Weekly Market Update - Good Cop, Bad Cop
Weekly Market Update (Week Ending August 26th, 2016)
Good Cop, Bad Cop
Markets were quiet and dull again this week leading into Friday's speech from Fed Chairwoman Janet Yellen. Yellen was speaking at the annual Fed conference in Jackson Hole, Wyoming. The topic this year was The Federal Reserve's Monetary Toolkit: Past Present and Future. The market however seemed to be more interested in what Janet Yellen had to say regarding current economic conditions. This was apparent in the wild market action that ensued after her speech.
Try to follow me here, because markets were whipsawing. Markets were trending higher before the Chairwoman spoke. Immediately after her speech, markets sold off on the notion that the Chairwoman said that the case for a rate hike has strengthened as of late. However, she was still not emphatic about an immediate rate hike, so markets again shot higher. So in this scenario, Yellen was playing the good cop. Enter the bad cop, Stanley Fischer from the Fed. After Yellen's speech, Fischer reinforced Yellen's message in a more direct tone, hinting that another strong jobs report next week could get the Fed to move, and possibly twice this year. After that, markets sold off, thus turning the rally into losses for the day and small losses for the week. After all was said and done, the Dow Jones Industrial Average fell 0.85% for the week and the S&P 500 fell 0.68%.
I bring this up not to focus on a single day in the market, but to highlight the fact that action in the market on any given day is still very sensitive to chatter from the Federal Reserve. And by all accounts, short-term markets are very irrational. It doesn't change the fact that owning good assets for the long term is a viable investment strategy, but it does remind us that the complacency of late can turn into volatility on just a few words from a Fed official.
Getting back to Yellen's speech, I thought there were some interesting things revealed regarding future policy actions. For one, the Fed clearly believes they have enough tools to fight the next recession even in the face of low interest rates. Keep in mind that some believe the Fed needs to raise rates so they can lower rates during the next recession. But reading Yellen's speech, she mentioned that the Fed still has room to expand their balance sheet by a couple trillion dollars and could even expand the types of assets they purchase. To me, this is a very critical point that hasn't really found it's way into the mainstream financial media. Can we interpret it that during the next crisis our Fed stands ready to buy corporate bonds like the ECB or dare I even say stocks like the BOJ?
On the bright side, market momentum has remained firm and stocks have been quite resilient, even breaking out to all time highs. As we know, markets are forward looking. GDP in the third quarter is expected to pick up from the lackluster 1% of the first half and the job market remains positive.
Michael J. Basile, CFA
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