** WEEKLY U.S. WRAP **
The Fed presented the stock market with a late Christmas present. It was good enough to lead to a fundamental shift in the outlook, and the S&P was up every day this week.
The Fed’s December FOMC minutes were released on Tuesday afternoon. The The minutes stated that “views differed on how much further tightening might be required” and that “policy decisions going forward would depend to an increased
extent on the implications of incoming economic data.”
In other words, several more rate hikes are by no means guaranteed. Market talk went from a fed funds rate of 5% or more later this year to expectations that the Fed might halt the rate hikes at 4 1/2% or 4 3/4% over the next several months.
The S&P 500 index surged 20 points on Tuesday.
The implication that the Fed might be nearing the end of the rate hike cycle is a very important fundamental issue. Higher rates would threaten economic growth in the latter half of 2006, and would lower the relative value of stocks in
valuation models.
The market response was rational. It also carried through the week.
The S&P index gained another 5 points on Wednesday, was up fractionally on Thursday, and posted a 12 point gain on Friday. All of this was possible because of the revised perceptions on Fed policy.
The Friday gain was due in part to a lower-than-expected 108,000 increase in December non-farm payrolls. This suggests weaker economic growth than expected, but at this time that is a positive for stocks because it adds to the argument that the Fed will soon stop raising rates. The key inflection issue for stocks is the interest rate outlook, not the economic outlook, and everything will be viewed through that perspective.
Other economic data this week were mixed. December auto sales were disappointing, but sales at retail chains were slightly better than expected for
the important month of December.
There were only a few earnings reports. Walgreen, Monsanto, and Accenture had good reports. Oil was up on the week and crude closed above $64 a barrel. That was considered tolerable, however, especially as natural gas prices continued their recent plunge.
The focus will shift to fourth quarter earnings reports over the next couple of weeks, but the underlying tone has clearly improved since late December. This
is due entirely to the revised expectations about the outlook for Fed policy.
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