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Will the Rally Continue?

Sheraz Mian

Wednesday, August 27, 2014

Stocks are indicated to open in the green today. But while sentiment remains favorable, don’t expect any major moves given the absence of any catalysts, particularly following Tuesday’s milestone finish.

The S&P 500 index barely made it above 2000, but it was nevertheless a finish above the psychologically important level that many of us didn’t believe would happen. Stocks have surprised many of us this year, particularly yours truly – bringing in solid returns to follow up last year’s spectacular performance. Given the struggles in the small-cap space lately, not everything in the stock market has worked this year. But the large caps certainly don’t seem to be experiencing any gravitational pull at this stage. A combination of a very accommodating Fed, a very profitable corporate sector and an improving U.S. economic backdrop has given us the ever-rising stocks. Should we expect the rally to continue?

The economic and corporate backdrops haven’t changed. If anything, they seem to have improved a bit on the margins. The one factor changing is the Fed’s policy. The central bank is already on track to end its bond-purchase program by October this year and is discussing now when it will start raising interest rates. One would have thought that benchmark interest rates would have started going up by now, in response to the QE end and the coming tightening cycle. But what we have seen lately is exactly the opposite – rates have actually come down. Is it a sign of complacency in the bond market, a function of its skepticism about the economic outlook, or a temporary safe-haven trade?

May be it’s a combination of all three. But how stocks do from here will depend a lot on what happens to bond yields. You should always be paying close attention to interest rates, but this is a particularly useful thing to do at present.

Sheraz Mian
Director of Research

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