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S&P Rises On Fed’s Promise To Keep Interest Rates Low

Market Digest – Week Ending 12/19

It was the Fed to the rescue again for stocks. The S&P 500 rallied 4% in the two days following the release of central bank minutes suggesting a rate increase is not imminent. The move reversed a similar sized decline which played out over the previous seven trading days. International stocks also gained, but again failed to keep pace as the dollar strengthened despite the promise of low rates for longer. A lone terrorist attack in Sydney, an abhorrent Taliban assault on a school in Pakistan, continuing reports of atrocities by ISIS, and increasing tension between the US and North Korea set a gloomy backdrop for an otherwise positive week in the capital markets. Oil remained volatile, finishing the week roughly flat after a rally Friday. Bonds fell.

Weekly Returns:

S&P 500: 2,071 (+3.4%)
FTSE All-World ex-US: (+2.2%)
US 10 Year Treasury Yield: 2.16% (+0.08%)
Gold: $1,195 (-2.2%)
USD/EUR: $1.223 (-1.8%)

Major Events:    

  • Monday – Nicholas Schorsch resigned from American Realty Capital Properties, one of the largest REITs, after revelations of accounting improprieties.
  • Tuesday – In a surprise move, Russia raised interest rates to 17%, but the ruble again fell.
  • Tuesday – Threats against movie theaters planning to show “The Interview” prompted Sony to let cinemas opt not to show the film.
  • Tuesday – Taliban gunmen stormed a military-run school in northwestern Pakistan and killed at least 141 people, almost all school-children.
  • Wednesday – U.S. stocks gained after the Federal Reserve retained its pledge to keep interest rates low for a “considerable time.”
  • Wednesday – The U.S. and Cuba agreed to restore diplomatic ties.
  • Thursday – Amazon started its one hour delivery service in one zip code in New York and promised to expand the service.
  • Friday – The FBI said evidence points to the North Korean government being responsible for the hacks into Sony Pictures.
  • Friday – The Treasury Department sold its remaining stake in Ally Financial, the last major TARP investment.

Our take:

Yellen or Bernanke, it’s hard to remember the last time the Fed wasn’t as (or more) accommodative than expected. This week was no exception with Fed minutes suggesting rates will stay near zero for a “considerable time”. Consensus expectations now suggest rates will start to rise in mid-2015. The market loved it.

Central bank thinking is that inflation remains low, so why take a chance of depressing economic growth or risk deflation? Makes sense – no one wants to be the party pooper. I’ve always been taught higher money supply leads to inflation, especially with low rates and a growing economy. According to the government, so far it hasn’t.

It’s puzzling. It could be that “velocity” is just low – people are just sitting on their money, but it feels unlikely Americans have given up their desire to consume and transact. Perhaps advances in technology and efficiency are creating cost reductions at a faster rate than money supply has increased. For example, amazing new robots help Amazon keep fulfillment costs down. Some of this is passed on to consumers. Or new innovations like Airbnb, which help keep a lid on hotel prices.

Or maybe the government is playing with the numbers. It certainly feels like there is inflation. Starbucks recently raised the price of a morning coffee. Netflix recently raised prices (without the outrage this time). I took a quick sample of recent spending on my Financial Dashboard to see if there was any insight.

Online Wall Street Journal subscription, $299 (feels more expensive)
Flight from Oak to Denver, $262 (similar)
Parking Oakland Airport, $22/day (similar)
Some songs on iTunes, 1.29 each (similar, but more than a few years ago)
Chipotle Burrito, $9.39 (feels more expensive)
Clothes, various (similar)


And then there’s housing. Housing is extremely regional, but at least near San Francisco “equivalent rent” (used in the official inflation number) is much higher. On the other hand, gas is obviously cheaper.

Who knows? It feels like there is inflation, but maybe not. The yield curve has become quite flat. The 30 year Treasury yields 2.75%, just about one percent more than the 5 year. This implies few are worried about a return of inflation. Often, it is wise to be wary of that which few are worried about.

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