Dow Jones Surges in October on Fed Hopes

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For a month with a spooky reputation, this October was a barn buster for investors. In fact, U.S. equities posted their strongest monthly gain in four years despite inching lower on Friday in response to mixed earnings reports.

In the end, the Dow Jones Industrial Average lost 0.5%, the S&P 500 dropped 0.5%, the Nasdaq Composite shed 0.4% and the Russell 2000 ended the day 0.3% lower. The dollar was weaker, gold extended its recent decline and crude oil gained 0.7% to close at $46.40 a barrel after a drop in U.S. rig counts.

Bank stocks were hit — after outperforming on Wednesday on net interest margin gains associated with higher long-term yields — after Keycorp (NYSE:KEY) announced its intention to buy First Niagara Financial (NASDAQ:FNFG). Sell side analysts threw up all over the idea, with Jefferies saying investors would need to wait until 2018 to see any earnings accretion.

Despite this, Edge Pro subscribers continue to enjoy a 155% gain in their Bank of America Corp (NYSE:BAC) November $16 calls that surged on Wednesday.

Energy led the way with a 0.7% gain followed by utilities and telecom. First Solar, Inc. (NASDAQ:FSLR) gained 11.9% on a big third-quarter earnings beat on project timing. LinkedIn Corp (NYSE:LNKD) added 11% on a top- and bottom-line beat.

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Back to October’s big gain. The catalyst for the move was the hope of more cheap money stimulus, pure and simple. Specifically, a downturn in the data that raised expectations the Federal Reserve wouldn’t be able to raise interest rates for the first time since 2006 this year — pushing forecasts for liftoff into 2016.

The surge started on Oct. 2 after stocks rallied in response to a weaker-than-expected September payroll report. Just 142,000 jobs were created — well below the lowest analyst estimate and under the consensus expectation of 203,000. Futures market odds of a December interest rate hike fall to 29%.

This ignited a surge of panic buying as investors had become, by some measures, the most pessimistically positioned since the financial crisis. The worst performers during the August-September market selloff turned tail and led the way higher with big gains in areas like energy, industrials and materials.

The buying continued throughout the month as economic data — from retail sales to core durable goods — all suggested the U.S. economy was hitting a soft patch. On Thursday, we learned third-quarter GDP growth slowed to just a 1.5% seasonally adjusted annualized rate, below the 1.7% expected and the 3.9% result in the second quarter.

According to Macroeconomic Advisers, fourth-quarter GDP growth is currently tracking at 2.2%. Much depends on the severity of winter weather this year.

Inflation has also been weak, undermining the Fed’s stated requirement for confidence that it is set to return to its 2% target over the medium-term before raising rates. On Friday, we learned the Fed’s preferred measure, the core Personal Consumption Expenditures price index, inched to a lower-than-expected 0.1% monthly change in September vs. the 0.2% expected and the 0.4% growth posted in August.

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It’s the same story with personal income, which got no help from flat wages and salaries in September. Weakness in the Employment Cost Index, which measures labor costs for businesses, also took a turn lower as shown above, suggesting more labor market slack, less negotiating power by employees and a slowdown in overall economic demand.

The start of the third-quarter earnings season also helped as companies once again used diminished expectations, cost control, share repurchases and accounting trickery to delivery positive surprises. According to FactSet, of the 340 companies in the S&P 500 that have reported results to date, 76% have reported earnings beats. This is above both the one-year (74%) and five-year averages (72%).

Friday’s action revealed, however, that some of the positive momentum might fade heading into November.

Overnight, the Bank of Japan surprised investors by leaving its existing bond buying stimulus program unchanged. While U.S. equity futures climbed in response during early morning trading, the decision cast a pall over the session since the BoJ also pushed back its anticipated time frame for achieving its 2% inflation goal into late 2016 or early 2017.

Also, the subdued trading action of Thursday and Friday followed a surprisingly hawkish Federal Reserve policy statement on Wednesday, in which policymakers left open the possibility of a December interest rate hike. The move was unexpected by most analysts, pushing up the futures market odds of a December rate liftoff to 50-50 for the first time.

If the flow of U.S. economic data (starting with next Friday’s October payroll report) turns positive stocks could suffer as investors realize that the Fed’s long experiment with near-zero interest rate policy is less than two months away from ending.

Alternatively, continued weakening of the data would force Fed officials to acknowledge a 2015 rate hike isn’t happening — opening the door to an epic Santa Claus rally that could very well set new record highs.

Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/10/fed-rate-hike-earnings-economic-data/.

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