Canaccord Genuity strategist Tony Dwyer says selling in September could be a big mistake.» Read More
In a classic 1899 poem by Stephen Crane, a man insists to the universe that he exists, only to hear the universe reply: "The fact has not created in me / a sense of obligation." As the Federal Reserve looks to adapt to changing economic conditions by removing stimulative policies, the conversation between chair Janet Yellen and investors could sound somewhat similar.
"If the numbers change and the Fed rhetoric all of a sudden changes, they're not going to care whether investors feel like the rug got pulled out from underneath them," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank, on Tuesday's "Futures Now."
The Fed is currently using an ultralow target on the federal funds rate to keep short-term interest rates low. But as economic conditions change, the Fed has said they will raise rates.
"The great economist Wayne Gretsky said you have to skate to where you think the puck is going, not where it is, and the problem the Fed has is that by its own forecasts, you're going to have real interest rates that are still sharply negative next with an economy already at full employment and inflation at target, and yet somehow bond investors think rates are going to stay where they are," LaVorgna said. "So the problem is, if you wait till the last minute, which is what this Fed wants to do, you do really risk financial issues, and the fact that you may ultimately destabilize the economy because you have to raise rates significantly more than you thought. That's the problem."
Is there something seriously wrong with the economy?
It's a scary prospect, and a concern that's gotten louder and louder over the past year. In economic circles, it goes by the alliterative name of "secular stagnation." And it's a phrase that Fed watchers are likely to hear more and more in the months ahead.
Recent comments by the vice chairman of the Federal Reserve, Stanley Fischer, indicate questions within the central bank about whether the slow growth that has followed the recent recession could reflect, or at least could potentially morph into, longer-term issues within the economy. And while Fischer avoided the phrase "secular stagnation" in his Monday speech, Minneapolis Fed President Narayana Kocherlakota is planning to host a November symposium that directly addresses the issue of secular stagnation by name, CNBC has learned.
"I think there's a lot of concern about how long this will last, and I think that's certainly high on the agenda right now. At least people are entertaining that possibility now that it could drag on for longer," said Brown University associate professor of economics Gauti Eggertsson, who authored (along with fellow Brown economist Neil Mehrotra) the landmark paper "A Model of Secular Stagnation," which provides an in-depth explanation of how a long period of low growth could come about.
The theory of secular stagnation was first developed by Alvin Hansen, who wondered in the midst of the Great Depression whether diminishing investment opportunities in a maturing economy would stunt economic growth and permanently prevent full employment—at least in the absence of robust government intervention, which soon came in the form of the second world war.
These theories have found a new life in the aftermath of the so-called Great Recession, as the U.S. is experiencing (albeit to a much less dramatic degree) slow growth over a relatively long time period.
In November 2013, noted economist Larry Summers (who was considered, alongside current Chair Janet Yellen, a leading candidate to head the Fed) began to invoke the same phrase in arguing that the interest rate that the economy requires has fallen below zero.
The problem is that it is very difficult for nominal interest rates to fall below zero due to a constraint known as the zero lower bound. The upshot? Even with the Fed keeping short-term rates just above zero, market interest rates cannot possibly create adequate demand for loans, and thus the economy stagnates.
Without embracing the secular stagnation thesis, in Sweden on Monday, second highest-ranking Fed official Fischer gestured toward those concerns.
Noting slow growth in "labor supply, capital investment and productivity," Fischer warned that "This may well reflect factors related to or predating the recession that are also holding down growth" and noted: "How much of this weakness on the supply side will turn out to be structural—perhaps contributing to a secular slowdown—and how much is temporary but longer than usual lasting remains a crucial and open question."
"There was a level of concern on that point that I don't think we generally hear," said Nicholas Colas, chief market strategist at ConvergEx, referring to Fischer's speech.
The stagnation debate will also be addressed by a new eBook entitled "Secular Decline," which is due to be published on Aug. 18, and hosts contributions from Paul Krugman and Nomura's Richard Koo, in addition to Summers, Eggertsson and Mehotra, and others.
Investors are gearing up for a big week of retail earnings, with companies including Wal-Mart, Macy's and J.C. Penney set to release results. But as concerns about the American consumer persist, few expect to hear anything especially encouraging.
"I think that the consumer has been struggling over the past six months," said Anthony Grisanti of GRZ Energy. "And we know that companies have been able to do more with less, and they've been able to squeeze a little bit more money out of their earnings. But what we haven't seen is the good sales coming in from the consumer. So if those consumers aren't strong, if those numbers aren't strong, I'm a seller" of S&P 500 futures.
"I don't right now see any inflection point that would make me change my mind in the near-term," said Jonathan Golub, chief U.S. market strategist at RBC Capital Markets. He recently downgraded his view of the consumer discretionary sector to "market weight." "But obviously, I'll be watching very closely, because retail earnings are the only thing holding us between now and the end of earnings season."
