ATLAS WILL SHRUG – The Fed can’t hold up stocks forever

Stocks FedBy David Nelson, CFA, CMT

Stocks have made a dramatic recovery since the Christmas Eve low. The recent price action pushing shares up  close to 20% begs the question; is there enough fuel to extend the rally? Friday’s volume was well above normal and last week’s strong performance led by Technology comes on the heels of the worst week of the year.

Friday’s close puts stocks at the highest levels this year just above resistance that has held back bulls since last October. Finally, the S&P 500 is living above the 200-day moving average and most of the long-term moving average slopes have turned North. So, what do stocks see that many analysts and strategists don’t?

We still have the usual suspects hanging over the market like a wet blanket. China negotiations seem to be in neutral with any visit by the two heads of state pushed off until at least April. Europe’s economy still struggles, and BREXIT is no closer to resolution than it was two years ago following a historic vote by the UK to leave the European Union.

S&P 500 1 Year Chart
Spx big breakout

I’ve talked often about estimate revisions being a strong leading indicator. While estimates have still edged lower in recent weeks the number of companies seeing downward revisions has fallen. To be fair, the earnings season is all but over, and analysts are human. They too can be reacting emotionally not cutting and even raising estimates because stocks have been rising.

Estimate Revisions for the S&P 500*
Spx wrong direction

The Elephant in the Room

To state the obvious, the Fed is still the Elephant in the room and the single most important piece of the puzzle. Last week’s push higher came following a 60 Minutes interview with Fed Chairman Jerome Powell where he gave a favorable view of the economy and still expects the Fed to be “patient.” The FOMC 180 degree turn in rhetoric now matched by policy is the single biggest factor bulls can hang on to. Investors will be looking to Wednesday’s rate decision for any commentary on future hikes and plans for a balance sheet that still sits just above $4 Trillion.

Last week’s benign CPI (Consumer Price Index) and PPI (Producer Price Index) help re-enforce the mindset that the FOMC can let the economy play out before stepping on the brakes. Bond Vigilantes will continue to cry foul saying the Fed must move now to avoid unwanted inflation down the road. The concerns raised are certainly valid and history is on their side, but the argument can also be made that there are structural deflationary forces today that help clamp down on inflation. Technology sits at the top of that list along with the Amazon effect driving down prices across a spectrum of goods. As it relates to inflation the Fed has taken a wait until we see the whites of their eyes mindset. 

Chicken or the Egg?

Ok, so we have one of the strongest financial forces on the planet acting as a back stop while analysts and investors sort out the noise. In the end, stocks will follow earnings or earnings will follow stocks. I don’t care what comes first, the chicken or the egg. Without multiple expansion and I believe that isn’t in the cards both need to move together. In just a couple of weeks Q1 will be in the rear-view mirror and the first pre-announcements will be hitting the tape. Stocks better blow out the numbers. Lowered guidance across most sectors in Q1 set the stage for top and bottom-line beats. The Fed can only hold up markets for so long. In the end without a little help Atlas will Shrug.

*Data by FactSet