The dark storm clouds that have gathered over the markets over the last few weeks seem to be the combination of the approach of September, regarded as the worst month for stocks, and talk of the Federal Reserve's tapering of its Quantitative Easing program. In regards to the month of September, since 1929 the ("S&P 500 (NYSEARCA:SPY)") has registered a -1.1 percent return in that time period according to Scott Minerd of Guggenheim Partners.
Source: Bloomberg, Guggenheim Investments. Data as of 12/31/2012. *Note: Data reflects average monthly price returns.
Before we get to the second factor, the Fed's tapering, let's take a look around the markets.
The big news in the Fixed Income markets have been the jump in Treasury yields, specifically the 10 year. The yield on the 10 year has had a strong run from a near term low of 1.629 on May 1 to 2.81 today. The 10 year is tied to many consumer loan products, especially mortgages, and a move above 3 and its corresponding higher interest rates may endanger the economic recovery. While the Fed has telegraphed its intentions to taper its stimulative bond-buying program, it has also indicated that it intends to keep interest rates low.
As the economic recovery has plodded along, bad news for the economy became good news for the markets. The worse the numbers became, the more stimulus was provided by the Fed to support asset prices. But with the approach of a potential tapering, the economy has to start reporting improving numbers for asset prices to continue to rise. Since the Fed has made the labor market a priority, so will we, initial claims for unemployment have returned to levels not seen since the fall of 2007.
The Fed has to "thread the needle" here. With the 10 year yield rising inflation may become a problem. As long as the yield on the 10 year stays below 3, inflation should remain contained.
Stock prices are a reflection of a company's earnings. Earnings are the result of sales, and for customers to purchase products and services they must have jobs. Along with employment, personal income has been rising and retail sales have also been improving.
We have evidence of the improving economy. However, we also have evidence of anxiety in the Fixed Income market with the spike in 10 year yields. So is it time to get out of the market? Maybe not just yet.
We are in a period where we are experiencing rising bond yields and economic growth. As Jeffrey Kleintop, Chief Market Strategist at LPL Financial points out, there have been four periods over the last 20 years when interest rates rose for more than 12 months and by more than 1 percentage point. The S&P 500 index rose in all of those 12-month periods.
Finally let's look at market internals, using the S&P 500 ETF "SPY" as a proxy for the general market. Market professionals buy value both fundamentally and technically. Technically, the "SPY" has a strong upward bias with the support of fundamental economic growth. It is above both it's 50 and 200 day moving averages. Professionals use the 50 day moving average as a support in an overall upward trend to add to positions. One valuable market breadth measure is the New Quarterly Lows. It records the number of stocks in the S&P 500 index that are making new quarterly lows each trading day. Each rise in New Quarterly Lows led to a slight to moderate sell-off, like the one we just experienced. The improvement from the peak down to only 6 new quarterly lows indicates that support has been found.
As always the market is at a critical juncture and risk control is paramount in trading. Any positions initiated or added to must have an appropriately placed stop order in place.