Fed Chair Janet Yellen continues to be the fairy godmother of the bull market.
She proved so yet again last Wednesday when she sprinkled more fairy dust on the market, sending the S&P 500 up 1.7% from Tuesday’s close through the end of the week.
Yellen joined the Fed as vice chair in October 2010. She was promoted to chair of the Fed on February 13, 2014. Debbie and I have been keeping track of the performance of the stock market after she spoke about monetary policy and the economy either in a speech, congressional testimony, or a press conference. More often than not, stock prices rose. The same can be said about the performance of stocks following FOMC meetings since the start of the bull market.
Stock market sages say “Don’t fight the Fed” and it’s best to invest when “the Fed is your friend.” The Fed has been very friendly since the start of the bull market. The FOMC did terminate QE at the end of October 2014, but it stuck with NZIRP (near zero interest rate policy) until December of last year when the federal funds rate was raised ever so slightly from 0.00%-0.25% to 0.25%-0.50%. That’s still awfully close to zero.
However, the Fed’s December “dot plot” forecast signaled four rate hikes this year, and two Fed officials (Fed Vice Chair Stanley Fischer and FRB-SF President John Williams) warned at the beginning of this year that markets should take that forecast seriously. Investors scrambled to avoid fighting the Fed as the S&P 500 plunged by 10.5% from the start of the year through February 11.
The two officials backed off, and last week’s dot plot
showed that FOMC officials now expect only two rate hikes this year. In other words, the Fed decided not to fight the market, which is one reason why the S&P 500 is up 12.1% since February 11. The Fed is once again a very solicitous friend of stock investors indeed. And Janet Yellen remains the Fairy Godmother of the Bull Market.
Our faith in her helped us to nail last week’s FOMC meeting. On 3/8, we wrote: “We think they will back off from predicting four rate hikes this year and converge around two to three hikes.” Last Wednesday morning, we wrote: “More likely is that Fed officials will remain vague about their intentions, fearing that rate-hike talk might disturb financial markets again. Besides, why not postpone monetary normalization for a while now that the labor markets are showing more signs of normalizing, as lots of people who had dropped out of the labor force are reentering it and finding jobs?
“What about the rebounds in the core PCED, oil prices, and expected inflation? Melissa and I won’t be surprised if Fed officials start talking about their willingness to overshoot their 2% inflation target for a while, while the labor market continues to improve.
“If Fed officials adopt this dovish stance, then stock prices should move still higher. Even a melt-up is conceivable in this scenario. Commodity prices would continue to rise while the dollar falls still lower.” So far, so good.
Let’s review the latest developments:
The CRB raw industrials spot price index troughed on November 23 of last year. It is up 10% since then, led by its metals subcomponent, which is up 18%. The index rose smartly at the end of last week after the FOMC’s dovish meeting.
The CRB index is highly inversely correlated with the trade-weighted dollar, which continued to fall last week from a recent peak on January 20. The latter is now down 5% since then, and up just 2% y/y, though it is still up 17% since July 1, 2014. The trade-weighted dollar is also highly inversely correlated with the price of a barrel of Brent crude oil, which is up 48% since bottoming on January 20.
While the lower dollar is helping to boost commodity prices, the stronger euro and yen are frustrating the attempts of both the ECB and BOJ to boost their economies and inflation rates with negative interest rates.
The 10-year Treasury bond yield bottomed this year, so far, at 1.63% on February 11. It briefly touched 2.00% a few hours before the FOMC statement was released on Wednesday afternoon. Now it is back down to 1.88%. The BofA Merrill Lynch corporate junk bond yield composite is down from its recent peak of 10.1% on February 11 to 8.1% on Friday.
(4) U.S. stocks.
The dramatic rebound in stock prices in the latest relief rally has been led by valuation multiples as investors flipped from a risk-off to a risk-on stance. The Fed’s dovishness certainly confirms the recent prescience of the stock market. The S&P 500’s forward P/E rose to 16.5 on Friday, up from 14.7 on February 11. Over the same period, the valuation multiple for the S&P 400 MidCaps soared from 14.8 to 17.2, while it jumped from 15.2 to 17.9 for the S&P 600 SmallCaps.
Any further advance in stock prices would increasingly push the market into melt-up territory given that forward earnings are likely to remain stalled for the S&P 500/400/600, as they have been since the second half of 2014. The lower dollar and higher commodity prices should take some of the downward pressure off of earnings, but weak global economic activity will continue to weigh on them.
(5) Foreign stocks.
If the euro and yen continue to rally, that could depress the relative performance of stocks in the Eurozone and Japan. Here is the ytd performance derby of the major MSCI stock price indexes in local currencies: Emerging Markets (2.2%), US (-0.2), UK (-0.7), EMU (-5.7), and Japan (-13.5).
Emerging markets’ currencies have also rebounded, with their MSCI currency index up 5.9% from its nearly seven-year low on January 20. However, their MSCI stock price indexes are up 14.3% in local currencies and 20.1% in dollars since January 21. That’s mostly because they both remain highly correlated with the CRB raw industrials spot price index. Of course, that means that they are highly inversely correlated with the trade-weighted dollar.
Dr. Ed Yardeni
is the President of Yardeni Research, Inc., a provider of independent global investment strategy research. To read more of his blogs, CLICK HERE NOW.
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