Federal Reserve Bank of Atlanta President Dennis Lockhart and San Francisco Fed chief John Williams focused on the strong economy and rising inflation, inferring the possibility of higher interest rates over the coming months, though Yellen signaled China's economy and low oil prices remain a concern. The Fed delayed hiking interest rates in 2015 due to trouble in emerging markets, holding off until December to implement a modest increase.
As of the market close on Wednesday, the S&P 500 Index is approximately 2.5 percent away from its all-time high. Dividend paying funds continue to lead the way, though small- and mid-caps are beginning to outperform.
WisdomTree Bloomberg USD Bullish (USDU)
CurrencyShares Euro Trust (FXE)
CurrencyShares British Pound (FXB)
CurrencyShares Canadian Dollar (FXC)
CurrencyShares Japanese Yen (FXY)
WisdomTree Emerging Market Currency (CEW)
Yellen's comments sent the U.S. dollar lower against a broad range of currencies. The widely tracked U.S. Dollar Index is approaching the key support level at 93. A break of that level would not end the bull market which began in July 2014, but it would create a bearish intermediate term outlook which could carry the index to 88 before it finds the next area of support. A 7 percent dip would likely be accompanied by a substantial rally in emerging markets and commodities over several months.
Britain's polls have shifted in favor of staying in the EU; the pound rallied sharply last week as a result.
Commodity-related currencies, such as the Canadian and Australian dollars and emerging market currencies (NYSEARCA:CEW) rallied. Notably, all three have now erased losses going back to August 2015. The Australian dollar was particularly hard hit by China's surprise devaluation.
Crude oil bears especially close scrutiny over the week ahead. While the U.S. dollar has weakened over the past few days, the price of crude oil remains in the high $30 range. Most industrial commodities display similar patterns, save steel, which broke out to a new 2016 high on Wednesday led by gains from miner Rio Tinto (NYSE:RIO).
A correction in commodities is likely, and crude oil can dip towards the low $30s without risking the current bull rally. Two weeks from now, OPEC will meet in Doha, with non-OPEC countries invited as well. Iran said it will attend, but ruled out reducing production. A production freeze by other nations will do nothing to lift prices if the Iranians increase production.
SPDR Utilities (XLU)
SPDR Pharmaceuticals (XPH)
SPDR Materials (XLB)
SPDR Consumer Staples (XLP)
SPDR Consumer Discretionary (XLY)
SPDR Healthcare (XLV)
SPDR Technology (XLK)
SPDR Financials (XLF)
SPDR Retail (XRT)
Every sector gained ground over the past week except financials, which was dinged by Yellen's speech on Tuesday. Higher interest rates raise the profitability of banks and investors in the sector would prefer they come sooner rather than later. Investors have priced in Fed policy though, and interest rate hike expectations are still much higher today than they were eight weeks ago.
In contrast to financials, utilities and consumer staples bounced on Yellen's speech. Utilities use debt to finance operations and low rates are good for the bottom line. The relatively high yielding consumer staples sector benefits from yield hungry investors sticking with a stable producer of income. Dividend funds with overweighting in these sectors have thus far performed very well in 2016, besting non-dividend competition.
Investment grade bonds continue to rally as interest rates decline, but high-yield bonds paused with oil prices.
iShares MSCI Emerging Markets (EEM)
Emerging markets have benefited from U.S. dollar valuations and stronger commodity prices. EEM has erased nearly all of its losses going back to the August 2015 devaluation in the yuan. The rally failed in October, with EEM stalling at the important $36 level. The fund is a mere 5 percent from that level. Given the volatility in EEM, a test of this level is definitely possible in April.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.