Did QE Work?

Almost exactly six years ago the Federal Reserve launched an unconventional program of buying bonds to rescue a faltering economy. Since then, the Fed’s balance sheet has ballooned by $3.5 trillion, close to 25 percent on the nation’s gross domestic product. The central bank is expected to announce the end of the program, known as Quantitative Easing, when it concludes a two-day policy meeting this week. So did QE work? To answer that question, we have to review the policy’s two goals: (1) to restore the functionality of markets, which had essentially locked up amid the financial crisis and (2) to boost the economy by lowering interest rates.

There is no doubt that the first round of QE, which began in November 2008 and the second round, which ran from August 2010 – June 2011, eased the strain in markets. According to Joe Gagnon, Senior Fellow at the Peterson Institute for International Economics, QE also “inspired confidence and…it convinced financial markets that the United States wouldn’t turn into Japan, which they were worried about.” The net result is that markets did start functioning more smoothly.

According to a Federal Reserve Board study, those first two rounds of QE also boosted economic growth. The bond buying “raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred…the incremental contribution of the program is estimated to grow to 3 million jobs.” Additionally, Bill McBride of Calculated Risk estimates that QE probably lowered interest rates by 0.50 percent, allowing consumers and companies to refinance their higher interest debt, thus reducing monthly payments and improving monthly cash flow.

There have been a few couple of criticisms of QE, including that it artificially boosted stock prices because investors were dissuaded from investing in bonds; it penalized savers, who have been staring at zero percent rates on their savings, checking and CD accounts; and it will ultimately lead to rampant inflation and a weaker US dollar.

Despite these concerns, it seems like doing nothing would have been far worse. Sure, stock prices are trading higher than they might have without QE, but where would they be if the economy were stuck in an even lower gear? And yes, savers have taken it on the chin, but hopefully, they were not damaged as much in the downturn because of those nest eggs. And while concerns about potential inflation are always important to consider, there is absolutely no evidence of inflation in the US economy to date – in fact, recent reports point to a slowdown in prices, not an acceleration.

QE may not have been the perfect policy solution, but in an environment where the government was a roadblock (anyone who thinks that austerity would have been the correct policy solution should take a look at how well it has played out in the eurozone), QE was far better than doing nothing.

MARKETS: Investors snapped a four-week losing streak, as earnings took center stage. With 208 S&P 500 companies reporting, the index is on track for 5.6 percent earnings growth from last year, according to FactSet. That compares with expectations for 4.5 percent growth before earnings season started.

• DJIA: 16,805 up 2.6% on week, up 1.4% YTD
• S&P 500: 1964, up 4.1% on week, up 6.3% YTD (largest weekly percentage gain since Jan 2013)
• NASDAQ: 4483, up 5.3% on week, up 7.4% YTD (largest weekly percentage gain since Dec 2011)
• Russell 2000: 1118, up 3.4% on week, down 3.9% YTD
• 10-Year Treasury yield: 2.27% (from 2.2% a week ago)
• December Crude Oil: $81.01, down 1.3% on the week (4^th weekly loss, down 20% from June)
• December Gold: $1231.80, down 0.6% on the week
• AAA Nat'l average price for gallon of regular Gas: $3.06 (from $3.31 a year ago)

THE WEEK AHEAD: With worries about global growth slowing down, investors are eagerly awaiting the first estimate of third quarter growth. The economy likely expanded at an annualized rate of 3 percent, which would be down from the Q2 reading of 4.6 percent, though an improvement from the 2.2 percent pace averaged so far in this expansion.

Mon 10/27:

Amgen, Merck, Twitter

10:00 Pending Home Sales

Tues 10/28:

Dupont, Facebook, Pfizer, Sirius/XM

8:30 Durable Goods Orders

9:00 S&P Case-Shiller HPI

10:00 Consumer Confidence

FOMC Meeting Begins

Weds 10/29:

Hershey, Kraft, Visa

2:00 FOMC Meeting Announcement (no presser)

Thurs 10/30:

Conoco Phillips, GoPro, Kellogg, LinkedIn, Mastercard, Time Warner Cable

8:30 Weekly Jobless Claims

8:30 Q3 GDP – First Estimate

Fri 10/31:

Chevron, Exxon Mobil

8:30 Personal Income and Spending

9:45 Chicago PMI

9:55 Consumer Sentiment

Financial Crisis Anniversary: A Short History of QE

Happy Anniversary! Six years ago this week, the US financial system was brought to its knees. Over the course of seven days, Lehman Brothers filed for bankruptcy; Bank of America said it would buy Merrill Lynch; Goldman Sachs and Morgan Stanley became bank holding companies; the Federal Reserve bailed out insurance giant AIG; the Treasury Department had to insure money-market funds; and the government submitted its first draft legislation of TARP. Yeah, that all happened in one week! Two months after that momentous week, the economic downturn, which started in December 2007, accelerated. In an effort to create liquidity in the bond market and to help rescue the economy from plunging into the abyss, the Federal Reserve took the aggressive and unusual step of buying mortgage backed bonds, and eventually expanded the program to include government bonds.

As a reminder, here’s a short history of the central bank’s bond buying stimulus plan, known as “Quantitative Easing” or “QE”:

• November 2008: The first 15-month period of QE begins with purchases of mortgage securities, later expanded to include Treasury debt
• August 2010: Fed launches QE2 with a defined $600B target
• June 2011: Fed completes QE2
• September 2011: Fed announces “Operation Twist,” which allows the central bank to swap short term Treasuries for long-term ones
• September 2012: Fed launches QE3 and extends its intention to maintain low short-term interest rates until mid-2015
• December 2012: Fed announces that QE3 would be open-ended at $85B/month and that outright Treasury purchases would replace Operation Twist.
• June 2013: Fed Chair Bernanke announces that QE would wind down later in 2013 and would likely conclude by mid-2014, provided that the economy improves
• December 2013: Fed officials began the process of unwinding their bond-buying program by reducing purchases by $10 billion dollars to $75 billion

Six years later, the Fed strategy continues, but the central bank is in the process of unwinding the third version of that bond-buying program. The central bank will conduct a two-day policy meeting this week, where it is widely expected to announce another $10 billion cut, reducing monthly purchases to $15 billion. If you are doing your Fed math (or can subtract), you will quickly realize that QE3 will likely end at the October 29^th meeting.

