Fed hawks and doves could provide rate clarity

Janet Yellen, chair of the U.S. Federal Reserve.
Investors look to Fed speakers for clarity   

With higher rates in mind and the end of the quarter looming, investors may find it time to adjust portfolios as they focus on Fed speakers, economic reports, and the rising U.S. dollar in the week ahead.

Strategists mostly see the market moving higher into the year end, barring any geopolitical surprise. They are also watching to see the continued reaction to the Fed's slightly more aggressive expectations for interest rate hikes, as it moves closer to ending its quantitative easing, or bond buying, program this fall.

Stocks enter the last full week of September with the Dow and S&P 500 at record highs, and the dollar poised for an 11th week of gains.

The dollar has been marching higher as the U.S. economy outperforms and as the Fed looks set to tighten policy, versus other major central banks. Seven different Fed speakers are out in the week ahead, and traders will be listening to see if they fine tune the Fed's slightly more hawkish message.

"We're getting closer to earnings, closer to the mid-term election and getting closer to where people want to take a view on whether Europe is deteriorating," said David Bianco, chief U.S. equity strategist at Deutsche Bank. But he said the environment is currently fairly good for stocks, and he is not now looking for the 5 to 10 percent correction he had been looking for.

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On the calendar, housing is prominent with existing home sales data Monday and new home sales Wednesday. Durable goods Thursday could show a reversal after a huge gain last month on aircraft orders. The second revision to second-quarter GDP is expected to now show growth at 4.6 percent when it's reported Friday.

"We've gotten to the time of year where a lot of people will look at their winners and losers, and we could have some repositioning into the next month or so," said Wells Fargo Advisors chief macro strategist Gary Thayer. "That could cause a little volatility here. Right now, we think the economic news is expected to stay pretty good…If we get a little volatility and the market does well, we could see a good finish into the end of the year."

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The Fed statement Wednesday was fairly dovish but it did signal it is going forward with rate hikes next year and could raise rates even slightly faster than some on Wall Street had expected. That added fuel to the dollar's gains, and sent rates higher, particularly at the short end of the curve.

"One of the things that happened in the bond market is inflation expectations are coming down. A lot of what is moving the bond market is reduced demand for inflation protected securities, both because the Fed is getting a bit more hawkish and the dollar is getting stronger and we're seeing weakness in important commodities, like gold, silver and oil," Thayer said.

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Thayer said he sees the economy in a sweet spot now, though growth is now slower than the second quarter. It is expected second-quarter growth will again be revised higher, to 4.6 percent, when it is released Friday. But it will be strong enough to continue fueling stocks.

Trader on the floor of the New York Stock Exchange.
Adam Jeffery | CNBC
Trader on the floor of the New York Stock Exchange.

Bianco said there's a chance portfolio managers could chase performance into the end of the year, as they did last year. He expects the S&P 500 to finish the year 40 points higher at 2,050, and reach 2,100 by the end of next year.

He said one risk is if the 10-year note yield rises too quickly, or rises above 3 percent this year, which could sting stocks. Bianco also said he does not expect price to earnings ratios to rise into the Fed hiking next year, as they have done in other periods of Fed tightening. That would constrain the size of market gains.

The S&P P/E is already 17.5 percent on a trailing basis. "The earnings are not going to surge. There's going to be healthy earnings growth. That's why you want to lean toward health care and tech. Don't look for a cyclical bounce," he said.

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Thayer, however, likes cyclicals because of the improvements in the U.S. economy, but he notes materials and energy stocks could get hit with weaker commodities prices. He also said it's an unusual time where the U.S. economy and markets are breaking with the world, in a similar way as they did during the Asian crisis in the 1990s.

"I'm hoping the market takes more notice what happens with the dollar and commodities. We're seeing gold and silver break down. If that were to continue next week, I think that would be a positive for the credit markets, and wouldn't necessarily be bad for stocks," Thayer said. "We're in a period where we might see some rebalancing in the stock market. There could be some profit-taking."

Analysts have also been watching the financials, which could be poised for more gains, as the Fed moves to hike rates next year. The S&P financial sector rose 1.7 percent in the past week, and is now up 3.9 percent in the past month. Wells Fargo was at an all-time high Friday; JP Morgan was at its highest level since April, 2000, and Morgan Stanley and Goldman Sachs are both at their highest levels since the financial crisis.

Following the record-setting Alibaba IPO, the biggest bank or thrift issue ever is coming to market this coming week. Citizens Financial Group is looking to raise $3.36 billion.

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"I think a lot of people are watching new issues right now. I think that's a sign of confidence in the economy. I think that's a good thing. I don't think we've seen oversupply of new issues yet," Thayer said.

Analysts are watching the surge in mergers and acquisitions for the same reason. Barclays is recommending investors stick with the acquiring companies.

"The conditions that have caused this to be a unique M and A cycle, with acquirers' shares outperforming the market, remain in place. Debt financing costs are low, cash is elevated and should be put to better use, and there are potential tax savings available, all which can lead to higher EPS estimates and better stock price performance. Until these conditions change, we believe M and A will be a positive force for the S&P 500, as it has been recently," Barclays analysts wrote.

However, they do have a target of 1,975 on the S&P 500 for this year.

What to Watch

Monday

Earnings: AutoZone

8:30 a.m.: Existing home sales

10:05 a.m.: New York Fed President William Dudley

Tuesday

Earnings: CarMax, Carnival, Bed Bath and Beyond

9:00 a.m.: FHFA home prices

9:00 a.m.: St. Louis Fed President James Bullard

9:30 a.m.: Kanas City Fed President Esther George

10:00 a.m.: Richmond Fed

1:00 p.m.: $29 billion 2-year note auction

2:00 p.m.: Minneapolis Fed President Narayana Kocherlakota

9:15 p.m.: Kansas City Fed's George

Wednesday

Earnings: Accenture, Paychex, KB Home, Vail Resorts, Worthington, Jabil Circuit

10:00 a.m.: New home sales

12:05 p.m.: Cleveland Fed President Loretta Mester

1:00 p.m.: $35 billion 5-year note auction

1:00 p.m.: Chicago Fed President Charles Evans

Thursday

Earnings: Nike, Micron, Diamond Foods, Thor Industries

8:30 a.m.: Weekly jobless claims

8:30 a.m.: Durable goods

11:00 a.m.: Kansas City Fed

1:00 p.m.: 7-year note auction

1:20 p.m.: Atlanta Fed President Dennis Lockhart

Friday

Earnings: Blackberry

8:30 a.m.: Real GDP Q2 final

9:55 a.m.: Consumer sentiment