Wash, Rinse, Repeat

Originally posted at Briefing.com

If you want something really clean, the process is pretty simple. Basically, you wash, rinse, and repeat. That's all well and good for your hair, your car, or your dog. When it comes to the capital markets, it kind of makes a mess.

That's where we are today, too — in a messy situation, which in turn has led to some messy trading behavior.

Today, we'll be airing some of that dirty laundry and explaining why the wash, rinse, repeat cycle keeps the market from having a shiny luster.

Setting the Tone

The tone of things was set early this year, not so much in the 3.1% decline the S&P 500 suffered in January, but in the 5.5% increase it enjoyed in February.

Thus began a roller-coaster ride that saw an even split for the S&P 500 in the first half of the year: three months up and three months down. After the first six months, the S&P 500 had advanced a whopping 0.2%.

The month of July has broken in favor of the bulls, yet there was certainly some bull fighting throughout the month as economic growth concerns worked their way into things. But, alas, all that really seemed to do was spur the bulls to buy the dips because concerns about growth led to optimism about the Federal Reserve ("Fed") holding the fed funds rate at the zero bound for longer.

And that brings us to the first piece in a heap of dirty laundry that has worked its way into the capital markets' wash, rinse, repeat cycle.

Some Dirty Laundry

1) The Federal Reserve's Policy Stance

We all know where the Fed's policy stands. The uncertainty lies in when it is going to change. Some say September; some say December; and some say not until sometime in 2016.

The Fed tells us it is data dependent, so the market hangs on every economic release. For many, the data on the labor market says the Fed will go, while for others the data on inflation says the Fed will stay.

The Fed itself has intimated it would like to raise rates before the end of the year, but the fed funds futures market implies there isn't a whole lot of confidence in that prospect, showing just a 53% probability of a rate hike at the December meeting.

This question of "when" has worked the market into a lather, because it has participants thinking one thing one day and another thing the next. It's a frustrating experience of washing the views, rinsing the views, and repeating the views.

2) Earnings Reporting

This piece of laundry may not fit as well in the wash, rinse, repeat cycle as it does in the spin cycle. That's because every reporting period comes with spin — and it is the spin that is the essence of the wash, rinse, repeat cycle.

Every quarter analysts' consensus EPS growth estimates start out higher than where they stand at the start of the reporting period and every quarter companies check in with results that exceed those reduced expectations.

The market gets a little skittish on the estimate reductions and then, lo and behold, it rallies back on earnings results that are "better than expected," never mind that the actual results are typically below the growth levels projected before the start of the downward revisions.

We're on that track now. S&P Capital IQ informs us that second quarter earnings per share are on pace to decline 0.2% versus a 4.4% decline projected on June 26 (and an expectation for 4.2% growth on January 1), yet the recovery we've seen recently in the stock market has been pinned in part on the spin that the results have been "better than expected."

Same stuff, different quarter. Wash, rinse, repeat.

3) Economic Growth

Just you wait. Sustained GDP growth of 3.0%+ will be seen six months from now. That's been an enduring refrain it seems for six plus years now. It hasn't happened.

Real GDP growth has been pinned predominately below 2.5% for so long now that a growing number of economists are now advertising 2.5% as the potential growth rate, suggesting the U.S. economy is indeed on the cusp of hitting escape velocity.

We can admit that the ingredients seem to be in place for sustained GDP growth above 2.5%, taking into account factors like the drop in energy prices, the rise in employment levels, and the weak business investment that will eventually need to be strengthened. Nonetheless, economic growth continues to defy the hopeful expectations, riding high for a few quarters and then falling off for a few.

Still, hope springs eternal for economic prospects. The Fed keeps saying so, as do a lot of other non-policymakers.

The enduring and encouraging change we're all waiting for, though, hasn't been seen. What's been seen is more of the same. Wash, rinse, repeat.

4) Worst-case Scenarios

There seems to have been a lot of these through the recent years. The U.S. potentially defaulting on its debt... the eurozone potentially falling into a prolonged and crippling period of deflation... Russia invading Ukraine... Greece leaving the eurozone... China headed for a hard landing.

That's just to name a few. Each and every time the market has been rattled by worst-case scenarios unfolding only to be saved each time by policymakers intervening to prevent the worst-case scenarios from unfolding.

We suppose some credit for their actions can be given in certain instances, but sometimes the action itself just prolongs the pain (eg. Greece being bailed out multiple times with practically no ability to repay the entirety of its debt anytime soon, if at all).

Anyhow, the policymaking approach has taken the capital markets on quite the roller-coaster ride and it's pretty much been the same pattern each time: watch markets sell-off on fears of worst-case scenarios unfolding and watch them rally back on the eleventh-hour news that a solution, or a stop-gap solution, has been found.

Sell the rumor. Buy the news. Wash, rinse, repeat.

5) The Dollar and Commodities

These two have gone hand-in-hand, if for no other reason than that commodities are dollar-denominated.

Time and again, it is relayed that a stronger dollar and lower commodity prices are undoubtedly good things for the U.S. economy. The rub is that the stronger dollar is weighing on the earnings results for U.S. multinationals and making life more difficult for exporters; meanwhile, some think the plunge in commodity prices has more to do with weakening economic activity than it does with the move in the dollar.

[Listen to: Craig Johnson Still Bullish on Stocks; Sees More Downside for Gold, Oil, and Commodities]

These dynamics are an ongoing point of debate and they are often sold in conjunction with how the capital markets are behaving. That is, if the dollar is up and commodity prices are down, and stocks are up, the latter strength is related to the economic advantages of those trends. If the dollar is up and commodity prices are down, and stocks are down, the latter weakness is tied to the concerns surrounding those trends.

The market keeps going around and around with this one, washing, rinsing, and repeating the opposing views when it is most convenient to do so.

6) Commentary

I can't air others' dirty laundry without airing my own. Even I know my commentary has been redundant. It's been washed, it's been rinsed, and it has been repeated, largely because the news cycle hasn't changed.

Regular readers have hopefully picked up by now that we don't expect the market to do much this year -- or at least until the Federal Reserve takes its zero interest rate policy out of the dryer and folds it.

The uncertainty of when that will be was the overhanging question at the start of the year and it remains the overriding question seven months into the year.

Accordingly, things have been messy at times on the trading front with the continuation of news that keeps getting washed, rinsed, and repeated.

What It All Means

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Chief Market Analyst
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