And just like that, the Fed will have undone its historic policy and will return to its more mundane tool of manipulating short-term interest rates to fight inflation.

Remember way back in March, when Janet Yellen made her first and now-famous snafu? She said that the central bank might start increasing short-term rates “six months” after the conclusion of QE3, which would put the first hike in April of next year. Investors freaked out and sold stocks and bonds, because that time horizon was sooner than previously projected.

Those who think rationally might think, “If the data show that the economy is improving and as a result, the Fed increases short term interest rates, isn’t that a good thing?” You might think so, but so much of the recovery stock market rally has been predicated on zero percent interest rates, which have made equities the most favored asset class.

So how will markets react to higher rates? According to Capital Economics, “The S&P 500 rose by an average of about 5 percent in the six months before the first rate hike in each of the last seven major tightening cycles [1971, 1976, 1984, 1986, 1994, 1999, 2004]…And it also gained an average of about 5 percent in the nine months after the first hike.”

That said, it’s hard to count on the rally continuing indefinitely and although nobody wants to say it, this time is different, since this rate hike cycle follows a once-in-a-generation financial meltdown and large-scale asset purchases by the Fed. Fasten your seat belts…it’s going to be a bumpy ride.

MARKETS: Stock indexes snapped a 5-week winning streak.

• DJIA: 16,987 down 0.9% on week, up 2.5% YTD
• S&P 500: 1985, down 1.1% on week, up 7.4% YTD
• NASDAQ: 4467, down 0.3% on week, up 9.4% YTD
• 10-Year Treasury yield: 2.61% (from 2.46% a week ago)
• October Crude Oil: $92.27, down 1% on the week
• December Gold: $1231.50, down 2.8% on the week
• AAA Nat'l average price for gallon of regular Gas: $3.40 (from $3.54 a year ago, lowest since Feb)

THE WEEK AHEAD:

Mon 9/15:

OECD releases its global economic outlook

8:30 Empire State Manufacturing

9:15 Industrial Production

Tues 9/16:

8:30 Producer Price Index

FOMC 2-day policy meeting begins

Weds 9/17:

8:30 Consumer Price Index

10:00 Housing Market Index

2:00 FOMC concludes/Fed economic projections

2:30 Fed Chair Yellen Press Conference

Thurs 9/18:

8:30 Weekly Jobless Claims

8:30 Housing Starts

10:00 Philadelphia Fed Survey

Alibaba prices its IPO – could be largest IPO in US history

Scotland votes on a referendum on independence, which would break up the 307-year-old U.K. and plunge Britain into a constitutional crisis. Voting concludes at 5:00pm ET

Fri 9/19:

Apple releases iPhone6

10:00 Regional/State Unemployment

Quadruple Witching: simultaneous expiration stock index futures, individual stock futures, stock index options and individual stock options

Sat 9/20

G-20 finance ministers and central bankers meet in Cairns, Australia

Dow and S&P Reach Milestones: Bubble Fears Arise

The Dow pierced the 16,000 level for the first time ever - and perhaps more impressively, it made the jump from 15,000 to 16,000 in just six months. The S&P 500 poked above 1800 in less than 4 months after taking out 1700. To put the rapid rise into context, after first reaching 1500 in March 2000, it took the broad index 13 years to reclaim that level. For tech fans, the NASADAQ recently touched 4,000, a level not seen since September of 2000. Although the economy has improved and corporate profits continue to surpass expectations, the Federal Reserve is responsible for the lion’s share of the stock market’s move higher over the past year. Without low short-term interest rates (0 to 0.25 percent since December 2008) and $85 billion worth of monthly bond buying, it’s hard to build a case where stocks would be at these levels.

But we are where we are. The S&P 500 is up 26 percent this year and has risen by 166 percent since the March 2009 lows, which means that bubble fears are arising anew. The bears point to troubling signs, including: ordinary investors are finally buying back in -- money is pouring into stock mutual funds and exchange-traded funds at the highest rate in four years; investor sentient has become almost uniformly optimistic; borrowing to purchase stocks is at record levels; and the main gauge of investor fear is low. Some warn that taken together, investors are becoming complacent, setting everyone up for a correction, which is a pull-back of more than 10 percent.

But just because a correction could be coming, does not mean you should bail out. If you are a long-term investor with a 15 or 20-year time horizon, there is no reason to alter your game plan – use the new highs to rebalance and keep investing in a diversified portfolio. But if you are the kind of person who simply cannot handle the ups and downs of the stock market, remember that just because stocks are higher, does not make them any safer. Please use caution before jumping back in!

Even if new milestones don’t really mean too much, I am happy to use them as an opportunity to remind you to review where you stand, create a target allocation and force yourself to rebalance according to your goals.

Here's what smart money has known forever--the quicker you learn these rules, the better:

Don’t let your emotions rule your financial choices. There are two emotions that tend to overly influence our financial lives: fear and greed. At market tops, greed kicks in and we tend to assume too much risk. Conversely, when the bottom falls out, fear takes over and makes us want to sell everything and hide under the bed.

Maintain a diversified portfolio. One of the best ways to prevent the emotional swings that every investor faces is to create and adhere to a diversified portfolio that spreads out your risk across different asset classes, such as stocks, bonds, cash and commodities. (Owning 5 different stock funds does not qualify as a diversified portfolio!)

Avoid timing the market. Repeat after me: “Nobody can time the market. Nobody can time the market.” One of the big challenges of market timing is that requires you to make not one, but two lucky decisions: when to sell and when to buy back in.

Stop paying more fees than necessary. Why do investors consistently put themselves at a disadvantage by purchasing investments that carry hefty fees? Those who stick to no-commission index mutual funds start each year with a 1-2 percent advantage over those who invest in actively managed funds that carry a sales charge.

