Last week, the market fell less than 1% on the Nasdaq, 1.5% on the Dow and 1.7% on the S&P 500, but we saw four straight days of alternating gains and losses of 400 or more points on the Dow.
In retrospect, this volatility looks a lot like Shakespeare’s line about “sound and fury, signifying nothing.” The market bottom came early last week, on high volume, in a panicky Monday capitulation, when the S&P 500 closed at 1,119. Then we saw a successful retest last Wednesday with the S&P closing a notch higher, at 1,120, followed by an impressive rally Thursday and a solid high-volume gain Friday.
The S&P 500 now yields 2.24%, which is more than most Treasury securities. With earnings rising so sharply, the S&P sports a 14.5 trailing P/E, down from 17.7 a year ago. This tells me that last week’s panic was exciting but relatively meaningless in the long term. This latest dip makes high-quality big-cap stocks look especially attractive. We may retest our recent lows, but I expect most Blue Chips to hold up well, even though some small-cap stocks might feel more like hot potatoes during the next few weeks.
Computerized trading programs ran wild last week, especially during the last hour of trading. Speculation in financial derivatives also hit a record high last week. Gold shot up to $1,819 per ounce Wednesday before the CME Group (parent of the COMEX commodity exchange) raised the collateral requirements for gold, effective at Thursday’s market close. That helped to prick the gold bubble a bit. The Swiss franc also settled down in the last two days of last week as investors turned to higher-yielding big-cap stocks.
In the meantime, Ben Bernanke emerged as a market savior last Tuesday when the Federal Open Market Committee boldly proclaimed the Fed would hold key interest rates at ultra-low levels through at least mid-2013. The FOMC essentially told investors they need to look elsewhere (i.e., to blue-chip stocks) for higher yields than Treasury securities. The bad news was the FOMC statement said the “downside risks to the economic outlook have increased.” This new language might have contributed somewhat to greater market uncertainty, fueling last Wednesday’s “retest” of Monday’s lows.
The Fed also indicated it had discussed a wide range of policy tools available to “promote a strong economic outlook recovery.” Translated from Fedspeak, that means the Fed discussed the possibility of buying more bonds. The Fed’s balance sheet is now nearly $4 trillion (up from less than $1 trillion before the financial crisis of 2008). The Fed gave no signal that it wanted to start another round of quantitative easing (QE3), so Fed watchers now will focus on Bernanke’s speech at the Fed’s upcoming retreat in Jackson Hole, Wyo., on Aug. 26 and on the release of last Tuesday’s FOMC minutes Aug. 30.
Not surprisingly, the U.S. dollar tumbled after the Fed said that its zero-interest-rate-policy will last until 2013. (A weak dollar has helped fuel rising profits among many multinational companies.) Interestingly, of the 447 S&P 500 stocks that have announced their second-quarter results so far, sales are up 15.3% (excluding the troubled financials), while earnings are up a very healthy 22% and the average earnings surprise was +5.5%. The second quarter is shaping up to be the 10th quarter in a row in which earnings have exceeded analysts’ expectations. It might come as a surprise to many investors (since the financial press ignores these facts), but corporate profits are at a record high and P/E ratios are shrinking!
What’s next? First, we need so see the VIX subside in the upcoming weeks, and then we need to see some serious trading volume pick up after Labor Day, when institutional managers return from their summer hiatus. Then, I expect to see domestic stocks firm up no later than Sept. 30, in time for quarter-ending window dressing and corporate stock buybacks. I expect we’ll see another late-September rally, much like the sudden rally that we saw in late June, at the end of the second quarter.
