Weekly Trends

Ryan Lewenza, CFA, CMT, Private Client Strategist

March 20, 2015

The Fed Loses Its Patience

Equity Market YTD Returns (%)

The highly anticipated March Federal Reserve (Fed) meeting came and went
with few surprises. As expected, the Fed removed the patient wording with
respect to keeping interest rates low and their monetary policy
accommodative. This move is the first step to normalizing interest rates
following seven years of record low interest rates.

S&P/TSX Comp

S&P/TSX Small Cap

-0.8

S&P 500

1.5

Russell 2000

4.2

MSCI World

While the Fed moved one step closer to hiking rates, they did however temper
expectations on the timing and degree to which they may tighten. In particular,
the Fed downgraded its 2015 GDP growth outlook and lowered its expectations
for the Fed funds rate. In our opinion the messaging of this statement was
quite brilliant in that it recognized the need to tighten, but reassured the
market that they will be slow and disciplined in their policy tightening.

2.4

MSCI Europe

16.9

MSCI EAFE

4.3

MSCI EM

0.9
-5 -3 0 3 5 8 10 13 15 18 20

We believe the continued strong labour gains along with improved economic
momentum will lead to interest rate hikes this year. Given this view should we
be worried about rate hikes derailing the economy and current bull market?

Canadian Sector

Historically the S&P 500 Index (S&P 500) has risen in the six and 12 months
following the first Fed hike. We examined S&P 500 returns following the start
of each tightening cycle since 1980 and found that the S&P 500 is up on
average 2.7% and 5.3% in the six and 12 months, respectively, after the first
Fed hike. From our perspective, the beginning of Fed tightening is positive as it
signals an improving economy, which is generally consistent with stronger
corporate earnings growth, and higher equity valuations.
Moreover, one of the best predictors of a recession and equity bear market is
an inverted yield curve. Currently, the US yield curve sits at +195 bps, well
above the typical zero or negative reading seen before recessions.

1.7

TSX Weight Recommendation

Consumer Discretionary

6.6

Overweight

Consumer Staples

3.7

Market weight

Energy

20.8

Market weight

Financials

34.6

Market weight

Health Care

5.1

Underweight

Industrials

8.8

Overweight

Information Technology

2.6

Overweight

Materials

10.8

Underweight

Telecom

4.8

Market weight

Utilities

2.2

Underweight

Level

Reading

Technical Considerations
S&P/TSX Composite

14,873.9

50-DMA

14,856.3

Uptrend

200-DMA

14,908.4

Downtrend

46.7

Neutral

RSI (14-day)

Chart of the Week

S&P 500 Has Gained On Average 5.3% 12 Months Following First Fed Hike
6.0%
5.0%

S&P 500 Average Performance After First Fed

Hike (periods include '80, '83, '88, '94 '99, '04)

5.3%

16,000
15,500
15,000
14,500

4.0%

14,000
2.7%

3.0%

13,500

2.0%

13,000

1.0%

12,500

0.0%

12,000

-1.0%

11,500

-2.0%
-3.0%

S&P/TSX
50-DMA
200-DMA

-2.0%
1 month

11,000
Jul-12

-1.8%
3 months

6 months

Jan-13

Jul-13

Jan-14

12 months

Source: Bloomberg, Raymond James Ltd.

Please read domestic and foreign disclosure/risk information beginning on page 5

Raymond James Ltd. 5300-40 King St W. | Toronto ON Canada M5H 3Y2.
2200-925 West Georgia Street | Vancouver BC Canada V6C 3L2.

Source: Bloomberg, Raymond James Ltd.

Jul-14

Jan-15

Weekly Trends

March 20, 2015 | Page 2 of 4

The Fed Loses Its Patience

The highly anticipated March Fed meeting came and went with few surprises. As
expected, the Fed removed the patient wording with respect to keeping interest
rates low and their monetary policy accommodative. This move is the first step to
normalizing interest rates following seven years of record low interest rates. In this
weeks publication we outline the likely factors in the Feds decision to remove the
patient wording, the potential future path of interest rates, and what it could
mean for the equity markets in the months ahead.
Coming into this Fed meeting there was significant debate over whether the Fed
would remove the patient term and begin the normalization of interest rates. We
were in the camp that believed it would come out of the statement predicated on
two key factors. First, job growth in the US has been very strong over the last year,
pushing the US economy closer to full employment. Over the last 12 months the US
economy has added on average 275,000 jobs per month, driving the unemployment
rate down to 5.5%, the lowest level since the financial crisis. With full employment
being one of the Feds two key mandates we believed this was sufficient to warrant a
shift in the Feds current dovish stance. Second, we felt the current weakness of
inflation (the second mandate of the Fed) would likely prove transitory, and begin to
reverse in the coming quarters. In recent weeks we have seen a stabilization of
inflation expectations, a necessary precursor to higher inflation. Given these factors
the Fed was warranted in tweaking their current accommodative monetary stance.
While the Fed moved one step closer to hiking rates, they did however temper
expectations on the timing and degree to which they may tighten this year. In
particular, the Fed downgraded its 2015 mid-point GDP growth outlook (from 2.8%
in December to 2.5% currently) and lowered its expectations for the Fed funds rate
at year-end (from a mid-point of 1% to 0.625%). In our opinion the messaging of this
statement was quite brilliant in that it recognized the need to tighten, but reassured
the market that they will be slow and disciplined in their policy tightening.
We continue to forecast the first hike of 25 bps at the June meeting versus
consensus in September. Central to this view is that we see the US economy showing
stronger economic momentum. As captured in the Citigroup US Economic Surprise
Index below, we have witnessed a very clear pattern of economic data disappointing
early in the year then improving through the summer and into the second half of the
year. We believe the continued strong labour gains along with improved economic
momentum will lead to interest rate hikes this year. Given this view should we be
worried about rate hikes derailing the economy and current bull market?
Strong US Labour Gains Support Future Fed Hikes