Limit big risks. If you are going to make a risky investment, such as purchasing a large position in a single stock or making an investment in a tiny company, only allocate the amount of money you are willing to lose, that is, an amount that will not really affect your financial life over the long term. Yes, there are people who invest in the next Google, but just in case things don’t work out, limit your exposure to a reasonable percentage (single digits!) of your net worth.

Ask for help. There are plenty of people who can manage their own financial lives, but there are also many cases where hiring a pro makes sense. Make sure that you know what services you are paying for and how your advisor is compensated. It’s best to hire a fee-only or fee-based advisor who adheres to the fiduciary standard, meaning he is required to act in your best interest. To find a fee-only advisor near you, go to NAPFA.org.

For those who want to protect their portfolios against the eventual rise in interest rates, you may be tempted to sell all of your bonds. But of course that would be market timing and you are not going to fall for that, are you? Here are alternatives to a wholesale dismissal of the fixed income asset class:

Lower your duration. This can be as easy as moving from a longer-term bond into a shorter one. Of course, when you go shorter, you will give up yield. It may be worth it for you to make a little less current income in exchange for diminished volatility in your portfolio.

Use corporate bonds. Corporate bonds are less sensitive to interest-rate risk than government bonds. This does not mean that corporate bonds will avoid losses in a rising interest rate environment, but the declines are usually less than those for Treasuries.

Explore floating rate notes. Floating rate loan funds invest in non-investment-grade bank loans whose coupons “float” based on the prevailing interest rate market, which allows them to reduce duration risk.

Keep extra cash on hand. Cash, the ultimate fixed asset, can provide you with a unique opportunity in a rising interest rate market: the ability to purchase higher yielding securities on your own timetable.

Week ahead: Will Yellen Pump or Pop Bubbles?

Is Janet Yellen a bubble pumper or bubble popper? That’s what some lawmakers wanted to know when the presumptive heir to the Fed Chairmanship appeared before the Senate Finance Committee last week. Considering that the S&P 500 is up 166 percent from the March 2009 lows, some are worried that the Fed’s aggressive monetary policies are far more responsible for boosting stocks than the recovering economy and improving corporate profits. To her credit, instead of pulling out the Greenspan/Bernanke mantra of “we can’t identify bubbles, but we will clean up after they burst,” Yellen said that nobody, including any of the fed officials, wants to go through another 2008 again. While she does not currently see evidence of a bubble-like environment “that threatens financial stability…I think it is important for the Fed, hard as it is, to attempt to detect asset bubbles when they are forming.”

Senator Bob Corker (R-TN), who is no fan of the Fed, Bernanke or the current central bank policies, asked Yellen whether she would have the guts to prick a bubble. Yellen said that the central bank could let the air out of the bubble by employing regulatory measures, like restricting leverage, and, if necessary, it could raise interest rates. Corker interrupted her and asked the money question: With a bull market raging, would you have the mettle to use these unpopular measures? “I believe that I would,” Yellen said. “I believe that is the most important lesson learned from the crisis.”

Bubble popper it is!

The rest of the Senate appearance was pretty much what you would expect: a defense of the monetary policy that Yellen helped create. She said that the Fed’s bond buying program had “made a meaningful contribution to economic growth and improving the outlook” and said that when there has been progress in labor market, the Fed would reduce its purchases.

As the confirmation process continues, investor attention will shift to the current chair, Ben Bernanke this week. He will deliver a major speech on Tuesday night, which along with the release of the minutes from the last policy meeting could contain clues about future central bank actions. Specifically, everyone wants to know whether there are specific metrics that would lead to a change in policy.

While the central bank maintains that the current game plan is necessary, there are risks to the strategy. At every meeting, Fed officials weigh the benefits of quantitative easing (QE) versus the costs, which include managing a ballooning balance sheet and the threat of higher inflation in the future. The Fed’s purchase of mortgage-backed and treasury securities, has so far left the central bank holding $3.86 trillion in assets. Defenders of the policy say that the Fed can simply sell those assets in the future, but doing so could mean absorbing significant losses, since the Fed would likely be selling as bond prices were falling. In theory, the Fed has other policy options, but they have never been tested, which makes economists a bit nervous about their efficacy.

One group not showing signs of nerves is investors. All of the sudden, Mom and Pop are getting back in the game. According to Strategic Insight, inflows into stock mutual funds and Exchange-traded funds are on track for a total of $450 billion for 2013, which would be more than the last four years’ inflows. Of course, the idea that regular people are jumping back in after 56-month, 166 percent bull-run may mean that the market could be setting everyone up for a correction (a pull-back of more than 10 percent). Then again, the technology bull market lasted from October 11, 1990 until March 24 2000, resulting in a 417 percent gain, so maybe the bull has more upside.

MARKETS: For the sixth consecutive week, the Dow and S&P 500 closed higher and at new all-time nominal high levels.

• DJIA: 15,961, up 1.3% on week, up 21.8% on year
• S&P 500: 1798, up 1.6% on week, up 26% on year
• NASDAQ: 3986, up 1.7% on week, up 32% on year (briefly touched 4,000 for the first time since Sep 2000)
• 10-Year Treasury yield: 2.71% (from 2.75% a week ago)
• Dec Crude Oil: $93.84, down 0.8% on week (6^th consecutive losing week)
• Dec Gold: $1287.40, up 0.2% on week
• AAA Nat'l average price for gallon of regular Gas: $3.21

THE WEEK AHEAD:

Mon 11/18:

10:00 NAHB Builder Index

Tues 11/19:

7:00pm Bernanke speech to NABE

Weds 11/20:

8:30 Retail Sales

8:30 CPI

10:00 Existing Home Sales

10:00 Business Inventories

2:00 FOMC Minutes

Thurs 11/21:

8:30 Jobless claims

8:30 PPI

10:00 Philadelphia Fed Survey

Fri 11/22:

10:00 Job Openings and Labor Turnover (JOLTS)

Dow, S&P Records: What to do now

For the 26th time this year, the Dow finished at an all-time nominal closing record and the broader S&P 500 saw it’s 20th record close of the year. This year, stocks are up about 18 percent – an amazing performance, but (buzz-kill alert) we there is still quite a ways to go to reclaim new highs, when adjusted for inflation: the Dow has to rise above to 15,730 and the S&P 500 has an even steeper climb to over 2,000. Don’t even start to calculate the NASDAQ, which needs to add another 1425 points to get back to the nominal closing high. We all know that Ben Bernanke’s Federal Reserve is responsible for the lion’s share of the stock market’s move higher. Without low short-term interest rates (0 to 0.25 percent since December 2008) and $85 billion worth of monthly bond buying, it’s hard to build a case where stocks would be at these levels. That’s why all eyes have been on Bernanke over the past 8 weeks, as he has tried to explain under what circumstances the central bank would taper its bond purchases.

