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The Markets This Week

August 29, 2016 | Weekly Commentary

In a week that really came down to one day’s events, stocks fell almost 1%, buffeted by seemingly conflicting comments from Federal Reserve officials. The Dow Jones Industrial Average lost 157 points, or nearly 1%, to 18,395.40, while the Standard & Poor’s 500 index declined 15 points to 2169.04. The Nasdaq Composite fell 0.4% to 5218.92.

Trading was quiescent Friday ahead of a speech by Fed Chair Janet Yellen, and stocks drifted lower. Although Yellen said the case for raising interest rates had increased of late, she said the rise would be gradual.  Yellen made no reference to a potential September hike. Nothing new here. After her speech, stocks recovered all the ground they lost earlier in the week. Then Stanley Fischer, the Fed’s generally hawkish vice chair, appeared on CNBC, and indicated that Yellen’s speech was consistent with a possible rate hike in September and December.

The equities market wasn’t prepared for a potential hike just a few weeks away, and stocks plunged 1% from the day’s highs. Unsurprisingly, the financial sector was effectively the only one up on the week; higher interest rates are good news for banks and insurers.  After Fischer’s comments, the fed futures market showed investors putting the probability of a September hike at more than 40%, double what it was a few weeks ago and up from nearly zero right after the Brexit vote. “It’s hard to read the Fed tea leaves,” says Joe Saluzzi, co-head of trading at Themis Trading. “Two rate hikes would seem to be in play now.”

This week promises to be another one where Friday could be a key session. On Sept. 2, U.S. unemployment data for August will be released. If results turn out to be much better than expected, look for September-rate-hike market expectations to spike sharply. The jobs data could turn out to be the most important numbers of the year, outside of election results.

If the Fed has been giving mixed signals, the market has exhibited contradictory reactions. Shares have risen when the threat of a rate hike was postponed. But this year there have been occasions also when the market rose when a rate rise seemed more likely. What gives?

If a hike is based on a stronger economy, the market likes that, says Saluzzi. “Yet the data isn’t enough to make you feel good about it,” he adds.  He’s referring to Friday’s report about second-quarter gross domestic product, which was revised downward to 1.1% from a preliminary read of 1.2% by the Commerce Department.

“The economy continues to be lukewarm,” says Jonathan Golub, chief equity strategist for RBC Capital Markets.  Leave out the energy-sector earnings rebound from year-ago decimated levels, and corporate earnings haven’t grown much in the past 12 months. Yet bond returns are so much lower than equities, which have returned 5% from dividends and stock buybacks, that the relative attraction of stocks versus fixed income “could continue unabated for a while,” says Golub.

Beyond what the Fed does or doesn’t do next month, look for the debate on fiscal stimulus to pick up ahead of the elections, he adds. Short of that, he notes, the economy looks stuck in second gear.

(Source: Barrons Online)

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