Investors exasperated by the market's lethargy in the face of double-digit profit growth should now be starting to understand Wall Street's preoccupation with the Federal Reserve.
The smart money has suspected all along that the stock market wouldn't really gallop again like it did in 2003 unless the central bank managed to do the (nearly) impossible: rein in the liquidity glut that it pumped into the economy starting in 2001 without causing a painful slowdown, or even a recession. Now, with the Fed in the second year of its campaign to raise interest rates, investors aren't so sure that will ever happen.
Fed funds futures are pricing in a 70% chance of another quarter-point rate hike in August on top of the one that's expected with near certainty next week. Two weeks ago, traders were anticipating a mere 5% chance of another hike in August.
The stock market's recent rattling reflects those raised expectations, as did Tuesday's desultory session, which saw stocks wilt late.
After trading as high as 11,029.83 intraday, thanks in large part to strength in
Dow Jones Industrial Average
ended up 33 points, or 0.3%, to 10,975. The
was off fractionally at 1240 after trading as high as 1249.01; and the
edged down 3 points, or 0.2%, to 2107, about 20 points below its intraday best.
The earlier gains came as financials showed signs of leadership and a round of economic data from the real estate sector suggested that the housing market might have some fight left. At one point, the Philadelphia Banking Index was up 0.7% after the Commerce Department reported U.S. housing starts rose 5% in May to an annualized rate of 1.96 million. That beat the expected gain of 1.1%.
Both data points provide optimism because financials and housing are intertwined due to the prevalence of mortgage financings. And both are particularly prone to a hard landing as rates climb higher. Staying power among financials and housing would suggest the Fed could still have some wiggle room to raise rates, drain liquidity and ward off inflation without causing financial turmoil. That's especially reassuring to investors because the new Fed chairman, Ben Bernanke, and his fellow governors keep pounding out hawkish rhetoric.
"Headline measures of inflation of late have been bothersome, with higher oil prices contributing to much of the run-up in those broad readings," Atlanta Fed President Jack Guynn said Monday before a group of bankers in Florida. "Monetary policy is now close to where it should be," Guynn added, but "we have to remain open to rethinking our policy setting as that outlook changes."
In an interview with
Monday, Dallas Fed President Richard Fisher said the central bank was focused on the inflation threat, and its goal is to make sure "expectations don't feed into inflationary behavior."
Together with Bernanke's public comments from two weeks ago that ignited a major selloff on Wall Street, the collective Fedspeak seems as focused on tamping down speculation in commodities markets as it is on cooling off the economy.
the Fed can jawbone at speculators and take the wind out of the commodity and oil markets, the less they will really have to raise real interest rates beyond the neutrality point in the future," says Paul Mendelsohn, chief investment strategist with Windham Financial Services. "The jawboning that we're seeing not just from Bernanke, but from the coordinated effort of all the Fed governors, is designed to push speculators out of these markets and stop them from raising prices higher. There's no question about it."
Meanwhile, after gold staged a 20%-plus correction from its May highs that kicked into overdrive under pressure from the Fed last week, the precious metal was on the rebound Tuesday. Gold futures for August delivery finished up $8.10, or 1.4%, to close at $580.50 an ounce. Silver for July delivery rose 30 cents, or 3%, to $10.27 an ounce.
Mendelsohn points out that gold's correction merely brought it down to its 200-day moving average, which could provide support for another run to the upside.
"Theoretically, the bull trend is still in place in metals, and all you've got is a correction within an upward market," he says. "You've taken the parabolic out of the curve, but you haven't necessarily ended the upward trend in gold and commodity prices."
If commodities start marching up again, the Fed could feel compelled to continue raising rates in order to squelch any threat of sustained inflation. With each step higher for interest rates, the risks to the stock market are increased.
Mendelsohn is keeping an eye on the financial and energy sectors for any sign of a technical breakdown. That, he says, could lead the S&P 500 down somewhere around 1160 or 1150. By the close on Tuesday, the Banking Index gave up most of its gains to close up a measly 0.1%, while the Philadelphia Oil Service Index lost 2.3% as crude prices eased.
was a notable laggard in the group, losing 3.5%.
Meanwhile, the housing data that started the day off strong was essentially viewed as a wash by the closing bell. Building permits were lower for the month, down 2.1%, and the data came a day after the National Association of Home Builders said an index of builder sentiment fell last month to its lowest level in more than a decade.
closed down 70 cents, or 1.6%, to $44.11;
dropped 56 cents, or 2.1%, to $25.98; and
lost 59 cents, or 1.2%, to $47.55.
"With inventory of new homes for sale high and rising very rapidly, it makes no sense for homebuilders to continue adding new supply at anything like the current pace," writes Ian Shepherdson, chief U.S. economist with High Frequency Economics.
In the event of a sudden dropoff in the housing market, consumers and the financial institutions that finance them could feel a pinch.
"For now, I have brought my allocation down, but boy, I will just wipe it out if I get confirmation that financials and energy are going lower," says Mendelsohn. "I don't see substantial money flows going anywhere else in this market."
So it was again on Tuesday, with the market remaining hamstrung amid ongoing and persistent fears of the Fed.