Stocks closed lower last week for the first weekly decline of the broad indices in over a month. The Dow Jones Industrial Average (chart) closed the week down 1%, the Nasdaq (chart) -0.3%, the S&P 500 (chart) closed lower by 1.1% and the small-cap Russell 2000 (chart) also finished the week lower by almost 1%. I suppose a bit of a pullback was overdue considering how much the market has gained over the past five weeks or so. Some of the chatter is that this most recent weakness is due in part to the upcoming Fed policy meeting next week, and the expectation that the Fed is on the brink of changing its language pertaining to interest rates. Between strong economic growth and healthy corporate balance sheets, it’s no wonder analysts are expecting a shift in demeanor over at the Fed. Furthermore, oil has dropped significantly since late June which is finally beginning to show up at the pump. Lower gas prices is a positive for the consumer which could add more fuel to the economy, no pun intended. But wait a minute, the job market recently has done an about face with less hirings occurring in the month of August, which could give the Federal Reserve a reason not to put the brakes on so quickly. Personally, I think the Fed will become a bit more vocal regarding rising rates over the coming months.
So what could this mean for stocks in the near term? For one, I expect more volatility between now and year end. Especially as it pertains to the upcoming third quarter earnings reporting season. We all know that the Fed will end its asset purchase program in October, and then next logical step for them is to begin to raise interest rates at some point in time. So corporate America sooner than later will have to stand on its own two feet and show top-line growth in order to appease investors and maintain their valuations. See, the accommodative policies over the past five years or so has in part given companies a pass so to speak if they weren’t growing their top-lines. What a lot of companies have done over the past few years is clean up their balance sheets by becoming more efficient by way of trimming expenses and implementing stock buyback programs. This of course in many instances improved their earnings and bottom lines, while not really growing their top-lines. Which is why I view the upcoming Q3 earnings reporting season as potentially one of the defining moments in this historic bull run we have enjoyed over the past five years. This could also be a “Goldilocks” moment where the Fed ends its asset purchase programs, begins to gently raise rates with minimal inflation in sight, and corporate America demonstrates top-line growth. This is what Janet Yellen and the Federal Reserve would call the perfect set-up. I, like most investors would love to see this theme play-out. However, let’s not forget the multi-trillion dollar balance sheet that the Fed has incurred during this unprecedented time of monetary accommodation, and as of now, no one really knows what type of impact this will ultimately have on our economy and our markets. Good luck to all and have a great week 🙂