The S&P 500 finished the week up 0.51%:
Friday's rally stopped any correction that may have been brewing in its tracks. What was interesting was that the market took the strong employment report as a positive for equities instead of negatively reacting to the possibility that the Fed would consider taking away the punch bowl sooner rather than later. The "good is bad and bad is good" paradigm which we have repeatedly seen over the past five years did not hold true this time.
The monthly employment report showed 204,000 jobs were created in the month, while the unemployment rate came in at 7.3 percent in line with estimates. Economists had expected only 120,000 new jobs in October. When the report was released I responded with a laugh! It seemed incomprehensible that with the government shutdown and the inevitable skewing of the data from that event that such a large variance from the previous reports could be possible. Mark Zandi, chief economist with Standard and Poors described the report as "bizarre" to which I wholeheartedly agree. Nevertheless, the market reacted as it always does to reports that defy expectations and, in this case, ignored the prospect of Fed imminent tapering and the rally started, erasing many of the losses incurred on Thursday.
Almost immediately, market pundits started speculating that maybe the economy was much stronger than many thought. Equities ignored the consumer confidence numbers about an hour later that came in lower than expectations.
A lot of emotion was spent by the wild swing we had between Thursday and Friday. Folks went from abject despondency when price action broke down on Thursday after an initially strong open to extreme euphoria on Friday regarding the economy and all the other ancillary issues that are connected to the present market environment we find ourselves. If you follow the financial media you might have felt like you were on a roller coaster; one day seemingly facing a meaningful market decline; the next day speculating on a new "golden age" for the economy and stocks. When these situations arise I find it's best to put all the emotion aside and just analyze the technical condition of all asset classes in order to cut through all the "noise" and determine whether anything meaningful has changed in the market and global economy. And that's what I intend to do for the rest of this commentary.
The reaction to the employment report immediately impacted Treasuries and they sold off. Remember, when bond prices drop yields rise. Here's a weekly chart of the Ten Year Treasury yield:
The ECB responded with a surprise interest rate cut on Thursday, lowering the interest rate it lends to banks at its normal facilities to 0.25% from 0.50%. It also reduced the rate for its overnight loans to banks by the same amount and offered unlimited loans to banks out to 2015.
Many on the street lauded Draghi's move as much needed (and it was) but underneath it is not seen as enough to stem the deflationary tide that seems to be overtaking the EU. Marc Chandler, Chief Currency Strategist at Brown Brothers Harriman and arguably one of the brightest minds on the street believes the latest move by the ECB will be ineffective. He argues here that what is needed is OMT (Outright Monetary Transactions) but the political impediments to implementing such a policy are possibly insurmountable. It's those "pesky" Germans that stand in the way! One way to loosen monetary conditions would be to lower required reserves banks have to carry coupled with a refi rate cut. In the absence of that, deflationary pressures in the EU are liable to persist.
In our country, with inflation running at an annual rate of 1.2%, there appears to be no signs of any inflationary pressures at this point in time. Here's the latest update of the Velocity of M2 Money Supply provided by the St. Louis Federal Reserve:
Additionally, the PCE (Personal Consumption Expenditures) Deflator which measures the average increase in price for all personal consumption in this country is abysmally low:
- S&P 500 at 1860 by year end
- no Fed tapering until at least March, 2014 (if then)
- Gold, depending on Fed largesse, may have seen it's bottom