There will be another chance for a taper-tantrum this week, when Bernanke provides his semi-annual testimony to the House and Senate. That means you have a couple of days to force yourself to rebalance your investment accounts.

Remember that just because stock are up, does not make them safe. If you are the kind of person who simply cannot handle the ups and downs of the stock market, then your inclination is probably to avoid stocks at all costs. But what if you kept your stock allocation to a level where they gyrations didn’t cause you to lose sleep? Maybe a stock allocation of 10 to 20 percent of your portfolio would allow you partially participate over time, but not get your hat handed to you if/when the bottom falls out.

Even if new records don’t really mean too much, I am happy to use them as an opportunity to remind you to review where you stand, create a target allocation and force yourself to rebalance according to your goals.

Here's what smart money has known forever--the quicker you learn these rules, the better:

Don’t let your emotions rule your financial choices. There are two emotions that tend to overly influence our financial lives: fear and greed. At market tops, greed kicks in and we tend to assume too much risk. Conversely, when the bottom falls out, fear takes over and makes us want to sell everything and hide under the bed.

Maintain a diversified portfolio. One of the best ways to prevent the emotional swings that every investor faces is to create and adhere to a diversified portfolio that spreads out your risk across different asset classes, such as stocks, bonds, cash and commodities. (Owning 5 different stock funds does not qualify as a diversified portfolio!)

Avoid timing the market. Repeat after me: “Nobody can time the market. Nobody can time the market.” One of the big challenges of market timing is that requires you to make not one, but two lucky decisions: when to sell and when to buy back in.

Stop paying more fees than necessary. Why do investors consistently put themselves at a disadvantage by purchasing investments that carry hefty fees? Those who stick to no-commission index mutual funds start each year with a 1-2 percent advantage over those who invest in actively managed funds that carry a sales charge.

Limit big risks. If you are going to make a risky investment, such as purchasing a large position in a single stock or making an investment in a tiny company, only allocate the amount of money you are willing to lose, that is, an amount that will not really affect your financial life over the long term. Yes, there are people who invest in the next Google, but just in case things don’t work out, limit your exposure to a reasonable percentage (single digits!) of your net worth.

Ask for help. There are plenty of people who can manage their own financial lives, but there are also many cases where hiring a pro makes sense. Make sure that you know what services you are paying for and how your advisor is compensated. It’s best to hire a fee-only or fee-based advisor who adheres to the fiduciary standard, meaning he is required to act in your best interest. To find a fee-only advisor near you, go to NAPFA.org.

For those who want to protect their portfolios against the eventual rise in interest rates, you may be tempted to sell all of your bonds. But of course that would be market timing and you are not going to fall for that, are you? Here are alternatives to a wholesale dismissal of the fixed income asset class:

Lower your duration. This can be as easy as moving from a longer-term bond into a shorter one. Of course, when you go shorter, you will give up yield. It may be worth it for you to make a little less current income in exchange for diminished volatility in your portfolio.

Use corporate bonds. Corporate bonds are less sensitive to interest-rate risk than government bonds. This does not mean that corporate bonds will avoid losses in a rising interest rate environment, but the declines are usually less than those for Treasuries.

Explore floating rate notes. Floating rate loan funds invest in non-investment-grade bank loans whose coupons “float” based on the prevailing interest rate market, which allows them to reduce duration risk.

Keep extra cash on hand. Cash, the ultimate fixed asset, can provide you with a unique opportunity in a rising interest rate market: the ability to purchase higher yielding securities on your own timetable.

Week ahead: Earnings, Boomerang Stocks, Bernanke to Capitol Hill

Let's start at the very beginningA very good place to start When you read you begin with A-B-C When you sing you begin with do-re-mi

- The Sound of Music (1959, music by Richard Rodgers, lyrics by Oscar Hammerstein II)

Investors used to think that starting at the very beginning meant examining corporate earnings. After all, buying stock in a company (or through a stock mutual fund) is a bet that the company will increase its ability to earn money over time. Yet there is ample proof that companies are having a harder time making money by selling more goods and services and have instead been relying more on cost containment and financial engineering to meet their earnings objectives.

S&P 500 corporate profits are expected to rise 2.9 percent in Q1 vs. a year earlier, according to analysts polled by Thomson Reuters, which would be a slowdown from 5.4 percent in Q1 and 6.2 percent in Q4. But those diminished earnings are coming on projected revenue growth of only 1.6 percent. “If companies are having a harder time making money, then why is the stock market rising?” asked a caller to my radio show recently. The answer to that question requires that we start at another beginning…or with Ben Bernanke.

In January, I jotted down 7 reasons why the stock market rally could extend well into 2013:

(1) (2) (3) The Federal Reserve is maintaining its low interest-rate policies (including the monthly purchase of $85 billion worth of bonds) until employment improves substantially

(4) Japanese officials have started to address the country’s multi-decade economic stagnation

(5) Europe is no longer on the precipice of disaster

(6) The much-feared hard landing in China never came to fruition

(7) U.S. housing is finally contributing to economic growth

You get the joke…Ben Bernanke’s Federal Reserve is responsible for the lion’s share of the stock market move. Without easy monetary policy in place, all of the other factors would not have boosted stocks to the levels that we are seeing now. Last September, the Fed launched its current round of bond buying (QE3) and also said that it would maintain low short-term interest rates until mid-2015. The announcement and the subsequent December pledge to keep the program open-ended sparked a rally in global equities.

