Following a modest pull back in late July/early August the equity markets have rallied back to the highs for the year. The support for the three week rally has been provided by an oversold/underbelieved condition at the August 7 low near 1915 using the S&P 500. More importantly, the stock market has been supported by improving economic conditions and declining interest rates this summer, which is an unusual configuration.
Following the strong second quarter GDP report, the yield on the benchmark 10-year T-note dropped to the lowest level in 12 months. This was counter to the notion that stronger economic growth would translate into higher interest rates. As a result, the equity markets are experiencing the best of both worlds, a better economy and low interest rates.
In a widely monitored speech last week, Janet Yellen offered no immediate time frame as to when the Fed would begin to raise interest rates. The Fed is focused on inflation to determine when to shift policy and inflation is tightly tied to income. Real wages have shown little growth the past five years growing barely above the inflation rate of 2.0%.
It is likely that wage gains would need to approach 4.0% before having an impact on the inflation rate. The yield on the benchmark 10-year Treasury note finished last week at 2.40%. We suspect that the yield would need to rise to 2.75% to 3.00% before it would have a negative influence on stocks.
The technical condition of the stock market is mixed. The market is no longer oversold and investor sentiment is moving toward optimism, suggesting upside progress will slow. The new high by the S&P 500 has not been confirmed by the Russell 2000 and Dow Industrials, which continue to lag.
Despite the rally momentum, which is a function of volume, remains elusive. Nevertheless, given the favorable monetary backdrop the benefit of the doubt must be given to the upside. Support, using the S&P 500, is 1915-1960 with resistance just ahead at 2000.
Got Questions? Ask Guido
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
Vice President of Private Wealth Management
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