The equity markets managed to carve out fractional gains last week despite the turmoil overseas. Stocks were supported by improving corporate earnings and fresh economic data that show the U.S. economic recovery is accelerating. Second quarter corporate earnings are also experiencing a revival with gains approaching 9.0%.

The improvement in the business environment, however, raises the prospect that the Federal Reserve could shift monetary policy sooner than expected. The principal support for the stock market the past five years has been the extraordinary policies adopted by Fed Chief Bernanke and now Janet Yellen to stimulate the economy. 

The concern is that the Fed, by reducing the level of quantitative easing, is already in a tightening mode and improving economic conditions could accelerate the end of the era of low interest rates. Friendly monetary policy since 2009 has trumped fundamental and technical analysis. This partially explains the increase in stock market volatility that is likely to continue into the fourth quarter.  Support is 1900 using the S&P 500 and resistance is in the vicinity of 1960. 

Continued weakness in the broad market has become a headwind for the popular averages. This is seen in the declining percentage of groups within the S&P 500 that are in defined uptrends.  There has also been a reduction in the number of issues hitting new 52-week highs and an expansion of issues recording new 52-week lows. 

Seasonal pressures are also a factor given that historically stocks are entering the weakest period of the year.  The rise in stock market volatility has caused a sharp uptick in short-term investor pessimism.  This suggests that the rally late last week will likely carry forward this week.  Nevertheless, with the Tape weakening and seasonal pressures mounting a cautious approach is warranted. 

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Article provided by Robert W. Baird & Co. with the authorization of its author for Evan Guido, Vice President, Financial Advisor at the Sarasota office of Robert W. Baird & Co., member SIPC. The opinions expressed are subject to change, are not a complete analysis of every material fact and the information is not guaranteed to be accurate. 

Evan R. Guido

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