Everything was honky dory until May 22^nd, when during Congressional testimony, Bernanke raised the prospect that the central bank could downshift from its accommodative policies, if economic data were to improve. The subsequent 7½ weeks were volatile for every asset class, with most (bonds, gold, emerging stocks) heading lower. The exception has been the U.S. stock market -- the S&P 500 and Dow Jones Industrial Average tumbled about 7 percent from their intraday record highs in June, before recouping all of those losses and recording a new nominal closing high by the close of trading on Friday.

If the boomerang stock market started its journey with Bernanke’s comments, it makes sense that markets would return home after another Bernanke speech. In it, the Chairman underscored that the central bank would continue to pursue highly accommodative policies for the “foreseeable future,” due to a weak labor market and low inflation. This time, investors took Bernanke at his word.

This week’s key event puts Ben Bernanke back on the hot seat for his semi-annual testimony to the House on Wednesday and to the Senate on Thursday. It is expected that the Chairman will draw a distinction between tapering bond buying, which is likely to begin at either the September or December Fed meeting, if all goes well in the economy; and raising interest rates, which is not likely to occur until 2015. Bernanke and company will have a lot more data to chew on between now and the September 17-18 FOMC meeting, including two more employment reports.

Markets: The risk-on trade was ON…at least for another week. For the 25th time this year, the Dow closed at an all-time closing record. The S&P 500 hit its 19th record close of the year, and the NASDAQ hit its highest closing price since September 2000.

• DJIA: 15,464, up 2.2% on week, up 18% on year (Inflation adjusted high: 15,731)
• S&P 500: 1680, up 3% on week, up 17.8% on year (Inflation adjusted high: 2036)
• NASDAQ: 3600, up 3.5% on week, up 19.2% on year (All-time closing high 5,048 on 3/10/00)
• 10-Year Treasury yield: 2.59% (from 2.72% a week ago)
• Aug Crude Oil: $105.95, up 2.6% on week
• Aug Gold: $1277.60, up 5.4% on week
• AAA Nat'l average price for gallon of regular Gas: $3.58 (up $0.11 in a week)

THE WEEK AHEAD: Bernanke’s testimony and earnings season will dominate. Readings on Retail Sales are likely to show an increase, due to a spike in energy prices and consumer inflation at the core level should remain tame.

Mon 7/15:

Citigroup

China GDP

The trial of former Goldman Sachs employee Fabrice “Fab” Tourre begins. He is charged with misleading investors in a mortgage deal begins

8:30 Retail Sales

8:30 Empire State Manufacturing Survey

10:00 Business Inventories

Tues 7/16:

Goldman Sachs, Coca-Cola, Yahoo

8:30 CPI

9:15 Industrial Production

10:00 Housing Market Index

Weds 7/17:

American Express, Bank of America, BNY/Mellon, eBay, IBM, Intel

8:30 Housing Starts

10:00 Ben Bernanke testifies before House

2:00 Fed Beige Book

Thurs 7/18

Capital One, Google, Morgan Stanley, Verizon, Microsoft

8:30 Weekly Jobless Claims

10:00 Ben Bernanke testifies before Senate

10:00 Philadelphia Fed Survey

10:00 Leading Indicators

Fri 7/19:

GE, Honeywell, Schlumberger

Week ahead: Fed Up, geopolitical risk reemerges

The Labor Department said the U.S. economy created 195,000 jobs in June and the unemployment rate remained at 7.6 percent. There was something for everyone in the report. Optimists focused on the fact that employment is trending higher. The previous two months were revised up, bringing total monthly job creation to just over 200,000 this year, ahead of last year’s pace of 175,000. And although the unemployment rate remained steady, it did so by absorbing 177,000 new workers into the workforce. Pessimists will underscore that there are still 11.8 million Americans out of work and the quality of many of the jobs was weak, with 75,000 new positions coming from low paying jobs in the leisure and hospitality industry. As far as the rate holding steady, pessimists note that a slew of part-time workers (360,000), many of whom would likely prefer full-time employment, boosted the workforce. As a result, the broad unemployment rate (unemployed, disgruntled and part time workers who would prefer full-time) jumped from 13.8 percent to 14.3 percent in June.

On a low-volume day, the optimists won the day, interpreting the report as proof that the economy was improving, but not by so much that the Fed would alter policy before its September meeting. Stocks gained ground, but the bond market was less convinced as 10-year treasury prices slumped and yields increased to 2.72 percent, the highest level in almost two years.

Is this what the rest of the year is going to be like? Since May 22^nd, after Fed Chairman Ben Bernanke testified before Congress and raised the prospect that the central bank could downshift from its accommodative policies if economic data were to improve, investors have been throwing a “Taper Tizzy.” Every day is highlighted by the question, “When and by how much will the central bank taper its bond buying?”

This week, the Fed-funk is likely to continue, after the release of the minutes from the last policy meeting. You might recall that was the meeting after which Chairman Ben Bernanke attempted to soothe investors with more details about the conditions under which the Fed would take its foot off the gas. Instead of the intended calming effect, Bernanke inflamed the situation and volatility spiked across all asset classes.

Taking the Fed at its word, we know that the exit strategy is a work in progress, which will be driven by economic data. Capital Economics sees five stages of the Fed’s exit plans. From an investor perspective, these stages might seem to match Elisabeth Kübler-Ross’ “Five Stages of Grief”:

(1) Taper monthly asset purchases this fall (DENIAL)

(2) End bond purchases completely by mid-year 2014 (ANGER)

(3) Modify forward guidance language included in FOMC policy statement (BARGAINING)

(4) Raise short-term interest rates in 2015 (DEPRESSION)

(5) Begin to sell Fed’s holdings of Treasuries starting in 2017 (ACCEPTANCE)

Regardless of the exact timing and staging, these steps will occur and the quicker investors adapt and accept them, the better off they will be.

