A holiday shortened week offered a respite for investors as stocks were in a holding pattern ahead of the Federal Reserve’s meeting on September 17. The S&P 500 Index came into Friday only 1 point above where it finished last week.
Economic data was light in the United States and generally in line with estimates. Producer prices were flat in August, a little better than the expected 0.1 percent decline. Import prices dipped 1.8 percent and jobless claims matched estimates. Chinese data drew more attention as producer prices fell 5.9 percent, an acceleration of the deflationary trend. Trade data was also weak, with imports tumbling more than expected in August. Markets rallied on the bad Chinese data because investors expect the government will launch a larger stimulus, even though Premier Li said they would only intervene to maintain stability. Instead of doing another stimulus similar to 2008, the country will rely on major long-term reforms to turn the economy around.
Copper prices rebounded strongly over the past few days, while oil prices retreated. Oil spiked from $38 to $48 at the end of August, but it has since drifted lower, to $44 per barrel as of Friday. For the moment, both remain in clear downtrends despite the recent rebounds.
Equities remain in an uptrend over the long-term, but are in limbo over the short-term. The S&P 500 Index will finish the week slightly below where it stood 1 year ago. The Nasdaq has done better, but still sits at December 2014 levels. The Dow Jones Industrial Average has performed the worst; it currently trades below where it finished in 2013.
The weakness continues to be due to shifting monetary policy. Investors have reacted negatively following every end in quantitative easing; drops in May 2010, August 2011, May 2013 and October 2014 were all a response to the end of, or pre-announced end of quantitative easing. The drop in August was most likely in anticipation of a September rate hike. A final dip in stocks and test of the August lows could unfold if the Fed hikes next week. Nevertheless, that could be the end of the selling because the Fed would not hike rates again until well into 2016.
Although some investors believe a rate hike will hurt the economy, a switch from 0 percent to 0.25 percent is not a significant change. It is meaningful for psychology though. Zero percent interest rates and quantitative easing caused investors to fear the future, since extraordinary policy indicates extraordinary conditions. This led to a wait-and-see attitude among homebuyers, as one example. In many parts of the country, there is little incentive to buy a home with rates stuck at 0 percent. A homebuyer knows they can borrow at the same rate later, so there is no cost to waiting in areas with no significant price increases. If home prices are weak, there can even be a benefit to waiting.
After the Fed hikes, many homebuyers on the sidelines will begin factoring in the risk of rising interest rates, which can be substantial even if they remain low. If 30-year mortgage rates move up 2 percent over the next few years (from 4 percent to 6 percent), the monthly payment on a 30-year mortgage will rise almost 30 percent. It is important to note that home builder stocks have been among the strongest in the market, which is likely due to investors anticipating this psychological change in the market.