Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.
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EQ: The existing home sales for April showed encouraging signs for the housing market, and when combined with last week’s housing starts data, should this alleviate the earlier concerns that investors had?
Stovall: Yes, I think it does. Housing seemed to be the straggler within the economic-growth picture where retail sales, leading economic indicators, and other factors were shown to be improving as we were moving further away from the weather-affected data.
Yet, housing seemed to not be recovering like the other indicators. But now with the April data for existing home sales and the jump in April housing starts data, I think investors are feeling encouraged that the housing recovery is back on track.
EQ: As we head into the second half of the year, the market is paying increasingly more attention to how the Fed will deal with interest rates. Do you think this Committee under Fed Chair Yellen will be overly candid with the market like it was under Bernanke?
Stovall: Yes, I do because I don’t really see any reason yet why they would change their policy. I think transparency is a primary goal of the Federal Reserve, which is an almost 180-degree turn from where it was during the Volcker and Greenspan administrations. So I would tend to say that transparency is probably something that will continue until they decide it’s working against them rather than working with them.
EQ: Will that transparency add to market volatility? In essence, we have different Fed members thinking out loud to the market as opposed to one unified voice from the Committee.
Stovall: That’s an interesting point because when you have so many board members or non-voting members who are making presentations, the implication is that they all know what everyone else is thinking and these are either trial balloons to see how the investing community reacts to these thoughts or if it’s just simply Fed members voicing their different opinions.
But investors are reactive to unanticipated news, and are always trying to get one step ahead of every other investor. So it probably will add to the volatility because not only will investors be hanging on every word, but will try to read between the lines when possibly there is no subsurface message to be delivered. As a result, volatility will increase as a response to the comments from the Fed.
EQ: In April, inflation jumped more than expected, as you noted in this week’s Sector Watch. If inflation starts to climb too high too quickly, what are some ways the Fed will be able to deal with it?
Stovall: I think the Fed will remind investors that while a very popular reading is the headline Consumer Price Index (CPI), probably the more important gauge is the core CPI, and of even greater interest to Fed members is the core Personal Consumption Expenditure (PCE). This is the current number that is reading 1.2 percent, versus a 2.0 percent reading for the headline CPI.
First off, I think the Fed will remind investors that they’re looking at a different set of inflationary data.
Second, I think that Fed members will end up “jawboning” the market down by raising rates through their comments without actually raising the rates. As we saw after Fed Chair Yellen’s first press conference, investors can react very quickly and very violently to perceived changes in policy.
Third, of course the Fed can slowly begin a rate-tightening program, but maybe even before that we could find that the Fed engages in some peripheral activities. As an example, if they’re worried about the stock market, they could raise margin requirements. I think in this case, the worry has more to do with inflation itself, so I would tend to say that it will be a gradual increase in the federal funds and the discount rate.
EQ: You stated that the “line in the sand” for headline inflation historically is at about 4 percent before the S&P 500 begins to dip into negative territory. Where should investors look to as they try to gauge how close rates are to crossing that line?
Stovall: I think by going to the Bureau of Labor Statistics, investors can get a read every month on inflation—whether its headline, core, or so on—and do the monitoring on their own. Investors need to realize that a 4-percent line in the sand is historically where it has been, but it could end up being a little bit lower because inflation ended up being so low from the start. So there’s no guarantee that everything will be hunky dory up until 4 percent. Things can become unraveled before that.
Simply monitor the free data that the government provides on a monthly basis I think would be a good way to keep in constant contact with inflation trends.