U.S. stocks rallied for a third-straight session, and for the sixth day in seven, as the S&P 500 hit the high end of the recent trading range (1218) for the fourth time in two months – although the market did retreat in the final minutes once we hit that mark.  There was no clear indication for why stocks jumped again yesterday; the Fed released comments that signaled more QE is in the cards (more on that below), but the upsurge was well underway by the time that statement was released.

This wild ride we’ve been on within the 13% range the broad market’s been stuck in since early August doesn’t only continue, but has become more erratic – hitting the low and high ends of this range with greater frequency.  Recall, it was just a week ago Monday in which the S&P 500 slid to 1075.  That retreat ended on October 4 when stocks engaged in a wild 4% reversal late in that session, and suddenly we’re back to the high end just seven sessions later.

Financials, industrials and consumer discretionary led the way yesterday.  Utilities, health care and tech were the day’s laggards.

It’s nice to see stock prices bounce back to the high-end of the current range, but unfortunately the market can’t recover without bringing the price of crude along too.  These prices don’t normally have such a strong positive correlation, but such is reality in an environment with which monetary policy is unprecedentedly aggressive.  (One doesn’t have to go back too far in the memory bank, not in the world of investing at least, to remember a soaring stock market and a falling price of crude – such as when oil fell 35% and stocks jumped 207% during the economic revival of 1982-1989 or when crude slid 40% – averaging $18.70/bbl – when stocks jumped 212% in the years that ran 1992-1999; it was not until the Fed began to pump massive amounts of money into the market as result of the perceived Y2K problem in 1999 when crude began to jump during the tail-end of the ‘90s, but even so it still traded at just $25/bbl.)

Now though, stocks remain more than 20% below the 2007 peak and flat since 1999, yet the consumer is stuck with $85/bbl crude – while at the same time troubled with a 9% official jobless rate and declining real wages.  The price of crude should be no higher than $40 in this environment.

The market cheers when the Fed pumps more money into the system because much of this liquidity goes to levitate stock prices.  But the Fed cannot control where this money goes, and plenty of it ends up in the crude trade.  Hopefully, more people are beginning to realize that outside of their lender of last resort function, the Fed doesn’t really solve problems at all, but they sure can create them.

Market Activity for October 12, 2011

Sector Activity for October 12, 2011

European Scene

The Slovakian Parliament has reportedly found the votes to pass expansion of the EFSF (just to remind, Slovakia is the final euro-zone country to vote on beefing up the bailout fund that all 17 countries must ratify).   So they went from rejecting it one day to having the votes to approve it the next; it appears there was an “Angela Merkel is on the phone” moment.  They are expected to conduct the next vote on Friday.  From here, I guess the next thing markets will have to deal with is that the new and larger bailout fund is still not enough to thwart Europe’s debt woes.

Mortgage Apps

The Mortgage Bankers Association reported that its applications index rose 1.3% last week, bouncing a bit from the 4.3% decline in the previous week.   The overall index is down 17.2% over the past year.

Apps to refinance a mortgage rose 1.3% (dropped 5.2% in the previous week) and purchases rose 1.1% (slipped 0.8% in the prior week).  The two measures are down 19.5% and 2.9%, respectively, over the past 12 months.  The average contract interest rate on the 30-year fixed mortgage rose seven basis points in the latest week, but remains extremely low at 4.25%.

FOMC Minutes

The minutes (notes) from the September 20-21 Federal Open Market Committee meeting revealed that a number of members wanted to keep more asset purchases as an option as they saw “considerable uncertainty” that economic growth would pick up.  Translation:  More QE remains on the table.

As you may recall, what the Committee announced directly after that September meeting was Operation Twist (technically “maturity extension”), which involves the purchase of more longer-dated Treasury securities.  But that action also entails selling short-term securities, thus there is no additional liquidity injected into the marketplace from a monetary standpoint.  They refrained from mentioning QE in that statement.

So these minutes offer the initial signal that QE3 (in Fed jargon, LSAP – Large-Scale Asset Purchases) is coming.  It may take a more firm statement from Bernanke to ramp commodity prices significantly higher from here, but based on the QE/commodity relationship thus far, it won’t be long until an experimental Fed further bludgeons the consumer.

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Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900