The Liquidity Rally Continues

This morning, the National Association of Realtors announced that existing home sales in February dropped 7.1% to an annual rate of 5.08 million units, the lowest level since November. Last week, however, the S&P 500 continued its central bank-induced liquidity rally, finishing in positive territory for the first time in 2016. It has been quite a ride for the widely followed index so far this year. The S&P 500 closed 2015 at 2043.94, and hit 2016 lows of 1829.08 on February 11th before closing this week at 2049.58. From its 2016 low through this past Friday, the index has returned 12.34% including dividends, after beginning the year by losing 10.27%. Year to date, the S&P 500 has returned 0.80%, trades at a P/E ratio of 18.55 and carries a dividend yield of 2.21%. Without a sharp and broad rebound in the earnings picture, it will be hard to justify the market’s current multiple of earnings. 
 
In addition to the influence of the Fed, the correlation between oil and the equity markets continued last week. West Texas Intermediate Crude Oil closed the week at a spot price of $39.44 per barrel, gaining 2.44%. This represents a more than 50% increase from the February lows of $26.21 per barrel. As a result, many energy and related names have advanced with oil. This week, ExxonMobil advanced 2.45% while Apache produced returns of 1.35%. FedEx also gave the bulls reason to cheer on St. Patrick’s Day, beating sales and earnings expectations and rising 11.83% on Thursday alone. Looking ahead to this week, multiple consumer-oriented companies, including Nike, Oxford Industries, and General Mills, will all report results.
 
Treasury prices rose over the course of the week as the Federal Reserve cut the number of projected interest rate increases this year. The latest “dot plot” from the Fed’s meeting indicated only two projected interest rate increases in 2016, compared to a projected four increases from the December 2015 meeting. Investors had already expected that four increases were unrealistic, but the confirmation this early from the Fed was unexpected, causing Treasury yields to fall Wednesday and Thursday.
 
Fed Chairwoman Janet Yellen said that longer-term inflation expectations were “well-anchored,” and they would allow inflation to move higher as they have the tools to deal with it later on. This caused longer-term yields that are more affected by inflation expectations to fall less than shorter term yields. The Fed also cited risks of a weakening global economy, which could spill over domestically, but stressed that the U.S. economy is still improving. For what it is worth, federal funds futures are not fully pricing in the next rate hike until early 2017.
 
Perhaps the Chairwoman is concerned that higher domestic interest rates will continue to elevate the US dollar, much to the detriment of our major exporters. Her counterparts abroad continue to struggle to jumpstart ailing economies. Last week the Japanese central bank left policy unchanged but downgraded its economic outlook at its meeting on Tuesday. The BOJ primarily blamed a slowdown in emerging markets for the downgrade. Despite adopting negative rates at its January meeting, the BOJ must now contend with a strengthening yen, a further headwind to growth and inflation.
 
Meanwhile, in Norway, the Norges Bank cut its policy rate to 0.5% — an all-time low — from 0.75% and indicated it could trim rates further, going so far as to say that it has the ability to adopt negative interest rates, like several of its Nordic neighbors. We are fairly certain that negative interest rate policies (“NIRP”) will not end well, even if central banks manage to levitate risk assets in the absence of much-needed – but more politically painful – structural reforms.