chances for a rate hike were low, judging from the futures market, but many investors expected somewhat more hawkish language in the Fed’s statement, perhaps pointing to a December increase in rates.

That’s pretty much how it played out. To sum up the Fed’s announcement in a few words, how about: “Things are strong. It’s not quite the time. We’ll do it by year end.”

In its statement, the Fed cited a “strengthened” case for an increase in rates, but said it would “wait for further evidence.” One key difference from the July post-meeting statement was this: “Near-term risks to the economic outlook appear roughly balanced.” That “roughly balanced” language was a change from the previous statement, which said risks to the economic outlook “appear to have diminished.” And “roughly balanced” is similar to the language the Fed used before last December’s rate hike.

Futures prices at CME Group now indicate a 58% chance of rates going up in December. The November Fed meeting, which occurs right before the U.S. election, doesn’t hold much of a chance for any Fed move, with futures predicting just 12% odds for a hike at that time. The bond market, which had fallen going into the meeting, is rallying again, with the 10-year yield falling to 1.64% today from 1.7% before the meeting. The VIX volatility index is getting pounded, falling back down to near lows seen over the summer.

Though the Fed hinted that the case for rate hikes had strengthened and indicated a hike is possible later this year, it pulled back the odds for future increases. Fed policy makers now anticipate only one rate increase this year, two next year and three in 2018 and 2019. That contrasted with June, when the Fed expected two rate increases in 2016, three in 2017 and three more in 2018. If the Fed is projecting fewer rate hikes, that could be read as saying the Fed doesn’t expect as strong an economy.

Indeed, the Fed now projects 1.8% growth in Gross Domestic Product (GDP) this year, compared with a projection for 2.4% GDP growth at the start of the year. The economy has grown less than 2% a year since the end of the Great Recession, compared with long-term GDP growth of 3.3%, and hasn’t grown 3% over a full year since 2005.

Despite the Fed forecasting weaker long-term economic performance, all 11 S&P 500 (SPX) sectors rallied after Wednesday’s Fed announcement, even though the financial sector, which presumably would have the most to gain from higher rates, was one of the weakest gainers on the day. The Nasdaq made a new all-time high. Energy and utilities, both of which climbed 2%, led the charge higher, but many other sectors posted 1% or better gains on the day as the SPX climbed back into what had been a longer-term range between roughly 2150 and 2190. Resistance now rests at around 2177.

The energy sector’s boost came as oil rallied on continued drawdowns in U.S. stockpiles, an odd occurrence for this time of year. The U.S. Energy Information Administration (EIA) said domestic crude inventories fell by 6.2 million barrels for the week ended Sept. 16, versus a 3.4 million-barrel drop forecast by oil market analysts polled by Reuters. Strength in crude boosted the stock market earlier this week, so we’ll see if that happens again.

Overnight, markets in Europe and Asia posted strong gains in the wake of the Fed decision and the U.S. market rally. The Bank of Japan announced Wednesday new plans for economic stimulus in an attempt to boost inflation, but left the deposit rate unchanged.

U.S. jobless claims early Thursday came in at 252,000. Wall Street analysts had expected 262,000. Leading indicators are due today as well as existing home sales. But not much else is on the economic calendar for the remainder of the week. Focus now may shift toward Monday’s U.S. Presidential debate.

S&P 500

FIGURE 1: REVISITING EARLY SEPTEMBER.

The S&P 500 (SPX), plotted through Wednesday's close on the TD Ameritrade thinkorswim® platform,  posted its highest close since Sept. 8, rallying in the wake of the Fed’s announcement. The SPX is now back in the range it had traded in between late July and early September. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Could Buybacks Boom Again? Not so Fast: Recent buyback announcements by Target (TGT) and Microsoft (MSFT) fueled some speculation that this could be the start of a trend, the Financial Times reported. These announcements came after buybacks fell 3% from a year ago in the Q2. While it’s always possible more buybacks could be in the offing, it doesn’t seem all that likely that TGT and MSFT are part of a vanguard of something big. With the U.S. election looming, companies may remain on the sidelines for a while longer, assessing what’s going to change. This could be the case not only with buybacks, but with corporate investment as well.

Like a Moth Around a Flame: Front-month U.S. crude oil futures keep fluttering near $45 a barrel. There’s been only one day so far in September when oil hasn’t closed within 5% of $45, and even Wednesday’s surprisingly large U.S. stockpile draw didn’t change that. Front-month oil has also closed between $40 and $50 every trading session since July 1. What’s magical about this trading range and why should average investors care, anyway? Though oil prices and stocks aren’t linked as closely as they were earlier this year, there’s still a connection, and oil prices are sometimes viewed as a helpful synthetic way to measure strength in the broader economy. If oil is up, that could mean demand for all sorts of goods shipped using oil could be up. Higher oil demand can also be a sign of more cars on the road, perhaps indicating more people driving to jobs. Why the pivoting around $45? Prices below $40 haven’t been sustainable over recent years, perhaps in part because U.S. drilling dries up at such unprofitable levels, causing supplies to fall. On the other hand, U.S. oil drilling began edging higher this summer when prices tested the $50 a barrel mark, a signal that prices much higher than the current range could mean more oil coming to market. That fundamental factor could put a cap on any rallies.

Apple in the Driver’s Seat? There’s been talk for several years about Apple (AAPL) getting involved in automobiles, but even so, it was a bit of a surprise to read Wednesday in the Financial Times that Apple might be in talks with McLaren, a “supercar” and race car company that’s known for its expensive high performance vehicles. Wasn’t AAPL supposed to be focused on electric cars and cars that could drive themselves? Those kind of vehicles don’t readily bring to mind roaring supercars like those made by McLaren, and it seems unlikely that McLaren drivers would want control of their sports cars taken over by any fancy electronic gadgets developed by AAPL. But that scenario isn’t taking into account the full possibilities of any possible deal. Over the last few years, the U.K.-based McLaren has shifted into high gear with its automotive technology, developing lightweight materials like an exhaust system made from titanium and electronic systems used by auto racing businesses. And it’s rumored to be working on an electric car, according to media reports. Perhaps it’s those developments, more than splashy sports cars, potentially drawing AAPL’s interest. Neither AAPL nor McLaren would discuss the rumor with the media.

Good Trading,
JJ
@TDAJJKinahan

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JJ Kinahan

JJ began his career in 1985 as a Chicago Board Options Exchange...

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