The Bank of Japan has launched their own version of Operation Shock and Awe with massive amounts of new stimulus to try and revive their country. The combination of this new QE from Japan and the end of the fiscal year for many funds on Friday, October 31st, helped fuel another big surge for U.S. equities. Two weeks ago the S&P 500 delivered their best weekly performance of the year with a +4.1% gain. This past week the big cap index followed that performance with a +2.7% gain. The NASDAQ followed the prior week's +5.2% rally with a +3.2% gain last week. The Dow Industrials surged +3.4% and the small cap Russell 2000 index added +4.89%.

The last four days of October are normally pretty strong and this year did not disappoint. Most hedge funds and mutual funds have been underperforming their benchmarks and a good portion of this incredible bounce from the October low has probably been window dressing and performance chasing. Some of the market's best performers last week were the financials (+3.9%), the semiconductor index (+4.7%), and the Dow transportation average (+2.1%). The Transports ended the week at a new all-time weekly high.

The BoJ's decision to inflate their stimulus program sent the Japanese yen plunging. The value of the yen collapsed with a -2.76% drop against the U.S. dollar. That doesn't sound like much to an equity trader but it's a massive move in the currency market. The yen ended the week at a new seven-year low against the dollar. This dollar "strength" is weighing heavily on commodities, since they're all traded in dollars. The combined dollar index is now at a four-year high. It's no surprised that gold and silver are sitting at four-year lows. Gold had a rough week with a -4.85% drop and silver plunged -6.3%.

The price of crude oil, also traded in dollars, is at a four-year low. Brent crude saw its largest monthly drop in two years. U.S. crude oil flirted with a breakdown under $80.00 a barrel several times last week. Crude eventually settled at $80.54 a barrel. Brent crude closed at $85.86 a barrel. Meanwhile U.S. bonds continued to sink, now down two weeks in a row. The yield on the U.S. 10-year note ended at 2.33%.

Japan's QE Announcement

The main story on Friday was Japan's central bank announcement to boost their current QE program. The country has been struggling with deflation for years and their recent decision to raise taxes has hurt economic growth. Japan's latest GDP number showed growth falling -1.7% and inflation had dropped back to +1%. The BoJ wants to see inflation at 2%. In a move that completely shocked the world they announced significantly more asset purchases.

Now the BoJ will increase their bond-buying from 50 trillion yen a year to 80 trillion. That's about $712 billion worth. The amount of ETFs and REITs the bank will buy has been boosted from 1 trillion yen to 3 trillion yen a year. The BoJ also announced that the country's $1.26 trillion Government Pension Investment Fund (GPIF), which is the world's largest of its kind, will reduce its holdings of Japanese government bonds from 60% to 35%. They will double the amount of domestic and foreign equity ETFs and REITs from 12% to 25% each.

The combined purchases of the BoJ and the GPIF will be about $414 billion in bonds and equity ETFs. The U.S. market could be a huge beneficiary of this move since we're the largest and most liquid market for equities and bonds. Some analysts are estimating Japan could buy $200 billion worth of additional U.S. securities.

This surprise announcement sparked a widespread rally across the globe. The Japanese NIKKEI index was up more than +1,000 points intraday and closed with a +755 point gain. This is a +4.8% move and the NIKKEI closed at levels not seen since November 2007.

This decision by the BoJ is bullish for stocks but it's not without its critics. The decision itself was split with a 5-4 vote by Bank of Japan members. Analysts at Bloomberg have noted that it should help the Japanese economy but the program can't fix Japan all by itself. The biggest worry is the sheer size of the program. The BoJ's new QE, relative to the size of Japan's economy, is three times bigger than the U.S. Federal Reserve's QE program was. Prior to this decision by Japan the country's debt was already twice the country's GDP and over one quadrillion yen. There is absolutely no way that Japan will ever pay off its debt. Everyone knows this is a house of cards but no one knows when it will finally tumble. There was some speculation among Wall Street traders and analysts on Friday that this new QE program is a major warning sign on the longer-term health of Japan.

Economic Data

There was plenty of economic data last week. One of the biggest events was the two-day FOMC meeting. As expected Fed Chairman Janet Yellen announced that the Fed would begin their final taper of $15 billion a month to eliminate the central bank's asset purchases. Yellen also decided to leave the "considerable time" language in the Fed's statement, which suggest they will keep the fed funds rate unchanged (near zero) for the foreseeable future. Most are estimating that means at least six more months.

We also got a look at U.S. economic activity. The advanced estimate on Q3 GDP came in at +3.5%. That's down from Q2's +4.6% rate but above economists' estimates for only +3.0% growth. One of the biggest surprises was +1.8% increase in residential investment and a +1% jump in the real final sales component from 3.2% to 4.2%. We also saw government spending spike to +4.6%, which is the biggest increase since mid 2009.

The Richmond Federal Reserve manufacturing survey hit 20 when analysts were only expecting a reading of 11. The Chicago PMI data soared to a 12-month high with a rise from 60.5 to 66.2. Analysts were expecting a dip to 60.0. The U.S. Employment Cost Index (ECI) rose +0.7% in the third quarter. The wage component rose +0.8% following a +0.6% improvement in the second quarter.

The durable goods orders for September dropped -1.3% and the core rate fell -0.2% versus estimates for +0.5% growth. Pending home sales in September rose +0.3% versus a drop of -1.0% the prior month. The Case-Shiller 20-city Home Price index said prices rose +5.6% in August, down from the +6.7% increase in July.

