It was a bumpy week for the stock market, and Friday’s session started off with stocks edging lower. We did see things turn around a bit as the day wore on, though, as all three of the major indices managed to close in the green at their highs of the day. Granted it was not a big win for the day, but a win is still a win, and seeing stocks close out Friday in positive territory had the bullish crowd heading into the World Cup Finals weekend in a relatively good mood. The overall week, however, was slightly lower, with the Dow off 0.7%, the Nasdaq down 1.6% and the S&P 500 0.9% lower.
It was one of those up-and-down weeks for the stock market, where it was just unable to make up its mind about which way to move. The positives were the solid earnings from Alcoa (AA) to start the week, as well as a decent employment report, but the negatives were the problems at Portuguese bank Espirito Santo and concerns about the Fed’s plan to return itself to “normal” operations. There was a lack of “heavy” news, and if you throw in the light summer volume, it was no surprise to see the stock market tread water near break-even levels for the week.
One development that received a fair amount of attention was the slide in the yield on the 10-year Treasury. It closed out last week at around 2.65%, but slipped down to 2.52% to close out the week. This was interesting because the decline came against the backdrop of the Fed minutes from June saying that the Fed would stop buying those big slugs of Treasuries at the end of October. The buzz was also that the Fed would likely start raising interest rates by the middle of 2015, and common sense would say that interest rates should actually have risen on that sort of news.
Enter Portugal. While it was just one bank that missed a bond payment, it just so happened to be the largest, publicly-traded bank in that country. It immediately sent shivers through the EU that maybe all of the financial problems that the European Central Bank supposedly fixed a couple of years ago were not actually fixed. Critics of the ECB said two years ago that the ECB was merely “kicking the can down the road,” and oddly enough, one of those “cans” might have finally shown up in Portugal. That also might explain why “someone” was buying safe-haven, 10-year Treasuries in a big way this week.
As for our own version of the ECB, the Federal Reserve is clearly hard at work on an exit strategy from the extraordinary measures it took after the 2008-2009 financial crisis. The near-zero interest rates, the swelling balance sheet and the flat-out accommodation of all things financial over the past five years cannot go on forever, and the new “wild card” is what happens when the Fed actually stops buying Treasuries and starts raising interest rates. Many economy and Fed watchers think corporations will shift into “wait and see” mode as possible Fed rate hikes approach, and that has economists worried that “wait and see” could send a chill through the economy in early 2015.
With the economy, employment and earnings looking strong, though, maybe the Fed returning to “normal” will not be that big of a deal at all. If anything, we could see inflation take hold as the economy continues to improve, which might force the Fed to begin raising rates sooner rather than later. The 10-year Treasury should offer a clue as to what is likely to unfold in these varying scenarios, but seeing it declining right now shows that the bond market is clearly not worried about an overheating economy or inflation anytime soon. There is even talk that the falling 10-year could be signaling a possible recessionary scenario.
The Fed has not raised rates in eight years, so it is far from clear as to how the stock market will react to the Fed’s move towards “normalization,” but historically, the stock market has a tough time rallying if the Fed is raising interest rates. There are big concerns about “unintended consequences” occurring no matter what the Fed does over the next year, especially since the Fed has put in motion policies and programs never used before. Those actions have worked well for the most part, but we have never experienced an unwinding from such extraordinary Fed moves.
Earnings season shifts into overdrive next week, so that should give us a clue as to how vibrant this recovery really is. Likewise, we get second quarter GDP numbers at the end of the month, and economists are looking for a 3.2% growth rate. The Fed is walking a fine line, and it is not going to be a cake walk to return to “normal.” Maybe the economy and the stock market will be able to roll with any possible punches thrown its way, and maybe that will be enough to keep this magnificent bull market charging higher into next year. We shall see.
Global shocks like wars, economic collapses, or even surging oil prices could make the Fed’s job even more difficult, so hopefully the world stage will remain calm, cool and collected enough to keep the global engine firing on all cylinders in the year ahead. That said, the Gorilla wishes each and all a wonderful, relaxing July weekend. Though he is not a big soccer fan, the Gorilla will be tuning in to the Super Bowl of soccer on Sunday. It should be a good game. Enjoy!
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