MarketView for June 17

Summary

The three major equity indexes ended the day higher on Monday, although well off their highs, as speculation continued with regard to the future of QE3. Climbing from the start of the day's trading session, the indexes were more than 1 percent higher for much of the day, recovering all of last week's losses on the view that the Fed would reaffirm its policies of supporting the economic recovery at the end of a two day meeting that starts on Tuesday.

At the same time, there was additional support from economic data indicating homebuilders were more confident and that business activity in the New York Fed's district had expanded in June. On the negative side, the Financial Times reported the Fed was likely to signal that a move to reduce the program was close.

As a result of all the uncertainty, the Dow Jones Industrial Average has averaged daily swings of nearly 191 points, the result of Fed Chairman Ben Bernanke's comment that the Fed could reduce the pace of its stimulus in the "next few meetings" if the economy showed continued improvement and inflation remained moderate.

Recently a consensus has been building on Wall Street that the Fed would scale back its policy of buying $85 billion of bonds each month, which was credited with fueling a 15 percent rise in the S&P 500 in 2013. Now the Street is anxious to find out where the Fed stands on winding down the stimulus. The Federal Open Market Committee will release a statement on Wednesday, followed shortly after by a news conference by Bernanke.

Homebuilder sentiment rose in June to a 7-year high, the highest level since the start of the housing crisis. The PHLX housing sector index rose 1.6 percent. D.R. Horton saw its share price rise 1.5 percent to end the day at $24.26 while Toll Brothers added 2.4 percent to $33.66.

The New York Fed's "Empire State" general business conditions index indicated expansion in June after a negative reading in the previous month, but the data also showed measures of new orders and employment this month fell to five-month lows.

Netflix ended the day up 7.1 percent at $229.23 as the largest percentage gainer on the S&P after it signed a multi-year deal for programming from DreamWorks Animation. DreamWorks added 4.1 percent to close at $23.74. Advanced Micro Devices was up 2.8 percent at $4.05 after Barron's said prospects look better for the maker of microprocessors for personal computers.

On the downside, Time Warner Cable fell 2.5 percent to $101.29 after Raymond James downgraded the stock to "market perform" from "outperform." Terex fell 7.7 percent to $29.29 after the machinery maker cut its earnings forecast.

Trading volume was light as many traders held off adding to positions before the Fed announcement. About 5.24 billion shares changed hands on the major equity exchanges, a number that was well below the daily average so far this year of about 6.36 billion shares.

NY Manufacturing Rises

Growth in the New York state manufacturing sector picked back up in June, but the details were less encouraging as new orders and employment fell to their lowest levels in five months, a report from the New York Federal Reserve showed on Monday.

The New York Fed's "Empire State" general business conditions index rose to 7.84 from minus 1.43 in May, topping expectations for zero. A reading above zero indicates expansion. However, the forward-looking new orders index fell to the lowest level since January at minus 6.69 from minus 1.17, while inventories tumbled to minus 11.29 from minus 7.95. Employment gauges also worsened. The index for the number of employees slipped to zero from 5.68 and the average employee workweek index dropped to minus 11.29 from minus 1.14.

Stock index futures held their gains immediately following the data, with traders focused on the Federal Reserve's policy meeting later this week. The dollar extended gains against the yen and yields on U.S. Treasury securities briefly rose.

The outlook for firms was relatively resilient with the index of business conditions six months ahead edging down only slightly to 24.98 from 25.48.

The survey of manufacturing plants in the state is one of the earliest monthly guideposts to U.S. factory conditions.

Builder Sentiment Rises Above 50 for First Time in 7 Years

For the first time since the start of the housing crisis seven years ago, the majority of homebuilders view conditions in the industry as favorable.  The NAHB/Wells Fargo Housing Market Index rose eight points in June, the most since September 2002, to 52, the highest level since March 2006. Builder confidence has been trending up for the past two years, and currently indicates more builders view housing market conditions positively than negatively.

A key factor was the low inventory of existing homes which resulted in more buyers deciding on new homes. According to the report, this level of confidence is consistent with a 29 percent increase in housing starts this year, surpassing the 1.0 million mark for the first time since 2007.

Homebuilders felt optimistic for the coming months with the gauge of single-family sales expectations for the next six months accelerating to 61 from 52. The single-family home sales component rose to 56 from 48, while prospective buyer traffic climbed to 40 from 33.

Fed Creates Bargains

Since Ben Bernanke unleashed a bombshell on May 22 by suggesting the Fed could begin to pull taper its massive monetary stimulus, the markets have been feeling the pain. Bernanke said on May 22 the central bank "could in the next few meetings ... take a step down in our pace of purchases." This sparked an uptick in volatility that hasn't abated as investors recalibrate expectations for low bond yields that have bolstered borrowing and encouraged investors to take risks in other asset classes. 

Rather than run for cover, the sell-off has been viewed by many as a chance to invest at lower prices. For many, myself included, the gloom facing the markets has been overdone, an overreaction to the concerns that the Federal Reserve won't be throwing money at the economy forever. The economy has posted solid if still sluggish growth figures this year, and jobs growth has improved. The euro zone debt crisis has abated somewhat, with the monetary union no longer expected to drag so heavily on world growth. And despite the jitters, global central banks are far from ending easy money policies, pumping money into markets around the world. As a result, many are taking advantage of buying opportunities. 

Japan's stock market has lost 19 percent since that day. The 10-year Treasury yield hit a 14-month high last week. The BofA Merrill Lynch U.S. high yield index hit a three-month low. The benchmark MSCI EM stock index is down more than 17 percent this year, and the dollar is near a four-month low against a basket of currencies .DXY.

If you believe that the Fed has no intention of slowing its stimulus program, 10 year Treasury notes could see price gains as rates fall a bit. The 10-year Treasury yield touched 2.29 percent this week, highest since April 2012. The Federal Open Market Committee issues its next decision on Wednesday, and recently Fed officials have remarked that inflation is worryingly low, which might prevent them from reducing the $85 billion-per-month bond buying program, known as quantitative easing.

Junk bonds have been feeling the effect of the rise in Treasury yields, with the Bank of America/Merrill Lynch High Yield Master Index losing 2.91 percent from its peak in early May. The past two weeks have seen outflows of nearly $9 billion from high-yield funds, according to Lipper, a Thomson Reuters company.

Investors have dumped U.S.-based corporate junk bond funds in droves, pulling out a record $4.6 billion in the week to June 5, according to Lipper. High yield spreads are almost 500 basis points over Treasuries.

The difference in yield between benchmark emerging markets bonds and safe-haven Treasuries, measured by the JP Morgan Emerging Markets USD Bond Index rose to 337 basis points on Tuesday, the widest spread in nearly a year. Emerging markets currencies have also been weak of late as money exits countries such as Mexico and Brazil.

Investors flocked to Japanese equities in the anticipation that the heavy dose of monetary stimulus would bolster that market, and it has, at one point being up 54 percent in 2013.

However, domestic investors there have sold into this rally, and that has since turned into a full-fledged selloff. The Nikkei is down 19 percent since May 22, but some still questioned whether it was a time to buy. Japanese equities posted outflows for the week ended June 12 for the second straight week after 28 consecutive weeks of inflows.