Path of Least Resistance for Stocks Near Term

Stocks have been off to a great start in 2013 with the Dow Jones Industrial average reaching new highs earlier in March and the S&P 500 advancing more than 9% for the year as of March 8. With (Q4) earnings season behind us, it may be safe for a casual observer to assume that these gains in stocks have been fueled by decent corporate earnings. We believe Q4 earnings were terrible but that will be the subject of another article.

As I mentioned in my 2013 outlook piece, stocks have been and will likely continue to be influenced by the actions of the Federal Reserve and its open-ended quantitative easing program. The Fed’s easing program is in turn influenced by the improvement, or lack thereof, in the economy and specifically with the unemployment rate. The monthly unemployment report for February was released last week showing an unemployment rate of 7.7% and an increase of 236,000 jobs in the economy while January’s report was revised lower to show an increase of 119,000 jobs. While February’s report came in better than expected, the economy will need many more strong jobs reports for the unemployment rate to come near the 6.5% threshold that the Fed has set for itself as the point at which to change its interest rate policy.

The Fourth quarter GDP report that was released on February 28 showed rather lackluster growth in the economy at 0.1% after being revised up from a -0.1% rate initially. While this lackluster growth should give further ammunition to dovish Federal Reserve governors who argue for continued quantitative easing, it is also a sign that the efficacy of QE is eroding (at least in the eyes of more pessimistic, glass half-empty type of economists).

So given the above, where are stocks going in the near term?

The reason for the lengthy introduction above is to illustrate that stocks have been going up in the face of mixed results for the economy. We should assume that the Fed will continue with its open ended QE regardless of the next unemployment report or two. Nonetheless, stocks can’t continue to go up, even with QE, if the economy and earnings start to dramatically deteriorate. But with earnings season behind us, we will not get another glimpse into earnings until Q1 earnings season kicks off in mid April and which is expected to go on through the end of May. Similarly, the initial reading on Q1 GDP won’t come in before April 26. Until then, and absent any exogenous event, we are likely to see stocks continue their upward advance over the next 4 to 6 weeks fueled by (likely misplaced) optimism and performance chasing.

Tagged Stocks