The FOMC tightened the money supply on Tuesday by raising the Fed Funds rate 25 basis points to 3.75%, for the 11th time in about 18 months. Consequently, SPX fell over 30 points Tuesday through Thursday, and closed the week down about 23 points, to just over 1,215.
Price stability is the main goal of the Federal Reserve, because when the Fed targets inflation, growth fluctuates little. However, when growth is targeted, inflation fluctuates a lot, which eventually leads to instability. The data show the Fed has done an excellent job of smoothing-out the business cycle over the past 20 years. Sustainable growth is optimal growth, which raises living standards at the fastest possible rate.
The current Fed Funds Rate is still accommodative. Normally, a neutral stance is well over 5%. However, the Fed has been brilliant in lowering inflation expectations, which lower future inflation, over the tightening cycle using a combination of "jawboning" and actual tightening. Consequently, the economy has shifted from above trend growth towards trend growth smoothly. The smooth downshift in economic growth is reflected in the stock market. The VIX (S&P 500 Volatility Index) fell below 10 two months ago, which was a multi-decade low. VIX reflects investor fear, and there has been little fear of the stock market recently.
The chart below is a weekly chart of the SPX to VIX ratio, since 1990. Over time, SPX will rise and VIX will trade in a range. So, the ratio will rise. Also, there's generally an inverse relationship between SPX and VIX, i.e. when SPX rises, VIX falls, and vice versa. The 200-week MA (red line) shows the ratio is mean reverting. Typically, when the ratio is 30 to 40 points away from the 200-week MA, it will fall towards the MA. Also, the 40-week MA (blue line) shows a steep rise over the 2 1/2 year cyclical bull market. So, if the ratio rises above 100, caution may be required intermediate-term.
Economic reports next week are: Mon: Existing Home Sales, Tue: New Home Sales, and Consumer Confidence, Wed: Durable Goods Orders, Thu: Unemployment Claims, Final GDP, and Final GDP Price Deflator, Fri: Personal Income, Personal Spending, Revised Michigan Consumer Sentiment, and Chicago PMI. Notable earnings next week are: Mon: WAG, Tue None, Wed: RIMM RHAT KMG, Thu: PEP, Fri None.
I believe, the market will rise next week into the new quarter, although there may be a few more earnings warnings. It seems, end-of-the-quarter window dressing has already been completed (e.g. when oil stocks rose a week ago, while oil prices fell). Volatility may pick-up when earnings season starts in October, and some stocks will rise and other stocks will fall sharply on earnings. Economic reports and oil prices should continue to influence the market.
Charts courtesy of StockCharts.com |
