Stocks Hold the Line, Expecting the Fed Not to Do the Same – May 16, 2014

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Stocks Hold the Line, Expecting the Fed Not to Do the Same

It was a volatile week for most markets around the world.  Starting Monday, bulls were encouraged when Chinese authorities pledged new reforms to lift the country out of the doldrums. The promised reforms will include reduced regulations, easy access to foreign capital, and an overhaul of the system governing initial public offerings. That development, combined with renewed speculation over ECB bond buying, was enough to keep markets afloat from Monday through the better portion of the day Tuesday. Then selling pressure resumed, led by small cap and NASDAQ Composite stocks.

The selling reached a climax Thursday after a series of not-so-favorable news headlines hit the tape:

  • Eurozone first-quarter GDP growth fell short of expectations (of 0.4%), rising only 0.2% – with inflation in check. Rumors circulated that Greece, desperately in need of cash, was in the process of imposing a retroactive tax on foreign holders of its bonds. This triggered a sharp sell-off in PIIGS debt.
  • China’s bad debts witnessed the biggest quarterly increase since 2005, and now stand at a five-year high. As a consequence, lending curbs are being proposed.
  • Stateside, industrial production reportedly fell 0.6%, while advanced retail sales rose only 0.1% (against an expected 0.4%) in the month of April. And to dispel the myth that these results were weather-related, Walmart reduced its second-quarter profit guidance by as much as 10%. Then, to add insult to injury, US PPI and CPI data registered larger-than-expected gains (PPI was 0.6% in April against 0.2% expected, and CPI was 0.3%, the highest since June of last year).

MWM 14, 5-16 Box ScoresAs if unconcerned with such trifles, stocks returned to rally mode by the close on Friday – perhaps due to options expiry imbalances or in anticipation (certainty?) of more QE to prevent markets from imploding. They seem ready to do so at any moment. Exhibit A is that the put/call ratio has been trending steadily higher all year and now sits at 0.68. This is bearish, or at least cautionary. Exhibit B is that high-quality bonds such as Treasuries and German Bunds have been marching higher – also troubling. What it all means thus far is unclear, but a market dislocation in stocks sometime in the near term can’t be ruled out. Of course, the Fed may need to pull the trigger on more QE before that happens.

The precious metals managed a small gain for the week, even as the dollar rallied slightly against the euro. But that isn’t even a tempest in a teapot. The price action in gold has been listless for weeks now, held hostage to Fed tapering and delusional notions of a self-sustaining economy – which may continue for at least the remainder of this month. But if the news in the last week tells us anything, it is that reality is knocking at the Fed’s door – hard.

Best Regards,

David Burgess
VP Investment Management


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