Weak Economic Momentum Should Reverse In H2/15

500

11

300

10

100

-100

-300

-500

150

Citigroup US Economic Surprise Index

100
50
0

-700

US Nonfarm Payrolls Mthly Chg (LHS)

US Unemployment Rate % (RHS)

-900
'07

'08

'09

'10

'11

Source: Bloomberg, Raymond James Ltd.

'12

'13

'14

'15

5
4

-50

-100
-150
Jan-11

Jul-11

Jan-12

Jul-12

Jan-13

Jul-13

Jan-14

Jul-14

Jan-15

Weekly Trends

March 20, 2015 | Page 3 of 4

Market Reaction To Fed Hikes

With the Fed jettisoning the patient wording, it is clearing the decks for the first
Fed hike since the 2008 financial crisis. Some believe this reversal of policy to a more
hawkish stance will be the death knell of the current bull market. We disagree with
this assertion for the following reasons:

First, lets put things into perspective. We expect one 25 bps hike in June,
and potentially one more 25 bps hike later this year. This would take the
Fed fund rates up to a maximum of 0.75% by year-end. We highly doubt
that a modest increase in the Fed funds rate (off a record low level) would
have such a deleterious impact to a $17 trillion economy. Frankly, we would
welcome a rate hike as: 1) it would signal that the economy is getting
stronger and no longer requires intense monetary support; and 2) it would
provide the Fed with some ammunition should the US economy weaken
down the road.

Average Price Performance

Following First Fed Hike
8.0%
6.0%

4.0%

Second, historically the S&P 500 has risen in the six and 12 months
following the first Fed hike. We examined S&P 500 returns following the
start of each tightening cycle since 1980 and found that the S&P 500 is up
on average 2.7% and 5.3% in the six and 12 months, respectively, after the
first Fed hike. In fact, of the previous six tightening cycles since 1980 there
was only one occurrence (1984) where the S&P 500 was lower 12 months
after the first Fed hike. From our perspective, the beginning of Fed
tightening is positive as it signals an improving economy, which is consistent
with stronger corporate earnings growth, and higher equity valuations.

2.0%
0.0%

-2.0%
-4.0%

S&P 500 Average Performance After First Fed Hike

(periods include '80, '83, '88, '94 '99, '04)

-6.0%
1
12
23
34
45
56
67
78
89
100
111
122
133
144
155
166
177
188
199
210
221
232
243
254

Days James Ltd.

Source: Bloomberg, Raymond

Finally, one of the best predictors of a recession and equity bear market is
an inverted yield curve. An inverted yield curve occurs when long-dated
bond yields (e.g., 10-year Treasuries) are below short-dated bond yields
(e.g., 90-day Treasury bills). Historically, an inversion of the US yield curve
has conincided with the last seven recessions. Currently, the US yield curve
sits at +195 bps, well above the typical zero or negative reading seen before
recessions. Admittedly, if the Fed continues to tighten in 2016 it increases
the probability of an inverted yield curve later next year, but this is unlikely
a 2015 event.

In summary, our work suggests that the S&P 500 can continue to advance this year
despite the prospect of Fed tightening this year. Though the bears continue to pound
the drum of an imminent bear market as a result of Fed tightening, they may be off
the mark for 2015.
S&P 500 Returns Following First Fed Hike
6.0%
5.0%

S&P 500 Average Performance After First Fed

Hike (periods include '80, '83, '88, '94 '99, '04)

US Yield Curve And S&P 500 Bear Markets

5.3%

1200

2500

US Yield Curve (LHS)

S&P 500 (RHS) Log Scale

1000

4.0%
800

2.7%

3.0%
2.0%

600

1.0%

400

0.0%
200

-1.0%
0

-2.0%
-3.0%

-2.0%
1 month

-1.8%
-200

3 months

Source: Bloomberg, Raymond James Ltd.

6 months

12 months

50
'88

'90

'92

'94

'96

'98

'00

'02

'04

'06

'08

'10

'12

'14

Weekly Trends

March 20, 2015 | Page 4 of 4

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