For those who were getting sick and tired of the constant Federal Reserve naval-gazing, there is something new to agitate raw nerves: geopolitical risk. In the two years since the Arab Spring, there hasn’t been much discussion of geopolitical risk, which is loosely defined as the risk that an investment's returns could suffer as a result of instability in a country, due to a change in government, legislative bodies, other foreign policy makers, or military control. The situation in Egypt has all of the components necessary to qualify and has already pushed up crude oil prices -- NYMEX crude breached $100 per barrel for the first time in over a year. Thankfully, those increases have not translated to higher prices at the pump yet.

As a reminder, Egypt is not a major oil producer and has been a net oil consumer of oil since 2008. However, its control of the Suez Canal and its proximity to large Middle East oil exporters puts investors on alert whenever there is political unrest. Approximately 2.5 million of barrels of crude oil pass through the Suez Canal or the Suez-Mediterranean (SUMED) pipeline each day. Any disruption to the flow of oil could have ripple effects throughout the region.

Markets: In a holiday-shortened week, stocks benefited from a surprise announcement from across the pond. For the first time, both the Bank of England and the European Central Bank provided investors with forward guidance. Both central banks will maintain their aggressive policies for an extended period.

• DJIA: 15,135, up 1.5% on week, up 15.5% on year
• S&P 500: 1631, up 1.6% on week, up 14.4% on year
• NASDAQ: 3479, up 2.2% on week, up 15.2% on year
• 10-Year Treasury yield: 2.72% (from 2.49% a week ago, yield now at 23-month high)
• Aug Crude Oil: $103.22, up 6.9% on week
• August Gold: $1212.70, down 0.9% on week
• AAA Nat'l average price for gallon of regular Gas: $3.47

THE WEEK AHEAD: Q2 earnings season kicks off this week. S&P Capital IQ predicts earnings to increase by 2.9 percent from the same period a year ago and for the full year to rise by 6.3 percent from 2012.

Mon 7/8:

Alcoa

3:00 Consumer Credit

Tues 7/9:

7:30 NFIB Small Business Optimism Index

Weds 7/10:

2:00 FOMC Minutes

4:10 Ben Bernanke delivers speech commemorating 100th anniversary of the Federal Reserve

Thurs 7/11

Bank of Japan rate decision

8:30 Weekly Jobless Claims

8:30 Import/Export Prices

Fri 7/12:

JP Morgan Chase, Wells Fargo

8:30 Producer Price Index

9:55 Consumer Sentiment

Week ahead: Halftime for economy: Bumpy ride ahead, jobs in focus

The first 6 months of the year is in the books, so it’s a perfect time to check in on the U.S. economy’s progress thus far, and to look ahead to the second-half of 2013. Economic growth: Recovery from the Great Recession has been sub-par (the post World War II growth rate for the U.S. is 3-3.5 percent), with growth averaging about 2 percent since 2010. Q1 growth was revised down to 1.8 percent from 2.4 percent and Q2 is expected to be similar to Q1, due to the lingering effects of sequestration. But economists believe that activity should pick up towards the end of the year and that total growth for 2013 will be between 2 and 2.5 percent. The pace of growth is due to accelerate to 3 percent next year, but this seems like a long way off.

Jobs: 5 months into the year job growth has been good, not great. The economy has added an average of 192,000 non-farm positions per month in 2013, ahead of the 175,000 monthly pace seen in the previous two years; and the unemployment rate has edged lower to 7.6 percent from 7.8 percent in December. Still, there are 11.8 million Americans out of work, 4.4 million of whom have been unemployed for more than 6 months. So while layoffs have tapered off, economic growth has been too weak to spur widespread hiring. Most economists predict that June job creation will be approximately 150,000 – 160,000, due to recent softness in manufacturing data.

Housing: Housing is finally recovering from the abyss. Sales have increased and prices have made great advances, though from low levels. The recent Case-Schiller house price index showed increases of 12 percent from a year ago, but housing experts note that double-digit advances are not sustainable, especially as mortgage rates have spiked and sellers will likely to return to the market in greater numbers. The slow down should not be read as another leg down in the housing market, but a new phase in which growth is normalized.

Consumers: The first half of the year has been pretty good for consumers. Americans' debt obligations have eased as a percentage of their disposable income, household net worth has surpassed its 2007 peak and consumer confidence shot up to the highest level since 2008. Still, incomes have remained mired at similar levels to where they were 10 years ago. But for tame inflation, stagnant wage growth would be a bigger concern.

Federal Reserve: We can divide Q2 into two periods: before May 22^nd, which I propose we call “BB” or “Before Bernanke” and after May 22^nd, which can be referred to “AB”, or “After Bernanke”.

• BB: From April to mid-May, stocks marched higher, due to the Fed’s easy monetary policies; a surprise announcement from the Bank of Japan about its own stimulus plans; better than expected corporate earnings; the continued recovery in housing; Europe stepping back from the precipice of disaster; and the much-feared hard landing in China never coming to fruition.
• B-Day (Bernanke Day): On May 22^nd Fed Chairman Ben Bernanke testified before Congress and raised the prospect that the central bank could downshift from its accommodative policies (which were intended to drive down borrowing costs, push up asset prices and encourage more investment, spending and hiring in the broader economy) prior to Labor Day, if economic data were to improve. On that day, the Dow reached a fresh intra-day nominal high of 15,542. The bond market had already started to price in future Fed action, as the yield on the 10-year treasury spiked to 2.12 percent at the end of May, from 1.62 percent earlier in the month.
• AB/Stocks: The balance of the quarter was highlighted by huge gyrations in all markets, due to worries about when the Fed might pull back on its bond-buying. The height of the anxiety occurred after the June 19Fed Open Market Committee meeting. The S&P 500 index fell 7 percent from its intraday record high, before recouping some of those losses and finishing the quarter 3.8 percent below the record high. The AB period was marked by rampant volatility, with the Dow logging 16 triple-digit moves in June, the most in a month since Oct 2011.
• AB/Bonds: The 10-year bond yield climbed as high as 2.66 percent, before settling at 2.49 percent at the end of the quarter. . Treasury bonds handed investors a loss of 2 percent this quarter, the worst quarterly decline since the fourth quarter of 2010. While the jump in yields and drop in price has been sudden, 2.5 percent is still considered a low level.

