Bulls had been hoping for a Friday rally that would build on Thursday’s gains, but that was not to be the case. Friday’s fade was not all that bad, but it did close out a tough week that saw weekly losses of 1.1% for the Dow, 1.9% for the Nasdaq and 1.2% for the S&P 500. The main negative for the week was the Federal Reserve’s dovish comments that rate hikes would likely remain on hold for the long term. Janet Yellen and the Fed made it clear that the Fed was in no hurry to raise rates anytime soon, and while that normally would have been a “thumbs up” for the stock market, the conventional wisdom fell by the wayside and stocks drifted lower for the week. Thursday’s rally was a welcomed surprise, but buyers backed off on Friday.
The “Brexit” vote is scheduled for next week, and with the tragic killing of Parliament member Jo Cox, who was backing a “stay” in the EU vote, all bets are off on next week’s vote. The “leave” the EU momentum continues to increase, and that throws a lot of uncertainty into next week’s vote. Nothing would happen immediately, but the mere thought that other EU nations might follow with similar “exit” votes could put a lot of pressure on European markets. We saw the 10-year German bond dip to a zero interest rate this week, and it joins a host of other European nations with zero interest rates, so it is worrisome that so much capital is seeking safety rather than yield or even the possibility of growth.
These developments have made it all but impossible for the U.S. Fed to raise rates anytime soon, and after months of hinting at a rate hike, the Fed has its hands tied. Raising rates with so much uncertainty in Europe could rattle global financial markets, and until we get a decision by the British on the Brexit vote, the Fed will likely lay low on any hawkish comments concerning to rate hikes. The Fed also has its hands tied in that it does not like to conduct policy and rate hikes when a BIG Presidential election is looming less than five months away. This should make for an interesting summer, especially with both parties having conventions in the next couple of months.
As for the U.S. economy, we did get some fairly positive news this week in terms of the Empire State Index and the Philly Fed, which each show that economic activity remains solid in the Northeast. Home builders were upbeat this month as well, so once again, we continue to get enough positives to offset the negatives like the May jobs report. Some strategists are concerned, however, that the Fed has become a “slave to the markets.” This means that the Fed lacks a “vision” as to where it wants the economy to go, and with its fear of upsetting financial markets, it might be backing off in a big way of what it really wants to do in terms of raising interest rates.
The Fed has said for the past couple of years that it will remain “data driven,” but when the data is just not there, is it smart for the Fed just to lay low and hide out? There is a growing chorus of Fed critics saying that this perpetual zero interest rate policy (ZIRP) might be having an extremely adverse effect on the U.S. economy. Zero interest rates may have helped bail the global economy out of the 2008-09 crisis, but those policies were only supposed to be temporary. Seven or eight years later, we are seeing lackluster growth, and critics of central banks and the Fed are saying that enough is enough, and that rates need to be higher.
What makes this scenario difficult is that raising rates could wallop stock and bond markets in a big way. A crashing stock market and a sinking bond market could rattle consumer confidence and the housing market, so it is no wonder that the Fed has chosen to back off from rate hikes and signal that it is in no hurry to raise rates. Keep in mind that the Fed has only raised rates a quarter-point since 2008, and that December rate hike was followed by a 10% decline in the S&P 500 in the January-February pullback. The Fed seems to have the mentality of “if it’s not broke, don’t fix it,” but the worry is that inaction for too long might only compound the problem.
It was a tough week for the stock market, but the positive was that we did not see any sort of big meltdown. The S&P 500 closed at 2,071 on Friday, and that puts it right on top of its 50-day moving average of 2,070. It would be a plus if the S&P 500 can hold that level and bounce next week. That said, the Gorilla wishes each and all a relaxing Father’s Day Weekend, and we will be back in action on Monday. There is some great golf and basketball on Sunday, so enjoy a couple of days away from a challenging stock market. Summer is on the way, and the bullish camp is still rooting for a “Summer Rally,” so stay tuned, and maybe that rally will appear.
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