Fed Embarks on Rollover Strategy
As is its practice, the Federal Reserve telegraphed yesterday’s move with a few well-placed journalists. Reports late last week suggested the Fed might take a step back toward easing mode by reinvesting as its bond portfolio reaches maturity. Nobody complained too loudly, so the Fed confirmed the rumors in Tuesday’s announcement. The net result of the rollover strategy is that the Fed’s balance sheet will stay constant rather than gradually shrink. The amounts involved are relatively small, but the symbolism is important. Ben Bernanke is doing what little he can.
The Fed’s change of opinion came remarkably fast. This is evident in a comparison of this week’s statement with the one from June 23. Less than two months ago, the FOMC thought “that the economic recovery is proceeding and that the labor market is improving gradually.” Now, they say “The pace of recovery in output and employment has slowed in recent months.” Of course a “slower pace” of recovery is still a recovery. Nevertheless, the Fed came as close as it ever does to admitting a mistake with this line from Tuesday’s statement: “The pace of economic recovery is likely to be more modest in the near term than had been anticipated.”
One could reasonably ask, of course, whether the Fed may be unduly pessimistic. This is, after all, the same Fed that did not see the housing bubble forming or a severe recession coming until it was already upon us. Their forecasting record is not exactly flawless. Could the official negativity be a contrarian signal that the worst is now behind us? Possibly, but we would not bet on it. The stock market has held up because profits have held up, and profits have held up only because of ruthless cost-cutting at public companies. Declining worker productivity numbers suggest that further growth will require businesses to increase their payrolls. Stock valuations may have a hard time staying up once the cash hoard begins to be spent down. Today’s sharp decline in the major benchmarks could be a sign that this process is getting underway.
Interest rates are falling through the floor. Today, the ten-year Treasury yield dropped below 2.7% for the first time since April 2009, ending at 2.685%. More astonishingly, the two-year T-note rate is now below 0.5%. With the difference between two-year and ten-year rates now only about 2.2 percentage points, the yield curve is uncharacteristically flat and getting flatter. The U.S. Dollar had its biggest one-day surge against the Euro in almost two years as the Fed action made investors rethink prospects for global recovery. Gold prices were up early in the day Wednesday but then fell back by the close. Markets are clearly at some kind of inflection point, one which was already forming even before the Federal Reserve news. Now we will see which trends change, and in what direction.
Sector momentum rankings had only minor changes since last week. Materials, Telecom and Utilities are in a near-tie at the top of the list. Financials and Technology lost a little ground. Health Care made a nice jump out of last place but is still below average. All sectors are now in at least slight uptrends but, as we noted last week, the best-performing sectors are relatively small in terms of capitalization. This means that few investor portfolios are performing anything like the best sectors might suggest.
Our relative Style category rankings are not quite as flat as they were a week ago but the spread between best and worst is still historically small. Mid Value is still on top with several other groups right behind. The Small Growth category slid down six positions in the list. Micro Cap weakened further and still owns last place.
The International rankings look a lot like they did last week, in both absolute and relative terms. The U.K., Europe and Emerging Markets continue to hold the top three positions while Japan, the U.S. and Canada are on the bottom. Most of the world markets we track held their own and all are trending higher, at least in U.S. Dollar terms. Latin America – which is mainly Brazil – is also near the top of the list and is exerting its influence on the broader Emerging Markets benchmark.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“There are plenty of things for investors to worry about.”
David Kelly, JPMorgan
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