Investors in both the stock and bond markets, throughout the recovery, beginning in mid-2009, have viewed positive economic data as positive for financial markets, and they have traded accordingly. With the clock ticking on the inevitable start to Fed interest rate increases, good news will become bad news for financial markets, and for investors.
Despite the weak durable goods number this past week, which showed a larger than expected decline of 18.2 percent (economists had expected a decline of about 17 percent), the majority of economic data recently has been positive. Everything from GDP growth of 4.2 percent for the second quarter of 2014, to unemployment dropping to 6.1 percent, consumer confidence of 92.4 percent, strong auto sales, and more, have underscored the improvement in the U.S. economy. This improving economic landscape has provided a strong foundation for multiple new all-time highs for U.S. stock market indices, and historically low interest rates across the yield curve have driven bond prices sky-high.
The most recent Federal Reserve meeting yielded no surprises, but what was made perfectly clear is that the Fed intends to begin raising interest rates sometime next year — most likely around the middle of 2015. The takeaway for investors should be that regardless of exactly when the first rate increase takes place, higher rates are coming shortly. The timing of the first rate hike will be determined by the pace of the continuing improvement in the economic data.
This week we will receive September employment — the ADP private sector payrolls report on Wednesday, as well as the Commerce Department’s official U.S. employment report due Friday. While these reports, and especially Friday’s government data, will be the most important economic data of the month, we will see various other reports this week, including consumer spending, inflationary trends and auto sales. Virtually every economist expects these reports to be positive, with the average economist’s estimate for employment topping 200,000 versus the 142,000 reported for August employment.
Last week’s volatility, with the net drop of 166 points for the week for the Dow Jones Industrial Average, could turn into a significant and sustained downtrend this week. The markets’ overall direction will be determined by the way in which investors choose to interpret the economic data this week. If the data disappoints, investors, taking their cue from last week’s action, could resume their selling. Should the reports contain positive results for the economy, investors may choose to view it as a reason to buy. However, given the dwindling time window for the beginning to the next interest rate-raising phase for the Fed, investors may choose to see positive data as a reason to sell stocks and bonds.
Another reason for investors to be nervous is that technical indicators for U.S. stock market indices have turned decidedly negative. This past week the Russell 2000experienced a “death cross” where the 50-day moving average crossed below the 200-day moving average. Also this past week, the Standard & Poor’s 500 and the Nasdaq Composite Index traded below their 50-day moving averages, and the Dow is sitting on its 50-day moving average.
While moving average breaks are fairly common, it is far more uncommon for so many different indexes to exhibit breaks at the same time. If we add to this picture the fact that valuations are incredibly high, that the stock market has not had a significant — 10 percent or greater — correction in abut three years, and the pending increase to interest rates mentioned above, you have a technical and fundamental alignment of indictors all signaling lower market levels.
Investors throughout the current 5½-year bull market have been consistently bullish, even in the face of some formidable obstacles. They have been willing to step in and rally markets after minor corrections with supreme confidence. It will be interesting to see if the pattern repeats this week, or if investors begin to view good economic news as bad news for financial markets, with the result being the start to a major market correction.