Surge

Stocks across many major markets have surged to their fifth straight week of gains, marking the longest such run in more than two years. The MSCI All-Country World Index rose more than 13% from the February lows, and it wasn’t just mainstream developed market stocks moving higher. Almost universally eschewed just a few months ago, emerging markets and commodities have led the way higher. Why? Two related answers, namely central bank actions, and investor psychology.

On the back of already improving prices and market psychology (see Short Squeezes & Apple Juice) the European Central Bank (ECB) delivered a package of stimulus measures, cutting its main interest rates and expanding its already massive bond-buying program (also known and QE). ECB president Mario Draghi stated that the set of measures including a -0.4% deposit rate, and an increase in debt monetization to 80 billion euros (about $87 billion) per month would “reinforce the momentum of the euro zone’s economic recovery.”

This week, US Federal Reserve (Fed) Chair Janet Yellen followed Draghi’s statement with her own version of relative stimulus, as the Fed board decided to again delay interest rate hikes and revised their old forecast of 4 interest rate hikes in 2016 down to 1-2 for the remainder of 2016 and another 2 in 2017. “Most committee participants now expect that achieving economic outcomes similar to those anticipated in December will likely require a somewhat lower path for policy interest rates than foreseen at that time” said Yellen.

Since bottoming in January and February markets have turned higher along with investor optimism. Prevailing opinion holds that stocks have seen the lows for the year, and maybe longer, and central bank intervention and stimulus signal “all clear” for risk assets. We were cautiously optimistic near the panic lows and we remain cautious now. Even if the seven-year-old bull market continues for some time, underlying market character may change.

For some time, the bull case has rested on the continuation of economic growth without aggravating inflation or interest rate pressures. Low capacity utilization and relatively higher unemployment, proved absorbent. At full(er) employment, wage and core consumer price inflation could increasingly be seen as presaging higher interest rates. Heightened interest rate expectations could have a dampening effect on the prices of a broad range of financial assets representing future cash flows. At this point, it isn’t clear whether recently positive price trends mark the end of the correction, or merely a period of mid-winter sunshine.


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