More on bonds: Historically, the yield of the 10-year runs 1.5 to 2 percentage points higher than the inflation rate, which would suggest yields should be closer to 3 percent, even higher than the current 2.5 percent. While the move in bonds has probably been more violent than the Fed would have expected, the central bank would like to see both stocks and bonds return to more normal pricing. For those worried that the recent rise in long-term interest rates will derail the recovery, it is worth remembering that when the bond market plummeted in 1994 and yields surged, the subsequent five years saw unusually strong economic growth and large gains in stock markets.

What to expect in the second half of the year: Market volatility is likely to remain elevated, as each economic report will be parsed through the lens of “What will the Fed think about this report?” Global markets have become dependent on the Fed's unprecedented accommodative policy, including its monthly purchase of $85 billion worth of bonds (QE3). Due to the unusual nature of the Fed’s stimulus plans, it is difficult to draw on previous periods to help predict how the change in policy will impact the economy and markets. The very fact that we have not been here before is creating investor uncertainty, which is why the anticipated shift in Fed policy will likely remain the chief investment concern for the balance of the year.

Markets: June was the first losing month of the year for stocks, but all three major averages logged their third winning quarter in four and remain solidly ahead for the year. The Dow has seen its strongest first half of the year since 1999 and the S&P 500’s first half performance is its best since 1998. Volumes could be light this week due to the Independence Day holiday, but there will be plenty of action on the calendar, including policy committee meetings by the Bank of England and the European Central Bank, and the monthly jobs report in the U.S.

• DJIA: 14,909, up 0.8% on wk, down 1.4% on month, up 2.3% on quarter, up 13.8% YTD
• S&P 500: 1606, up 0.9% on wk, down 1.5% on month, up 2.3% on quarter, up 12.6% YTD
• NASDAQ: 3403, up 1.4% on wk, down 1.5% on month, up 4.1% on quarter, up 12.7% YTD
• 10-Year Treasury yield: 2.49% (from 2.514% a wk ago, biggest quarterly selloff since Q4 2010, worst first-half  return (-2.1%) since 2009)
• Aug Crude Oil: $96.56, up 3% on week
• August Gold: $1223, down 5.3% on wk, down 23% on quarter (worst quarter since the start of modern gold trading in 1974), down 30% YTD)
• AAA Nat'l average price for gallon of regular Gas: $3.50

THE WEEK AHEAD:

Mon 7/1:

8:58 PMI Manufacturing Index

10:00 ISM Mfg Index

10:00 Construction Spending

Tues 7/2:

Motor Vehicle Sales

10:00 Factory Orders

Weds 7/3:

7:30 Challenger Job-Cut Report

8:15 ADP Employment Report

8:30 International Trade

1:00 US markets close early for Independence Day

Thurs 7/4: US MARKETS CLOSED FOR INDEPENDENCE DAY

Bank of England and ECB rate decisions

Fri 7/5:

8:30 Employment Report

8:30 Weekly Jobless Claims

Week ahead: Economic growing pains: Fed to remove punchbowl

I thought about this 2003 Roz Chast cartoon “Worry Tank,” as global markets collapsed in the aftermath of the Federal Reserve policy meeting and the Chairman’s subsequent news conference. It’s as if we are all worried that the economy is actually stronger than we thought - gasp! As a result, the Fed should be able to stop spiking the punchbowl later this year and eventually, it will remove the punchbowl altogether, and we will somehow learn to muddle through on our own. Poor Bernanke: Even when he’s trying to tell everyone that the economy is improving and Fed stimulus will eventually not be necessary to boost growth, asset values crater.

There is an irony in the timing of the market’s first 2013 convulsion and the Fed’s upgraded view: It comes on the four-year anniversary of the end of the recession. The Business Cycle Dating Committee of the National Bureau of Economic Research “Determined that a trough in business activity occurred in the U.S. economy in June 2009.” The 18-month recession that began in December 2007 was the longest of any recession since World War II.

Of course it wasn’t really the end: The ensuing four years have been highlighted by a slow and painful recovery, during which job losses continued, housing prices kept dropping and every step forward was met with at least two steps back. Even today, it’s hard to feel upbeat about an economy that will likely grow by about 2.5 percent this year and still has 11.8 million people out of work.

The Fed acknowledges that things aren’t all rosy, but four years into the recovery, the FOMC “sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall.” Progress, right? Not exactly, according to the reaction of global markets. After learning more details about how the central bank would taper its bond buying and the conditions under which a change in policy might occur, investors freaked out by selling stocks, bonds, commodities and just about anything else where a bid existed.

Was the sell-off an overreaction? Maybe not; after all, but for the Fed’s open-ended bond buying program launched last September, risk assets like stocks likely would not have soared to their recent highs and 10-year bond yields, which dropped to 1.62 percent in early May, would likely have been higher, according Scott Minerd, global chief investment officer at Guggenheim Partners. He recently noted that Fed buying had badly distorted the bond market and that “The yield on 10-year Treasuries would be roughly 150 basis points higher than it is today” without the Fed’s actions. (This comment was made prior to last week's pop in yields.) An improving economy plus the eventual exit of the Fed from the market may mean that the sell-off in bonds this week (the steepest weekly selloff in price and jump in yields in a decade) was warranted. As noted last week, a healthy economy should be able to manage a steady and expected rise in yields, versus a steep and a surprise one.

Mark Spindel founder and Chief Investment Officer of Potomac River Capital LLC in Washington, DC says without QE3, “The economy would be in worse shape than it is today. Unemployment would be higher - and inflation, which was already low and falling, would have been even lower and we may have even seen deflation.” That would obviously be an ugly backdrop for stocks, so in Spindel’s mind “QE3 has been responsible for almost the entire move higher in the equities market since last fall.” If he is correct, then the Fed’s policies may have delivered what was promised and we should quit complaining about a 5 percent drop from the recent highs.

