Stocks rebound ahead of FOMC meeting this week

The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions. – Seth Klarman, American billionaire who founded one of the world’s largest hedge funds

In a relatively calm week that was devoid of any key economic data and notable corporate earnings reports, the S&P 500 rose 2.1%, marking one of the best weeks for the benchmark index in months and allowing investors a chance to breathe a collective sigh of relief. But it could be a case of calm before the storm as the Federal Reserve meets this week to decide whether or not to raise the federal funds rate. Recent stock market volatility caused by fears of slowing growth in China seemed to abate as Chinese officials announced that their expected growth would exceed 7% this year. The Shanghai Composite Index also rebounded last week as economic news out of China was somewhat better and the country promised to introduce additional stimulus measures. The other potential headwind for the stock market, the Fed meeting and the possibility of higher interest rates, will be answered on Thursday. Although there were just a few economic reports released last week and none of them typically considered significant, the results of two them could influence the Fed’s decision. The producer price index (PPI) was flat in August as inflation remains benign due primarily to low oil prices and a strong dollar. If both of these conditions persist, the Federal Reserve’s inflation target of 2% could be kept out of reach. The other economic report was the University of Michigan consumer sentiment indicator, which tumbled to 85.7 in September, well below expectations of a reading above 90. New York Federal Reserve President William Dudley has said in recent comments that the confidence survey would play an important role in the thinking of the Federal Open Market Committee (FOMC) on whether or not to raise interest rates. His reasoning is that reduced confidence could ultimately mean lower consumer spending and weaker growth in the economy. While Fed officials must take into consideration a number of factors in reaching a decision, these two recent reports could provide the tipping point.

Last Week

The number of job openings in July rose to 5.75 million, the highest level in 14 years, which means that the labor market is unable to supply the people that companies need. More often than not, this is a precursor for higher wages. Jobless claims fell to 275,000 last week, the 27^th straight week that claims have been below 300,000 as the labor market continues to be strong.

For the week, the Dow Jones Industrial Average gained 2.1% to close at 16,433 while the S&P 500 Index also rose 2.1% to close at 1,961. The Nasdaq Composite Index jumped 3.0% to close at 4,822.

 This Week

The Fed’s long-awaited and much-anticipated Federal Open Market Committee (FOMC) meeting will take place on Wednesday and Thursday of this week, with Fed Chair Janet Yellen holding a press conference after the meeting. Whether or not the Fed decides to raise interest rates remains a close call as convincing arguments can be made either way. In terms of economic data, retail sales are expected to increase on strong automobile sales while industrial production is forecast to dip slightly. The August consumer price index (CPI) is expected to be flat as inflation remains under control and the leading economic indicators for August should show modest improvement.

During many press interviews and conferences this past week, the tone among major companies in a variety of sectors was positive about their businesses and future profitability, a good sign ahead of the upcoming third quarter earnings season that begins in about three weeks.

Earnings reports will take a back seat to the Federal Reserve announcement and the economic data as the only prominent companies on the calendar this week are Oracle, Adobe Systems and FedEx.

Portfolio Strategy

It’s anybody’s guess what the Federal Reserve and Fed Chair Janet Yellen will do with regard to their zero interest rate policy that has been in effect since 2008. While most economists expect the Fed to raise interest rates by 25 basis points, most traders that look at federal funds futures believe that the central bank will forego a rate hike until December or possibly later. Market strategists, on the other hand, seem to be equally divided on the subject while Fed officials have offered differing opinions in public with no clear consensus on what the outcome will be. If they do decide to raise rates, the stock and bond markets might be vulnerable as bond yields are currently very low and stocks have been skittish lately. If they decide to keep rates unchanged but promise a rate hike soon, markets could also be weak. If they do raise rates but indicate that there will not be another rate hike for a while, markets could react calmly and take the news positively. If they do not raise rates and cite slowing growth in China and other global economies, lack of inflation and falling commodity prices, the bond market might rise but stocks could fall on fears that corporate profits might be at risk. Right now the odds seem to be slightly in favor of no interest rate hike. But whatever the Fed officials finally decide on interest rate policy, you can bet that the language in the Fed’s statement and Fed Chair Janet Yellen’s comments in the press conference will be handled in such a way as to minimize any disruption in the markets.