Golub noted with 452 of the S&P 500 companies having already reported, less than 50 percent of retail companies have unveiled their quarterly results so far. Retail remains the only major wild card for second quarter results.
The key name will be none other than the world's largest retailer. Wal-Mart is set to report on Thursday before the market's opening bell. And with Wal-Mart U.S. CEO Bill Simon (who has since left the company) telling Reuters in early July that the improving economic picture isn't reading through to Wal-Mart's sales, expectations are not high.
"The low or moderate income consumer is really struggling right now. They haven't seen any kind of significant wage increases, and they're living paycheck to paycheck," said Ken Perkins, the president of independent retail research company Retail Metrics. As a result, "Wal-Mart is having a heck of a time trying to generate positive comps [or sales comparisons to the prior year] in the U.S."
As high-yield bonds have dropped in recent weeks, words like "bubble" and "warning sign" have been thrown around. Some have said the class of corporate bonds, which pay higher yields due to a higher perceived risk of default, is a canary in the coal mine for other asset classes. But Bank of America Merrill Lynch's head of high yield strategy, Michael Contopoulos, says that concerns about the space are unfounded.
For Contopoulos, the recent story in high-yield bonds is a simple one: Spooked retail investors have begun pulling money out at a rapid pace.
"What we've seen in high yield has really been a retail-driven story," Contopoulos said on Thursday's "Futures Now." "There's been a confluence of events, between geopolitical, Fed and media coming out and talking about a leverage finance bubble, and the easing of lending standards, that have instituted some fear in the retail crowd. You couple that with valuations that were very, very rich at the end of the second quarter—I think that's really led to a little bit of retail panic, if you will, although that has subsided over the last few days."
While high yield bonds have bounced back from their lows, retail investors have not stopped fleeing the funds. On Friday, Lipper reported that investors pulled more than $7 billion from high-yield funds and ETFs in the week ending Wednesday, a new record-high outflow.
Still, now that so-called junk bonds have begun to bounce back, "I think you're going to see the high-yield market actually rebound pretty well," he said. "Fundamentals are strong, and they're as strong has they've ever been."
When trading gets tough, investing professionals tend to turn to the charts for guidance. And with tender geopolitical situations cropping up around the world, European economies in question and stocks getting closer to "correction" territory, many say the S&P 500's 100-day moving average is beginning to take on an outsized importance.
Known as a "smoothing mechanism," the 100-day moving average takes the average closing price from the prior 100 trading days, and thus provides an overall idea of the market's trend. The fact that the average takes into account precisely the prior 100 trading days (rather than 95 or 105, say) makes the exact level of the indicator somewhat random.
However, since 100-day moving averages are widely watched on Wall Street, the level that the S&P 500's moving average happens to be sitting on can begin to matter big time.
In fact, many traders point out that on Wednesday morning, the S&P 500 bottomed just 2 points (or 0.1 percent) away from its 100-day moving average, which comes in at 1,913.25. For chart watchers, this is a very good sign.
"We bounced right off the 100[-day moving average], and that's encouraging," Rhino Trading Partners' chief strategist, Michael Block, told CNBC.com. "If we broke it, that would be a concern. But we're right on that level, so let's see what happens."
Over the past year, buying the S&P whenever it has gotten down to its 100-day moving average has made for some terrific trades. Going back to June 2013, the S&P has touched its 100-day moving average six times—and each time, it has bounced back like clockwork.
It might be the market's most persistent mystery this year: If the economy is improving, and the Federal Reserve is pulling back on stimulus, then why are bond yields still so low?
For Lawrence McDonald of Newedge, the answer is simple: The first assumption, that economic growth is accelerating, is not really accurate.
Crude oil and gold have both sunk this year, and in July the S&P GSCI commodities index erased nearly all of its gains for the year. McDonald pointed out on Tuesday's "Futures Now" that you wouldn't normally see such bad commodity performance if the economy was really picking up.
Within the stock market, he notes that the retail sector is "massively underperforming" the S&P 500, which also seems to send a sour message about the economy.
But to this bond expert, the most troubling sign is that the 10-year yield has fallen relative to the 2-year yield. Known as a "flattening of the yield curve," this kind of relative performance tends to occur when bond investors don't think economic growth (and thus inflation) in the longer-term will outpace economic growth in the shorter-term.
In combination with his thesis that "the data is showing us something concerning in terms of the economy," McDonald determines that "all of those things together add up" to portray a dour portrait of economic growth.
Despite the summer heat, commodities have been anything but hot. In July, commodities suffered their worst monthly decline since May 2012, as the widely watched commodities index, the S&P GSCI, erased nearly all of its gains on the year with a 5.3 percent drop.
The big drags on the index were energy and agriculture, which each responded to specific drivers on the supply side of the equation, according to Jodie Gunzberg, global head of commodities at S&P Dow Jones Indices.
