Fed Stays Easy
The Federal Reserve provided a mixed message Wednesday, but the tone remained
equity friendly. From Reuters:
The Federal Reserve on Wednesday reaffirmed it was in no rush to raise
interest rates, even as it upgraded its assessment of the U.S. economy
and expressed some comfort that inflation was moving up toward its target. "Labor
market conditions improved, with the unemployment rate declining further," the
Fed said in a statement. "However, a range of labor market indicators suggests
that there remains significant underutilization of labor resources."
Stock Market Risk
When intraday volatility picks up, it is often difficult to see small changes
that are taking place. For example, it may surprise some that the S&P 500
is down for the week through Wednesday; it has given back 8 points since last
Friday's close. The weekly chart on the left below shows the broader NYSE Composite
Index as of July 4. The chart on the right is as of Wednesday's close. What
can we learn from them? While the big picture still favors bullish outcomes,
the odds of the stock market morphing into a correction are higher today than
they were on Independence Day.
Stocks Or Bonds?
Conventional wisdom is that stocks are a better place to be when the economy
is expanding and interest rates are rising. The charts below show stocks (SPY)
relative to bonds (AGG). The conviction to own stocks over bonds was stronger
on July 4 than it is today. In fact, the basket of bonds is beating the S&P
500 this week.
Since weekly charts only plot one point per week (Friday's close), the look
of the charts above after the bell Friday is more important than intraweek.
GDP And The Fed
Wednesday started with a better than expected reading on the U.S. economy,
which increased jitters heading into the 2:00 p.m. EDT Federal Reserve statement.
From Bloomberg:
Today's Commerce Department report showed gross domestic product expanded
at a 4 percent annual pace in the second quarter, confirming the Fed's
view that a first-quarter contraction was transitory. Consumers, whose
spending accounts for 70 percent of the economy, have grown more confident
as the labor market improves and rising share prices boost wealth. "The
GDP print this morning had given the market some pause as to how hawkish
the Fed might be," Stacey Nutt, chief investment officer at ClariVest Asset
Management LLC in San Diego, California, said in an interview. "Now it
seems like they were not as hawkish as feared."
Investment Implications - The Weight Of The Evidence
Our approach is fairly simple, since the risk of bad things happening is marginally
higher today, we prefer to take less risk than what we were willing to accept
on July 4. Less risk does not mean "bearish", "no risk", "short", or "100%
bonds". It simply means a lower allocation to stocks (VTI) and a slightly higher
allocation to cash and bonds (TLT). If stocks are backed by improving conviction
in the coming weeks, we are happy to increase the equity side of our portfolios.
Conversely, if the charts continue to roll over in a bearish manner, we have
already taken the first risk-reducing step. Currently, the weight of the evidence
says, "stay long for the most part, but it is prudent to pay closer attention
until things improve." We will enter Thursday's session with a flexible and
open mind.
