Stocks continued to push higher Tuesday in response to a batch of “Goldilocks” economic data. Consumer price inflation was softer than expected, providing the doves at the Federal Reserve with more ammunition to keep the hawks at bay. And housing looks set to get a lift as new construction starts jumped 8%, ending two months of declines.
The broad market looks ready for a Fed-fueled melt-up heading into Chairwoman Janet Yellen’s speech on Friday. That likely will set up a push to new highs that should last through November. Helping in this has been the diminishing geopolitical tensions in Ukraine and Iraq.
In fact, after largely skidding sideways over the last few months, the S&P 500 looks set for another move toward the 2000 mark and new all-time highs. Here’s why.
Click to Enlarge The main bugaboo that caused the S&P 500 to pull back into the lows seen earlier this month has been the geopolitical situation.
Go back a couple of weeks, and ISIS extremists were on the march in Iraq and Russia looked eager to annex eastern Ukraine. But now, thanks to U.S. airpower, ISIS is on its heels while Moscow seems desperate for a diplomatic, face-saving solution to the conflict between Kiev and pro-Russian separatists.
The rapid cooldown in tensions has pushed Wall Street’s “fear gauge” — the CBOE Volatility Index, or simply the VIX — back down to levels not seen since the middle of July.
The VIX is down more than 31% from its high earlier in August as options traders have suddenly become more confident that World War III isn’t about to start.
Click to Enlarge Another point of concern for the S&P 500 earlier this month was the march of stronger-than-expected economic data — particularly on jobs and inflation — that increased pressure on the Federal Reserve to raise its short-term policy rate sooner than the market’s comfortable with.
The Fed hasn’t hiked rates since 2006, and has kept interest rates near 0% since 2008, so any change here was always going to be a big deal.
With payroll gains posting their best winning streak since the 1990s, and with the job openings rate already at the peaks hit during the last economic expansion (job openings as a percentage of the labor force), the market was getting nervous that the Fed was about to take the cheap-money punch bowl away. This fear was magnified by the fact that the Fed’s ongoing QE3 bond purchase stimulus is set to end in October.
But recent inflation data has come in rather soft, and with a slight uptick in the unemployment rate last month (as folks reenter the workforce), the doves at the Fed appear to have enough justification to keep interest rates near 0% through the middle of 2015.
That’s boosting the corporate bond market, which suffered a dramatic pullback in July as chatter over a sooner-than-expected Fed rate hike grew louder. You can see this in the way the SPDR Barclays High Yield Bond ETF (JNK), shown above, has returned to its June-July highs.
The market has risen consistently during the August Jackson Hole conference put on by the Kansas City Fed. And another positive performance is likely given all the dovish media chatter out there about how the key policymakers at the Fed are looking to dial back the perception that the Fed has taken on a more hawkish tone.
Click to Enlarge It’s becoming increasingly clear that the lows set earlier this month were enough of an oversold condition for the broad market to rise out of for the next couple of months — likely until after the midterm elections in early November.
The technical indicators bear this out, with the percentage of S&P 500 stocks in uptrends flashing its first solid buy signal since April (shown above) as more and more stocks turn to the upside. And the stocks-vs.-T-bonds relationship — which had recently threatened the worst wipeout since 2011 — has stabilized and looks ready to turn higher from its deepest oversold level since early February.
Sentiment had become fairly depressed and is poised for a rebound. Just consider how penny-stock trading volume — one of the most speculative areas in the market — dropped to levels not seen since the last bear market in recent weeks.
November will also likely represent the first month since 2012 to not feature any bond buying purchases from the Federal Reserve as QE3 is wound down. So the lack of liquidity could result in some market turbulence then. But for the next three months, new highs await.
How to Play It
Click to Enlarge There are a number of exciting breakout plays in familiar names in play right now, including beaten-down retailer JCPenney (JCP) as it launches explosively up and out of a multimonth consolidation range while its new management team pulls the iconic clothier back from abyss.
Common shares are up 4.1% since I recommended them to my Edge clients on Monday, while the September $10 calls I recommended to Edge Pro clients are up 104%.
Other opportunities beckon in biotechnology, with stocks like R&D services provider WuXi PharmaTech (WX), which is up 4.1% since I recommended it to clients on Friday.
This comes after a number of profitable trades to the downside as stocks bottomed in early August, including a near-350% gain in Sprint (S) Aug $8 puts and a 204% gain in ConocoPhilips (COP) Aug $84 puts.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters, as well as Mirhaydari Capital Management, a registered investment advisory firm. As of this writing, he had recommended JCP, JCP calls and WX to his clients.
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