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Bad-News Bulls? Economic Pause Could Slow Down Fed

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May 19, 2015

Downward revisions to the U.S. economic outlook could prove to be stock-market supportive. Sounds counterintuitive, doesn’t it? But as far as Wall Street is concerned, slower growth could justify a slow-moving Federal Reserve. Bulls are guessing that the longer interest rates remain low, the longer the stock market punch bowl stays out. 

A recent spate of weaker-than-expected economic data, including retail sales and industrial production, sparked a downward revision to 2015 growth in at least one survey. The Philadelphia Federal Reserve queries professional forecasters each quarter. That poll group now sees 2015 annual GDP growth at 2.4%, down from a 3.2% expectation for the year in last quarter’s survey. 

Financial markets have already reacted to changing expectations on Fed timing. The U.S. dollar has softened in recent weeks as currency traders readjust the amount of monetary policy tightening already priced into the greenback. There are implications for bonds and stocks as well. 

"If the economy is really as bad as economists are projecting then there is a good chance the Fed won't increase interest rates this year. That means 10-year Treasury yields could drop and stocks could rally, as that has been the trend," said Ryan Campbell, content manager at Investools®. Generally, low market interest rates—used to set mortgage and business borrowing—tend to be supportive to the stock market. 

Tough Job Ahead

The Fed and investors have been treated to the same rounds of spotty results lately. 

"We saw a good employment number followed by a retail sales number that came in really weak. We have also seen earnings from the retail companies come in weak. Last week's University of Michigan consumer confidence number was also weak. It shows that the consumer, although back to work, is socking money away because they are nervous about the economy," said JJ Kinahan, chief strategist at TD Ameritrade. 

"If there are five stages to an economic recovery, we've been stuck at level three for five years," Kinahan said. 

The uneven nature of the current economic picture continues to challenge Federal Reserve officials, many of whom have broadcast their intentions to begin an interest-rate policy normalization process sometime this year.

Others think action in 2015 may be too soon. In a speech on Monday, Federal Reserve Bank of Chicago President Charles Evans reiterated his view that the central bank should hold off on hiking interest rates this year. 

What Will Rattle the Bulls?

TD Ameritrade clients can stay on top of upcoming economic reports via the economic calendar available on TD Ameritrade’s Trade Architect. "A retail trader might focus on the employment number—that remains the most important number. Also watch retail sales, durable goods, and the housing numbers," Kinahan said. 

Traders might also keep an eye on a shift in stock tastes. History has shown that typically defensive sectors, including consumer staples, energy, and health care, tend to draw interest as a bull market gets long in the tooth, notes Campbell. Using a relative strength study can help traders determine potential outperforming or underperforming market sectors (figure 1).

thinkorswim-charts-relative_strength

FIGURE 1: IT’S ALL RELATIVE. The example contract above tracks a health care exchange-traded fund, and in the lowest view, measures that health care ETF’s relative strength against the broad S&P 500 (SPX). For illustrative purposes only. Past performance does not guarantee future results. Not a recommendation to buy, sell or hold.

Age is More Than a Number

Since 1949, there have been 11 recorded bull markets in U.S. stocks. The current bull move has lasted 74 months, marking the third longest run, according to S&P Capital IQ. 

However, age itself doesn't mean it's countdown time.

"While we think a correction in prices is overdue, we don’t see an increase in volatility or the number of new highs as a signal of an impending bear market,” said S&P Capital IQ in a note. “Like people, it is normal for bull markets to get shakier as they age and add to their list of milestones. However, since duration is not synonymous with durability, this bull may have months and all-time highs yet to enjoy.”

Chart Relative Strength and More

How to get there: Launch the thinkorswim® platform > Charts > Studies > Quick Study > Lower Studies > Relative Strength