In an astounding upside reversal, the market was able to go from early losses to closing gains yesterday, and the primary reason for the advance had nothing to do with any economic reports or earnings from a major company, of which there were none. The reason put forth was that comments from a top Fed official, an ally of Chairman Bernanke, confirming the fact that the QE stimulus programs that have resulted in the purchase of $2.5 trillion of Treasuries and mortgage-backed bonds, are not going to end anytime soon.
Things started out on the downside, with the Dow reaching a 59 point loss on four occasions in the morning and early afternoon. At 1:15pm the major averages began an upside acceleration and the Dow went positive at 2:25pm before finally ending with a 35 point gain to its second highest ever close and only 37 points away from the record of 14,165 established on October 9, 2007.
Breadth numbers were positive at a 16/13 ratio and the VIX decided that it wanted to decline closer to reality for this level of the market, as for instance it went negative at 1pm while the Dow was still lower by 40 points, as if it “knew” that things were going to improve. It finally ended with a closing decline of 1.35 to 14.01 but once again the fact that on the down days this year it goes up by much more than it should has given equities more room to advance, as for instance the last time that the VIX was around this level was on February 22nd when the S&P was 1515 versus yesterday’s close of 1525. I have commented on this phenomena many times this year as to why people supposedly want to “buy protection” against market declines when the major averages keep grinding higher. This buying of so-called downside protection is what is allowing the overall market to keep gaining on the upside.
The Dow Transports did reach a new record-high level, continuing the trend that we have seen this year, as it has been in its own upside world so to speak. The Dow Industrials ended higher despite the fact that industrial stocks themselves did poorly on the initial negative news from China, which reported that its services industry index rose last month at the slowest pace since last September. This news caused the Shanghai Index to put in its poorest showing with a 3.7% decline, its worst since August 2011. These losers included companies that do business with China such as BA, CAT, 3M and UTX, but shifting around of sorts from one group to the other does not really last too long as all of these issues are doing better today. Even the Nasdaq was able to keep up due to additional strength in some of its recent leaders such as GOOG at a new all-time high, PCLN, AMZN and even old-timers such as ORCL, INTC and MSFT managed to gain as well. But the good times did not spill over to the shares of the stock named after a fruit, which got blasted once again to the downside and now has the ignominious distinction of declining by 285 points, or 40% from its record high last September.
The Euro held around the 1.300 level that represents a three-month low as those pesky Italian bond yields rose to a three-month high at 4.88% for the 10-year maturity on the ongoing political crisis and weak economic situation in that part of the world.
So what did the Fed vice-chair say yesterday that turned things around to the upside? She basically repeated what Chairman Bernanke had said the week before during his congressional testimony, namely that the aggressive monetary stimulus was justified considering how far the economy was operating below its maximum potential. She drove this point home with her assertion that “Insufficiently forceful action to achieve our dual mandate (steady economic growth and low inflation) also entails costs and risks and I believe that the balance of risks still calls for highly accommodative monetary policy to support a stronger recovery and more rapid growth in employment.” She concluded by saying that the “large shortfall of employment relative to its maximum level has imposed huge burdens on all too many Americans and represents a substantial social cost” and that “Prolonged economic weakness could harm the economy’s productive potential for years to come.” And there you go in the sense that there was no other reason that ostensibly turned the markets around to the upside.
And if you thought that yesterday’s upside reversal was something, take a look at what is going on today, as the major averages jumped higher right out of the starting gate and did not stop until the Dow reached a new all-tine high, at 14,286 at 11:15am. Breadth numbers are at an obviously very strong ratio at 3.7 to 1 and the VIX is cooperating once again by declining by only .69 to 13.32 versus a Dow gain of 141 as this is being written. And once again pointing out how this relationship has allowed stocks to go higher, the last time that the VIX was at this level was on February 6th when the S&P was 1512 versus the 1540 level that it is at today.
So what happened to cause this upside explosion, which in a sense is a culmination of the gains that the market has been putting in all year, with the Dow and S&P already 8% higher in 2013? Firstly, there was good overnight news from China, whose ostensible “bad” news yesterday as mentioned above sent the market down in the early going. And the news was that the government pledged more spending in order to boost economic growth to a rate of 7.5%. Then there was a very good February ISM Non-Manufacturing Index, which covers more than 80% of the U.S. economy and which rose at its fastest pace in a year, as the export component rose to its best level since May 2007 and a narrower trade deficit should boost G.D.P. Then there was the assumption that central banks will continue to supply stimulus measures, as evidenced by the recent speeches from top Fed officials, and from central bankers in other parts of the world as well.
Even the news from Europe was good for a change, although it is not helping the Euro to advance as it seems stuck around the 1.300 level for the time being. There was a services output report that declined by less than expected and retail sales rose by the most in three years in January. And how about the fact that both Spanish and Portuguese bond yields declined as well, and if that is not a turn-on for the markets then I do not know what it.
After four consecutive quarters of negative G.D.P. growth, we have had 14 consecutive quarters of positive growth, starting with the third-quarter of 2009, every quarter in 2010, every quarter in 2011, and every quarter in 2012. G.D.P. rose by 2.2% in 2012, and is projected to increase by 2% next year, according to various surveys.

Donald M. Selkin

Don Selkin is the Chief Market Strategist at National Securities Corporation, member FINRA/SIPC, (NSC) and provides the Fair Value analysis for CNBC each morning. The commentary provided in this Market Letter is intended to provide our customers with timely market analysis and should not be considered a research report. This Market Letter may contain, and is limited to: Discussions of broad based indices; Commentaries on economic, political or market conditions; Technical analyses concerning the demand and supply for a sector, index or industry based in trading volume and price; Statistical summaries of multiple companies’ financial data, including listings of current ratings; and, Recommendations regarding increasing or decreasing holdings in particular industries or securities. This Market Letter does not make a financial or investment recommendation or otherwise promotes a product or service of the firm. This Market Letter contains only news, facts, and commentary on information previously reported from a news source believed to be accurate and reliable by the author. These news sources include the following: {Bloomberg Financial, Reuters, Associated Press}.