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A Choppy Summer Ahead

Fri, May 31, 2013 - 8:31am

The ‘Sell in May’ advice may not have worked this year, but the market’s performance over the last few trading sessions provides plenty of clues about what to expect over the coming months. It will most likely turn out just fine in the long run for the stock market, but it is guaranteed to produce far more volatility and downward pressure in the near term.

Uncertainty about the future of the Fed’s QE program is pushing interest rates higher. This fear of a major spike in interest rates has emerged as a key worry for stock market investors. As a result, all incoming economic data is getting interpreted from the Fed perspective – whether it will prompt the Fed to ‘taper’ sooner rather than later. This morning’s moderately weak personal spending data should be somewhat calming from that perspective, but we have some more data coming out a little later. And then next week is the big deal with a lot of consequential reports coming out, particularly the May non-farm payroll report.

I have been in the camp that expects the Fed to start tampering its bond purchases in the not-too-distant future. In fact, I am of the opinion that the odds of the taper announcement coming at the June FOMC meeting will increase significantly if we get a strong non-farm payroll report next week.

As such, I am not terribly concerned about rising bond yields as I view the normalization of interest rates is a necessary precondition for putting the economic recovery on a stronger and more sustainable footing. The potentially problematic part on the interest rates front is not the direction of change, but rather the pace. A steady rise is fine, a spike is dislocating.

Given the Fed’s enormous ‘investment’ in the bond market in recent years, I strongly believe that they have plenty of ‘control’ over interest rates, even at the long end of the yield curve. What I am saying is that the Fed will not let interest rates spike in a disruptive way. That said, any rise in interest rates is a net negative for the stock market and we will see this play out over the coming days and weeks.

Source: Zacks

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