In the energy markets, Libya resumed exporting crude, which sent prices across the energy spectrum lower on the increase in supply. Meanwhile, agricultural commodities dropped nearly 9 percent, hitting the lowest level in four years as ideal weather conditions improved the supply outlook.
The strengthening U.S. dollar probably did not help matters, either. The U.S. Dollar Index, which compares the dollar to a basket of other currencies, rose 2 percent in July. As the dollar increases in value, commodities typically lose value. But that said, not all commodities were in decline—industrial metals like nickel and zinc had a good month, due to rising demand from China.
And despite the slide, Gunzberg said that there aren't many reasons to expect that the weakness will continue.
"The important thing is that inventories didn't build up all of a sudden," Gunzberg told CNBC.com. "It's more of a temporary drop from a good crop and what's happening right now with energy."
In addition, the calendar is actually working for commodity bulls.
"There has, historically, been a price increase in late summer, early fall—August, September, October, sometimes even a little bit into early November. Commodities are a little bit cyclical."
The bulls are looking for the market's mild 2014 rally to resume in the week ahead, as investors digest data that suggest the economy is growing but not quickly enough to turn the Fed more hawkish.
On Thursday, the S&P 500 suffered the worst session since mid-April, and followed up those losses with further declines on Friday. But Friday also brought the employment report, which many saw as a near-perfect number for the market.
According to the Bureau of Labor Services, 209,000 jobs were added in July, which was below economist expectations of about 230,000, but still marked the sixth straight month of plus-200,000 job growth. Meanwhile, the unemployment rate ticked up to 6.2 percent as more people entered the labor force, and average hourly earnings were almost perfectly flat.
The instant takeaway? That the economy is growing fast enough to power corporate results, but not so quickly as to spur the Federal Reserve to raise the key federal funds rate earlier than anticipated (widely regarded as the market's key concern right now).
This is "not what the bears wanted to see," Mizuho Securities chief U.S. economist Steven Ricchiouto wrote in a Friday note. "The net is that the economy is growing at or slightly below trend on average. There is no reason for the market to move out of its trend."
While S&P futures gained a bit of ground immediately after the report, the market did trade lower on Friday. But Michael Block, chief strategist at Rhino Trading Partners, was sanguine.
"We're going to be fine here," Block said. "I think it creates buying opportunities."
Gina Martin Adams started out the year with the lowest S&P 500 target on the street, at 1,850—a wager that stocks would end 2014 roughly flat. That target came a bit closer into view on Thursday, as the S&P 500 slid about 1.5 percent and got as low as 1,937.
But Wells Fargo's institutional equity strategist said on Thursday's "Futures Now" it could get even worse for the market than that target implies.
"You know, our price target for the end of the year implies that we're probably about 5 percent down, at the very least, at some point in the second half of the year," Adams said.
"I would say that you have to prepare yourself for up to 10. Ten is very, very normal in the grand scheme of markets, and would actually be fairly healthy, I think, washing out some of that excess optimism we've developed, and some of the complacency we've developed."
She says the decline is to be expected, given that the Federal Reserve is pulling back on stimulus. On Wednesday, the central bank reduced its asset purchasing program by an additional $10 billion per month, and is now contemplating when to raise its target on the key federal funds rate.
"When you look at history, it is very typical for the market to start to show some volatility, start to show some weakness in areas when the Fed is shifting gears. And I think that's the overall structure here," Adams said. "We're starting to get a little nervous for what it's going to be like to fly on our own without the support of the Fed behind us, and we're set up for a period of volatility here."
Investors certainly expect volatility to rise. The CBOE Volatility Index (commonly known as the VIX), which measures implied volatility shot up some 20 percent on Thursday to hit a three-month high.
Shortly after the market hit the lows of the day on Wednesday, one trader spied an opportunity. And in one huge options trade that caught the eyes of market participants around the globe and appeared to help out stocks in the afternoon, this major player made a wager that the S&P 500 will rise into the end of the year, perhaps getting above 2,050 as soon as October.
In a single combination of purchases and sales of S&P 500 options that occurred at about 12:20 p.m. ET, this trader sold 6,000 December 1,850-strike puts, bought 12,000 October 2,050-strike calls and bought 18,000 December 2,125-strike calls.
Options experts will tell you that this specific kind of trade is called a "ratio calendar risk reversal stupid" (seriously). But the bottom line is that by doing all this fancy footwork, the trader immediately took in a $2.7 million credit, but could make a lot more if the market continues to rise.
For every point that the S&P is above 2,050 at October expiration, the trader will make another $120,000 (given that 12,000 contracts were bought, and S&P options have a 100-times multiplier). And for every point the S&P is above 2,125 on Dec. 19, the trader will make $180,000. That means that if the market closes the year 15 percent higher, for example, this trade will yield some $25 million.
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