Medium-Term Outlook for Stocks/What Was Behind Friday's Stock Market Bounce?

The stock market outlook is positive into May, assuming the Fed does not throw up a roadblock.

Positive considerations include:  /1/ S&P 500 broke above the 2000 psychological resistance level on Friday, /2/ month- and quarter-ends should support stocks in the 2nd half of March,  /3/ Stronger Q116 GDP Growth should lift earnings reports in April.

A potential roadblock would be if the Fed does what Hilsenrath suggested in the Wall Street Journal early last week.   He said it was likely the FOMC would skip  hiking then funds rate on March 16, but leave open the door for a hike in April or June.  Such an outcome would in effect challenge stocks to sell off ahead of these meetings to see if the Fed would "blink" again.

In contrast, the risk that I see --  that the Fed hikes the funds rate but eases on the forward guidance (opposite of Hilsenrath's scenario) -- would be a positive for stocks, although there would likely be knee-jerk selling initially.  Note that skipping a rate hike and lowering forward guidance would be even more positive for stocks.

Explaining Friday's Stock Market Bounce
Market commentary attributed Friday's stock market bounce to a re-evaluation of Thursday's ECB policy moves, with market participants being more appreciative of it as an easing.   While stocks often reverse direction the day after a central bank meeting -- at least that's often the case the day after a Fed FOMC meeting - I think the ECB-related reasons for Friday's bounce were more subtle and really highlight the importance of China and this coming Wednesday's Fed decision.

       a.  If the markets truly had re-evaluated ECB policy as an easing, the euro would have fallen sharply on Friday, unwinding most of Thursday's bounce, instead of just edging down.

Importance of China
1. Thursday's bounce in the Euro lowered the trade-weighted value of the Remimbi enough to allow the PBoC to lift the dollar value of the currency on Friday (and still leave the trade-weighted value of its currency lower on the day) -- which the market took as a positive sign of confidence in the Chinese economy.

     a.  The bounce in the Euro was an ironic and unintended consequence of Draghi's comment that ECB rate cuts were likely over.

Fed Considerations   
1.  The ironic weakening in the dollar may have been viewed by stocks as an action that would offset the drag from a Fed tightening -- although the market gives low probability to the latter in March.

2.  The scenario in which the Fed hikes the funds rate but eases on the forward guidance may have acquired a little more credence, as it would be the mirror image of the ECB's move (see prior blog posting).