Going forward, the ability of the stocks to recoup whatever is lost during this period will hinge on growth. If the economy can manage to power ahead, despite the lingering effects of sequestration and higher bond yields, then companies will make money and stocks will rise. If the economy slows, it may mean that the Fed keeps policy as is, which may not provide stocks with the same boost that we just saw, due to investor fear over “the Fed’s next move.”

Markets:

• DJIA: 14,799, down 1.8% on week, up 12.9% on year
• S&P 500: 1592, down 2.1% on week, up 11.7% on year
• NASDAQ: 3357, down 1.9% on week, up 11.2% on year
• 10-Year Treasury yield: 2.514% (from 2.126% a week ago)
• Aug Crude Oil: $93.69, down 4.5% on week
• August Gold: $1292, down 6.8% on week
• AAA Nat'l average price for gallon of regular Gas: $3.58

THE WEEK AHEAD: It will be a fairly active week on the economic calendar, highlighted by regional manufacturing surveys, durable goods orders, personal income/spending and updates on housing. The third and final reading of first-quarter growth is expected to remain at 2.4 percent.

Mon 6/24:

8:30 Chicago Fed Manufacturing Survey

10:30 Dallas Fed Manufacturing Survey

Tues 6/25:

8:30 Durable Goods Orders

9:00 FHFA House Price Index

9:00 S&P Case-Shiller House Price Index

10:00 New Home Sales

10:00 Consumer Confidence

10:00 Richmond Fed Manufacturing Survey

Weds 6/26:

8:30 Q1 GDP

8:30 Corporate Profits

Thurs 6/27:

8:30 Weekly Jobless Claims

8:30 Personal Income and Spending

10:00 Pending Home Sales Index

10:00 Kansas City Fed Manufacturing Survey

Fri 6/28:

8:30 Chicago PMI

9:55 Consumer Sentiment

Week ahead: It’s all about the Benjamin’s (Bernanke)

After weeks of conjecture about the Fed’s next moves, guess who is in the spotlight this week, ready for his close up? Ben Bernanke and the Federal Reserve Open Market Committee convene a two-day scheduled policy meeting on Tuesday and Wednesday. While there is no expectation of any change to monetary policy (short-term rates should remain at 0-0.25 percent, which is where they have been since December 2008 and the central bank will keep buying $85 billion worth of bonds each month), Fed watchers will parse every word of the accompanying statement; pour over the updated economic forecasts; and listen closely to Bernanke’s subsequent press conference. Investors have been gripped by Fed-fever since Bernanke’s May 22^nd testimony on Capitol Hill, when the Chairman had the temerity to suggest that the central bank could taper its bond buying it the economy were to perk up. Suddenly, it was as if every trader feared what the rest of us have craved for over four years: economic improvement!

While there has been progress (jobs, housing, retail sales), chances are that the Fed will not taper until the September or December meetings. Don’t tell that to bond investors, who are trying to get a jump on the Fed by selling in advance of any announcement. And of course they are right: whether its September, December or early next year, the Fed will determine that the economy is strong enough to go it alone, without the central bank’s intervention.

When the government stops buying bonds and eventually starts to sell them, will it be the death-knell of the bond market? According to Capital Economics, the Fed absorbed 38 percent of the treasury bonds issued between the end of last September (when QE3 was launched) and the end of May 2013. When QE1 and QE2 ended, the damage to the bond market was muted, because anxious investors stepped in and filled the void. This time, there is no European debt crisis to create a “flight to quality” nor is there the belief that the Fed will act again. That said, if the rout in emerging stocks and bonds continues, there could be a uptick in foreign demand for US debt.

The whole idea of the Fed shifting gears is a good thing – it means that the economy is strong enough to go it along and frankly, if the economy can’t absorb higher interest rates, we have bigger problems brewing. In a “normal” economy, the benchmark 10-year yield usually runs close to the pace of economic growth. With most projections showing the economy returning to trend growth of 3 to 3.5 percent in 2014 and 2015, it would stand to reason that the 10-year yield would rise.

Some have been suggesting that the economy can already manage higher rates and that the Fed should get out of the way. Scott Minerd, global chief investment officer at Guggenheim Partners recently noted that Fed buying has badly distorted the bond market and that “The yield on 10-year Treasuries would be roughly 150 basis points higher than it is today” without the Fed’s actions.

“Won’t higher rates kill the housing recovery?” You would think the world had ended when 30-year mortgage rates increased from 3.375 percent to 4 percent, you know where rates were way back in 2011 and early 2012. It’s hard to imagine that 4 percent will stymie the housing recovery, though it may slow down the re-fi market, which has dropped by over 35 percent over the past 6 weeks.

Markets: The first three-day losing streak of 2013 came and went and we survived…and really, it wasn’t all that bad because despite falling in three of the last four weeks and losing 2.5 percent from the recent highs, U.S. stocks remain solidly higher on the year.

• DJIA: 15,070, down 1.2% on week, up 15% on year
• S&P 500: 1626, down 1% on week, up 14.1% on year
• NASDAQ: 3423, down 1.3% on week, up 13.4% on year
• July Crude Oil: $97.85, up 1.9% on week
• August Gold: $1387.60, up 0.3% on week
• AAA Nat'l average price for gallon of regular Gas: $3.62

THE WEEK AHEAD:

Mon 6/17:

G-8 Meeting in Northern Ireland

8:30 Empire State Manufacturing

10:00 Housing Market Index

Tues 6/18:

FOMC Meeting begins

8:30 CPI

8:30 Housing Starts

Weds 6/19:

2:00 FOMC Meeting announcement

2:00 FOMC Forecasts

2:30 Bernanke Press Conference

Thurs 6/20:

Euro zone finance ministers meet

8:30 Weekly Claims

10:00 Existing Home Sales

10:00 Philadelphia Fed Survey

10:00 Leading Indicators

Fri 6/21:

Quadruple Witching: When stock index futures, stock index options, stock options and single stock futures all expire. Because investors must close out of their positions, trading volume and volatility can increase on quadruple witching