markets-disconnected

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Since the Great Recession, the US stock market has been dependent on Federal Reserve stimulus to bolster corporate profits and maintain a stagnant economy.  Every time the Federal Reserve indicated a change in its accommodative policy, investors sold.  Since December 2014, when the Federal Reserve ended its third Quantitative Easing stimulus campaign, the US stock market has been stuck with less than a 4% increase up to election day 2016.  In December 2015 when the Federal Reserve announced its first discount rate hike in eight years, investors aggressively sold the following month setting all-time decline records.

Last week the Federal Reserve announced its second rate hike in the same number of years with an entirely different market response.  Barron’s reported this weekend:

“Conditions are much better this time around, says Michael Darda, chief market strategist at MKM Partners. Inflation expectations have been rising, not falling, and what weakness there has been in the credit markets has been a result of higher interest rates, not concerns about the ability of companies to pay their debt. That the response was so restrained despite the fact the S&P 500 has gained 6.1% since the beginning of November, should calm the skeptics. “A flattish response to a more hawkish Fed is a bullish response given how much the market had run up.”

Federal Reserve policy since 2008 has been to accommodate a weak economy by adding over $4.5 trillion dollars in stimulus through its various monetary programs.  The question has always been in determining the source of the new annual stimulus of $1 trillion if not from the Federal Reserve.  The answer has given at nearly all Senate hearings by Ben Bernanke, former Federal Reserve chairman, and currently by Janet Yellen.  The both regularly stated that no amount of monetary policy (Federal Reserve stimulus) can offset poor fiscal policy (government legislation).

Investors aware of what will propel corporate and economic growth understand that Federal Reserve stimulus is short-lived and did not produce long-term growth.  While the money was flowing out of the Reserve investors bought stock and the moment of reversing the flow investors sold.  Market buying and selling activity is the ultimate confirmation of whether policies are deemed to be a successful strategy for the economy and businesses.

Since the election, investors have been aggressively buying US stocks and pushing up the US dollar in expectation of changing fiscal policy that may produce the $1 trillion or more in new stimulus (assuming Donald Trump is confirmed today by the electoral vote). Simultaneously, bond investors have been selling bonds due to the unfavorable scenario for bonds of rising interest rates and inflation the result of improving economic activity. Markets which previously held strong correlation ratios have become as disconnected as the seventh strand of Christmas lights dangling from your neighbor’s side yard roofing. Take a look at the chart below.

spx_sml_ndx_chart

Although many of the President-elect’s policies are as clear as mud, movements in the market could not be more visible. Fluctuations occurring in each sector send waves of buy/sell execution through each industry in which that sector holds.  Building a narrative around the future of the market is a dangerous task, one that is certain to embarrass even the most savvy of investors in 2017. Market cycles which previously lasted months or years now can pivot in a matter of weeks or days. For now, macro analysis is proving to be the most helpful when determining where the money tide is moving.

WHAT DOES THIS MEAN TO ME?

If the market holds its current level through inauguration day, then we would conclude that investors have a more than favorable outlook of the US economy. From a simple technical standpoint, the S&P 500 is solidly above both its 50 day moving average (red line) and 200 day moving average (orange line).

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Considering the robust post-election rally, one would anticipate some level of a pullback as investors rebalance their portfolios.  However, strong holiday sales paired with positive corporate earnings reports in January might provide more tailwind to the current market landscape.

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