Consumer sentiment and confidence has been rising. The Conference Board's Consumer Confidence index rallied from an upwardly revised 89.0 (previously 86.0) to a new seven-year high at 94.5 in October. Meanwhile the final revision on consumer sentiment saw the October reading adjusted from 86.4 to 86.9, which is the highest level since July 2007.

Overseas Economic Data

The pace of data slowed overseas. The Eurozone said their CPI inched up from +0.3% to +0.4%. The region's unemployment rate was unchanged at 11.5%. Yet Italy's unemployment slipped from 12.5% to 12.6%. Germany saw its inflation drop to 0.7% year over year and the country's retail sales plunged -3.2% for the month, which was significantly worse than expected.

In Asia nearly all the data was from Japan. Japan's industrial production came in better than expected with a rise from 1.9% to 2.7%. Japan's retail sales also improved from +1.2% to +2.3%. Yet the country's unemployment hit 17-year highs at 3.6%.




Major Indices:

The S&P 500 has seen an incredible bounce from its October intraday low of 1,820 on October 15th to set a new all-time closing high at 2,018 on Friday. That's almost 200 points or +10.8% in just 12 trading days. Without a doubt we are short-term overbought.

On a short-term basis the 2,020 level is resistance. Beyond that I would look to the 2040-2050 area as likely resistance. The nearest support is probably the 1960-1980 area. The index's 2014 gain now sits at +9.2%.

chart of the S&P 500 index:

Weekly chart of the S&P 500 index

The rebound in the NASDAQ has been equally impressive. From the October 15th low of 4,116 the index is now up more than 500 points. This tech-heavy index has soared +12.48% in the last 12 trading days. Technically the breakout past resistance near 4,600 should be bullish but it's very overbought.

I'd watch the 4,500 area for support. The 4,700 level is potential resistance. The NASDAQ's all-time high of 5,132 is only another 500 points away. Year to date the NASDAQ is up +10.9%.

chart of the NASDAQ Composite index:

Intraday chart of the NASDAQ Composite index

The small cap Russell 2000 index has seen one of the most dramatic reversals higher. The bounce from its October 15th low near 1,040 has produced a +12.7% gain. The $RUT has sliced through every obstacle put in front of it and now the index is back in positive territory for the year (+0.8%).

Broken resistance in the 1140-1150 area might be short-term support. The next hurdle is likely the early September high near 1,184. Beyond that the 1,200 level and the all-time highs near 1,210 are overhead resistance.

chart of the Russell 2000 index

Weekly chart of the Russell 2000 index



Economic Data & Event Calendar

It's the first week of a new month and that means lots of economic reports. We'll see both the ISM manufacturing and ISM services in the U.S. The biggest report will be Friday's nonfarm payroll data. Yet all of these could be overshadowed by the European Central Bank's decision on interest rates and the ECB President's press conference on Thursday.

We will also continue to hear corporate results. The peak of earnings season has past but there will still be dozens of reports. Thus far earnings results have been relatively good. Corporate guidance has been somewhat better than normal, which is a good thing for the market.

Economic and Event Calendar

- Monday, November 03 -
U.S. construction spending
U.S. ISM manufacturing index
U.S. vehicle sales
Eurozone PMI data

- Tuesday, November 04 -
Eurozone Producer Price Index (PPI)
New York ISM data
U.S. Factory Orders

- Wednesday, November 05 -
ADP Employment Change Report
U.S. ISM Non-manufacturing (services) index

- Thursday, November 06 -
Weekly Initial Jobless Claims
Bank of England interest rate decision
European Central Bank interest rate decision
ECB President Mario Draghi press conference

- Friday, November 07 -
Unemployment rate
Nonfarm payrolls (jobs) report

Additional Events to be aware of:

December 17: FOMC meeting

Looking Ahead:

As we look ahead the outlook should be bullish for stocks. November launches the best six months of the year for stock performance. Historically the month of November is the third best month for the S&P 500 and the Dow Industrials since 1950. Over the last 30 years or so it has also been the third best month for both the small cap Russell 2000 and the NASDAQ composite.

Market performance after a midterm election also tends to be positive. The S&P 500 has rallied 12 out of the last 16 midterm Novembers with an average gain of +2.5%. Don't forget to vote on Tuesday, November 4th.

It is important to note that while seasonally the market bias should be up we are very short-term overbought. Just as the rally could have been fueled by some last minute window dressing by fund managers we could see some "undressing" this week. The good news is that investors will likely buy any dip but that doesn't mean we can't see a -2% to -3% pullback before moving higher.

Globally the world is facing a slowdown in China, Japan, and Europe. Japan will likely get a pass since the Bank of Japan has just launched a massive new QE program. China is growing at its slowest pace in five years but it is still growing at more than 7% a year. Europe is the biggest challenge for the market and that's why investors will be keenly focused on the ECB meeting and Mario Draghi's press conference this coming Thursday to see how the ECB plans to stop the economic decline. Draghi's last press conference was a significant disappointment.

The U.S. market looks like the most attractive bet for investors around the world. The U.S. is growing at +3.5%. The Federal Reserve has kept their "considerable period" language in their statement. The next rate hike is probably six months away. Gasoline prices in the U.S. are at their lowest level in four years, which is bullish for consumer spending, especially as we near the critical holiday shopping season.

The world appears to have gotten over its Ebola fears. The outbreak remains a terrible event in West Africa but the developed nations will likely remain unaffected.

On top of it all the headlines on Friday prove that central banks will continue to support equity prices. The U.S. Federal Reserve has ended its asset-backed purchases and in the same week Japan's central bank has tripled theirs. Now eyes turn towards Europe to see if the ECB will join the QE party.

James


“Those who don't know history are destined to repeat it.”
― Edmund Burke