OREANDA-NEWS. May 17, 2016. Stocks drifted lower for the third straight week, something that hasn’t happened since the start of the year. And although the loss during this streak is still quite modest, just 2.2 percent for the S&P 500, it does betray the sense of ennui that has overcome markets in the absence of conviction. Lackluster growth, falling earnings, experimental monetary policies, and political uncertainty have conspired to cast a pall over markets. The recovery rally from the February low has been driven by multiple expansions and seems to have run its course. In order for stocks to push higher, fundamentals need to improve, and on that score the evidence is mixed.

To some extent, the shallowness of the current pullback is a testament to the market’s resilience. Things certainly could be worse. First quarter earnings are down 7 percent. Equity mutual fund flows turned negative at the start of April, and accelerated sharply in the first week of May, and the percentage of bullish investors in the weekly AAII survey fell last week to its lowest level since the market bottom on February 11. But hope springs eternal. The lackluster earnings season was no worse than expected, and investor sentiment extremes can be a contrarian signal, as they were earlier in the year.

Slow Growth Environment Continues

The market’s resilience continues to be tested by the slow growth environment. The economic news from China continues to underwhelm. Previous reports on manufacturing and trade disappointed, and this past weekend it was industrial production and retail sales that failed to meet expectations. Stocks in the Eurozone also fell for the third straight week for dollar-based investors, as first quarter GDP was revised down slightly to a still respectable 0.5 percent quarter-over-quarter pace, and industrial production slumped for the second straight month in March. The same pattern was seen in Japan, where the Nikkei also fell for the third straight week in dollar terms. Results for first quarter GDP this week are expected to show barely positive growth.

Longer-term bond yields have been caught in the downdraft of economic malaise as well. Last week the ten-year note yield fell to 1.70 percent, its lowest level in a month and down sharply from 1.93 percent on April 26. In contrast, the two-year note yield rose four basis points to 0.75 percent. That too is down from its recent peak on April 26 of 0.85 percent, but last week’s move betrays a certain wariness regarding the likelihood of additional rate increases that is simply not evident further out on the yield curve. Contributing to that nervousness was a surge in retail sales in April that followed a firmer reading on wages from the April jobs report. The result is the flattest curve since 2007 between two and ten-year maturities. Not surprisingly, financial sector stocks underperformed the broader market last week. The XLF sector ETF dropped 1.1 percent, compared to the S&P 500 which dipped 0.5 percent. The KBW Bank index slumped 1.4 percent, and remains down 9.7 percent for the year. Despite these moves, the futures market now ascribes to just a 4 percent chance of a rate hike in June, and just 53 percent to one in December. But the strong retail sales report, and the strongest reading on consumer sentiment in a year from the University of Michigan, no doubt prompted some to step aside from the short-end of the curve just in case.
The price of oil rose again last week on an unexpected fall in inventories. WTI rose \\$1.55 a barrel to \\$46.21, a rise of 3.5 percent and its highest weekly close since November. This came despite a rise in the DXY dollar index, which has been edging higher since May 3.

Focus on Interest Rates Will Remain

Lastly, Minneapolis Fed president Kashkari last week admonished investors to stop obsessing over interest rates. Perhaps he failed to see the irony in his comments as he then proceeded to talk about, yes, interest rates. We have come a long way since the days when the Fed said nothing, leaving markets to divine its intentions by waiting for the weekly money supply data. But it seems that, under the objective of transparency, the Fed has gone too far. It has unwittingly created its own Tower of Babel, where everyone speaks and no one says anything. How can we not obsess over interest rates?  Years ago you would be hard pressed to ask the man on the street to name the chairman of the Federal Reserve. Now Fed officials are practically household names. By its own admission, the effectiveness of monetary policy is reaching its limits. Increasingly the Fed relies on guidance, or what it affectionately refers to as open mouth policy. But when every Fed official has an opinion and a forum in which to express it, the result is not clarity but confusion. Trust us, we would stop obsessing over interest rates if only we could.

Important Disclosures:       
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The AAII Investor Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis.       
   
The Nikkei index is a price-weighted average of 225 stocks of the first section of the Tokyo Stock Exchange.

The KBW Index is weighted according to capitalization and represents major banks and money centers from across the country.

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