The second quarter ended with a whimper rather than a bang. Investors have become confused and uncertain, thanks to the Fed. Despite that, the S&P 500 Index was still up almost 2.7% for the second quarter.
We experienced a pretty good rally this week off the lows but whether we go higher in the short term is just too hard to call. The markets gained almost one percent each day for the last three before succumbing to some profit-taking on Friday. Most of the impetus for that move can be attributed to a concerted effort by several members of the Federal Open Market Committee (the central bank) to talk the market up and U.S. Treasury interest rates back down.
The jaw boning obviously worked. The U.S. Treasury’s ten-year note dropped from 2.59% to 2.54%. That encouraged investors to buy the dip in the stock market. As readers may recall both stocks and bonds plummeted after the last FOMC meeting two weeks ago when Fed Chairman Ben Bernanke said that the Fed is prepared to taper its stimulus efforts in the months ahead if warranted.
This week the Fed’s bankers in speeches nationwide stressed that tapering would only occur if both the economy and employment were to gather strength. They pointed out that the data, thus far, has shown a mixed bag at best. However, not all investors were convinced. The price of gold, which lost another $100/ounce this week, seems to indicate that some investors believe the Fed’s stimulus efforts will be winding down in the foreseeable future.
In my opinion, the end of quantitative easing should be welcomed, as long as it is a result of a strengthening economy. I also understand that after five years of Fed activity in the financial markets, a weaning off period is necessary for investors to understand that the end of stimulus and the end of the world are not the same thing. A certain amount of Fed finesse is called for and so far they are doing a pretty good job in talking the market down from the ledge.
This event happens to coincide with a market that is badly in need of consolidation during a traditionally weaker summer period. So far the market from peak to trough has registered about an 8% decline before bouncing this week. It would not surprise me if in the weeks to come we re-test or even break that low, although not by much. These gyrations are simply the price of being in the equity markets. So be prepared for more volatility.
There is nothing on the horizon that I can identify that causes me undue concern. To the contrary, once the markets adjust to the new realities of a stock market that keys off the economy and earnings to find direction, I think we all will be pleasantly surprised. The future economy will turn out to be much stronger than anyone expects, which will drive the stock market to higher highs over the next two years or so.
Bonds are a different story. The thirty-year bull market in bonds is over and the sooner you accept that the better. Use any near-term price gains in Treasuries to sell positions.