Rally Mode

Stocks opened lower this morning (Dow -127 points; S&P 500 -.1%). But make no mistake, the market is in rally mode. Since October 27th these indexes are up between 7% and 9%. The 3-month correction is over and we’re now into a seasonally favorable part of the year. More than that, the recent retreat of interest rates has taken some pressure off of bonds, stocks, and the economy.

Josh Brown, CEO of Ritholtz Wealth Management says trillions of dollars currently parked in cash money market funds will begin to flow into the stock market. “ Here’s the problem with money market funds: if rates have peaked…then that 5% isn’t really 5% anymore, and you’re at risk of seeing that going to 4.5%, which is where it is now, then maybe 4%, then 3.5%.” That rate will look less and less attractive especially if the economy continues to hold up.

Retail price inflation slowed more than expected in October. The Consumer Price Index (CPI) didn’t rise at all from the prior month, and the annual rate slowed to 3.2% from 3.7%. Core CPI, which excludes typically volatile food & energy, edged down to an annual rate of 4.0%, the slowest in two years. Goods prices are mostly falling. Services prices are still rising, but at a lower rate. JP Morgan’s David Kelly says this report proves there is “disinflation in the economy.” It also proves that interest rates are already high enough to continue bringing down inflation. Of course, most inflation readings aren’t yet in neighborhood of the Federal Reserve’s 2% target. But I think general consensus holds that we’re on track to get there within the next couple of years. Reacting to the CPI report, economist Ed Yardeni noted that excluding shelter costs, CPI was up only 1.5% from a year ago.

Target (TGT) reported better than expected third quarter results and the stock shot up 17% yesterday. Sales fell 4% from the year-ago quarter, but with all the difficulties Target has faced over the past couple of years that’s considered OK. The good news is that management is rapidly working off bloated inventory (down 14%), freight costs are falling and even the theft problem improved. Profit margins are beginning to rise. The company still faces a tough retail environment and said shoppers are spending less on discretionary items. But the 17% stock price reaction tells me the worst-case scenario was already built-in.

The Census Bureau’s monthly US retail sales report is a bit confusing. News headlines characterized it as weaker. The Wall Street Journal concluded that consumer demand is cooling and Bloomberg News said retail spending is “slipping.” I think these assertions are somewhat misleading. Let’s review the facts. First, this report covers only spending on goods and in restaurants. Service sector sales are mostly omitted, limiting our ability to judge the health of consumer spending. Second, while it is true that retail sales fell -.1% in October from the prior month, September sales were upwardly revised to a gain of .9% from .7% initially reported. So there is some give-and-take here. I will concede that the year-over-year growth rate of sales slowed to 2.5% from 4.1% in September, but that’s still positive. Anyway, it makes sense that sales are slowing because inflation is slowing; prices of goods like gasoline, cellphones and apparel fell last month. My conclusion is that this report is far from alarming and shows just enough weakness to suggest that the Federal Reserve doesn’t need to continue raising interest rates.

Congress passed a temporary funding bill that will essentially kick the budget impasse can down the road another few months. A total of 209 Democrats and 127 Republicans voted for the bill. Republicans have a majority of House seats, but can’t seem to agree on spending priorities. So as Bloomberg News put it, Democrats had to “bail out” the new Speaker. The bill now goes to the Senate, where leaders on both sides of the aisle predict quick passage.