Good Evening: Today’s action in the capital markets did not appear very remarkable on the surface, but it did reveal once again that investors are (for now) willing to be patient with worsening economic fundamentals. The minutes of the last FOMC meeting seemed to reassure the markets that the Committee would keep their collective feet on the monetary gas pedal for as long as they deem necessary to ensure an economic recovery. How long market participants may have to wait until this blessed day arrives was missing from the text.
U.S. equity futures had a modest bid prior to this morning’s open, and the major averages popped for gains of between 0.5% and 1% shortly after the bell rang at the NYSE. A trio of economic data points hit thirty minutes into the session, and the numbers were almost uniformly weak (see below). Factory orders were expected to take a 2.5% hit, so the report showing they dropped 4.6% was definitely unwelcome, as was a much weaker than expected pending home sales figure for November. If housing is still at the epicenter of what ails our economy and financial institutions, then there was no relief to be found in this forward-looking report. The lone bright spot was the ISM services survey, which, while weak, wasn’t as feeble as had been feared.
Stocks eased back to the unchanged mark and even went red for a short spell before trading mostly sideways until the FOMC minutes were released (see below). I must have misplaced my rose-colored glasses because I didn’t see much hope in the text. Perhaps it was enough for market participants to know that the Fed is on the job, and they pushed equities back toward the highs for the day in response. A small bout of profit taking reduced those gains by the closing bell, leaving the averages up between 0.7% (Dow) and 2.5% (Dow Transports). Treasurys were down again this morning, but they managed to stage a small comeback after the FOMC release. Yields fell between 1 and 4 bps as the coupon curve flattened a smidge. The dollar continued its 2009 advance, and, once again, commodity prices rose in spite of the firm greenback. Energy prices fell back after an early rally failed, but there was more than enough strength in the grain and metals complexes to boost the CRB index by just more than 2%.
It may be a stretch to say there was a message embedded in today’s market action, but it appears the forces of belief are still in ascendancy. Since the November lows, the economic data has only gone from bad to worse. And yet, stocks have rallied (26% and counting in the S&P 500, while the Russell 2000 is up a hefty 38%), Treasurys have pulled back a bit, credit spreads have inched in, commodities have risen off the mat, and volatility (especially the VIX) has headed south. Perhaps the minutes of the FOMC meeting offer a clue as to why investors are edging back into riskier assets. The Fed’s moves back in December were fairly bold; it seemed at the time they were going “all in” to fight the economic fallout from the financial crisis. But the minutes released today had in them a whiff of panic, and it is precisely that fear in the Eccles building that comforts investors. Toss in President-elect Obama’s stimulus proposal, and market participants seem to be hoping are troubles will be behind us come summertime.
Even currency traders are currently voting this way, and the emerging consensus is that the U.S. will be the first country out of the financial and economic morass in which most of the globe is now mired. It could indeed play out this way, but I think it is too much to hope that we simply sail ahead from here. Disbelief will once again rear its ugly head, challenging Bernanke & Co. and thus forcing investors to consider less rosy outcomes. If the Fed, as BofA/Merrill’s David Rosenberg points out, is “writing off 2009”, then it’s not too hard to imagine investors losing patience at some point. A big test looms with this Friday’s unemployment report. If the U.S. manages to misplace another 500K+ workers, those believing in a second half recovery will probably at least scan the room for the nearest exit door. A less gruesome figure, however, might lead to another leg up in the rally now under way. I’ll retain my friendly bias toward risk assets for now, but I think prudence demands that I do more than keep an eye on the exits. By Friday, I’ll be standing right next to one.
— Jack McHugh
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U.S. Federal Reserve Meeting Minutes for December 16 (Text)
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