OREANDA-NEWS. January 27, 2016. Strong finish to the week led stocks to their first weekly gain of the year. The S&P 500 climbed 2 percent on Friday, following soothing comments from European Central Bank (ECB) president Draghi the day before and a second straight day of higher oil prices. It was enough to push the index higher on the week by 1.4 percent, and trim its decline since the start of the year to -6.7 percent. Eurozone stocks also rallied sharply following Draghi’s comments. But, so did the dollar versus the euro, trimming the weekly gain of 2.4 percent in euro terms to 1 percent in dollars.

Chinese stocks rose modestly on the week, and the currency was stable, after some acceptable economic reports. Oil also managed to find enough support to get its first weekly gain of the year, rising to \\$32.19 a barrel from \\$30.39 the previous week. Treasury yields edged higher, and the yield on the Bank of America Merrill Lynch High Yield Master II index was unchanged.

Markets Managed to Close in the Green After a Wild Week

Last week’s gains come as a welcome relief from the steady declines of the first two weeks of the year, but they didn’t come easily. The S&P 500 rose, but it had to recover from a 3.5 percent intraday decline on Wednesday to do it. The VIX index was volatile in both directions. Overall it fell 17 percent last week, from 27.0 to 22.3, but not before spiking to its high for the year at 32 on Wednesday, as stocks were sliding lower.

After ending the previous week at a yield-to-maturity of 9.52 percent, the yield on the Master II index climbed to 9.85 before closing at 9.53 percent. Volatility in oil followed a similar pattern, ending the week with little change, but spiking mid-week. Treasuries were comparatively quiet. The two-year note climbed just two basis points to 0.87 percent, after dipping only to 0.82 percent on Wednesday. The ten-year edged higher by three basis points to 2.06 percent, and dropped only to 1.94 percent on Wednesday.

The firmness in oil was attributed mostly to short covering. Whether it can hold those gains, or add to them will continue to be important for other asset categories as the recent correlation among oil, stocks and bonds is extremely tight. As for stocks, it was energy, technology and consumer discretionary stocks that led the way higher. Only two groups were down, industrials just fractionally, and financials, down 0.7 percent.

Investors Looking for Strong Earnings and Economic Data

Many of the largest banks reported fourth quarter earnings and the results were mixed. And fed funds futures showed a small change on the week, offering little hope for higher rates and wider net interest margins. Without the participation of financials, any rebound remains in question.

Last week was the ECB’s opportunity to give markets a boost. This week it is the Fed’s turn. They are not expected to announce any additional policy action, but neither did the ECB, which simply promised to do so in March if conditions warrant. Markets will be looking for something similar from the Fed, despite recent public comments that the market is underestimating the expected pace of rate increases this year. On the economic calendar this week are new and pending home sales, durable goods orders and the fourth quarter advance GDP estimate. Consensus expectations are calling for just 0.8 percent annualized growth, which would be the slowest since the first quarter.

The persistently stronger dollar is an ongoing headwind to commodity price and emerging market currency stability. And market-based measures of inflationary pressures continue to fall. The selloff in stocks has brought valuations closer to fair value, but they are not yet cheap. According the Factset, the 12 month trailing price to earnings (PE) ratio of the S&P 500 is now 16.2X, still slightly above the ten-year average of 15.7X. Of course, the elevated PE in energy, due to a lack of earnings, is distorting the market’s PE to some extent. Fourth quarter earnings are now expected to decline 6 percent and the expectation for full year 2016 has continued to fall, now 5.9 percent. More than anything, markets need evidence of firming economic activity. In its absence, central banks will continue to be looked upon to lend support.     

Important Disclosures:

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.

The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.

The Shanghai Composite Index is a capitalization-weighted index of all stocks on China’s Shanghai Stock Exchange.

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