Since the advent of the modern central bank, it's been common knowledge that easy money tends to make securities rise. Perhaps nothing illustrates this point better than the behavior of markets last week. But buyer beware: Significant danger lurks just below the surface.
Last week's roller coaster
The first two days of the week were forgettable. On Tuesday, the first trading day of September, typically the worst month of the year for stocks, the Dow Jones Industrial Average (INDEX: ^DJI) got off to a rough start, briefly dropping below 13,000 before closing down by 0.4%. And on Wednesday, the index simply meandered about, ending only marginally lower.
All of that changed on Thursday. Following the European Central Bank's announcement that it will initiate an aggressive bond-buying program targeted at sovereign debt from countries such as Spain and Italy, the markets went wild. The Dow finished the day at a new 52-week high, up by nearly 2%. Even disappointing figures released on Friday concerning jobs and the technology sector didn't dampen the mood as the markets continued to advance, albeit at a more muted pace.
It's for this reason that stocks could see another lift in the days ahead. Given the news on the jobs front, it's widely anticipated that, like the ECB, the Federal Reserve will launch another round of bond purchases known colloquially as quantitative easing. "For most forecasters," reports The Wall Street Journal, "the release Friday morning of tepid-at-best August hiring data essentially seals the deal that when the central bank ends its two-day monetary-policy meeting next Thursday, it will in some fashion offer fresh stimulus to the economy."
If last week is any indication, the companies best positioned to benefit from additional monetary policy are the financials, as two out of three of the best performing Dow stocks were banks. The top performer, Bank of America (NYSE: BAC), ended the week up by nearly 11%. And coming in third was JPMorgan Chase (NYSE: JPM), the nation's largest bank by assets, which closed out the week 6.5% higher. Sandwiched in between was aluminum producer Alcoa (NYSE: AA), illustrating the belief that easy money will drive up commodity prices.
Why investors should nevertheless tread carefully
Despite these movements, investors would be wise to question the medium-term viability of recent advances, given the growing signs of slowing domestic and global economies. Here at home, in addition to the dismal jobs numbers, the Institute of Supply Management's index of national factory activity fell to 49.6% in August; anything below 50% is indicative of a contraction.
And things arguably looks worse abroad. According to a recent report from China's national bureau of statistics, industrial output in August rose at the slowest pace in three years, as production increased 8.9% year over year compared with analysts' median estimate of 9% and July's growth rate of 9.2%. On top of its other problems, moreover, it's widely known that Europe is already mired in a deep recession.
In light of these trends, multiple companies have recently downgraded their forward earnings guidance. Economic bellwether FedEx did so last week, predicting that its current-quarter earnings per share will probably be in the range of $1.37 to $1.43, down from its previous forecast of $1.45 to $1.60. Intel (Nasdaq: INTC) followed that news up by noting that its quarterly revenues are likely to come in approximately $1 billion short of previous estimates. Consequently, it appears that we may be in for a bumpy ride going forward.
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