The five-week summer rally in the equity markets was interrupted last week with the S&P 500, Dow Industrials and Russell 2000 losing about 1.0%. The decline was triggered by weakness in the bond market as the yield on the benchmark 10-year Treasury note climbed to 2.60% from 2.35% two weeks ago. Stronger than expected August retail sales renewed fears that the Federal Reserve could raise interest rates sooner than anticipated. The anxiety level was further elevated in anticipation of this week’s meeting of the Fed’s Open Policy Committee.

Despite the improving trends in the U.S. economy we believe it is unlikely that the Fed will suggest a time frame for shifting policy from offense to defense. The real strength in the economy remains difficult to measure due to the volatile first half GDP numbers and there is evidence that inflation pressures are actually receding. Falling energy prices and a rising U.S. dollar argue against inflation gaining a foothold anytime soon. In addition, reports this week on Producer and Consumer prices are likely to show pricing pressures flatlined in August. This is expected to keep Fed Chair Janet Yellen firmly in the dovish camp.

Gold prices have steadily declined the past three months. In addition to being considered a reliable indicator of future trends in inflation, gold is often used as a hedge against black swan events in the global economy. The fact that international investors are not aggressively turning to gold suggests that recent geopolitical events are not seen as a threat to the financial markets. Our outlook on gold has been that investors should wait for a breakout above $1400 before assuming the long-term trend has turned positive. Sentiment on gold, however, has slipped into the zone that indicates that pessimism is nearing an extreme, which raises the potential for a short-term trend reversal.

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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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