6/21/2011
By Brian Sozzi, Research Analyst

Since the first post FOMC decision press conference held by Chairman Bernanke on April 27, the S&P 500 has given back almost 6%.  The market's four-day relief rally has temporarily quieted concerns of a major impending correction in equities, though sentiment indicators I track remain bearish.  In my view, the Bernanke Rout in stocks from late April until recently was triggered by the following factors that arose in the original press conference:

* Somewhat surprising reduction in central tendency output growth to slightly below projections made by Committee in January.
* Cold water was tossed on the pace of the economic recovery through the consistent use of the word "moderate" by Bernanke.  Although at the time forecasters were dropping their 1Q GDP expectations, the consensus held was for a strong snapback in the second half of the year.
* Further quantitative easing measures were not outlined, with the reiteration of the end date (2Q) upheld.  The Fed stated its intention to reinvest the proceeds of maturing Treasuries and MBS, but the market wanted its pound of flesh.

Ironically, the Fed's continued adherence to the view of inflation being "transitory" has been correct. The very definition of transitory is something "in brief duration", and in that regard rising prices, such as gasoline and other commodities, have cooled as a result of a slowing U.S. expansion in the first half of the year and a mixed growth picture in many emerging markets.  Additional evidence of transitory inflation could be found in the latest CPI and PPI measurements.   Prices are still elevated compared to a year ago and are major headwind to U.S. consumers; there is a lag between when a General Mills (GIS) or a Kellogg (K) announce a price increase and when they appear at the store level.  However, these price increases are arriving to market at a period of a more cautious consumer, so they may not stick entirely as trade-offs are made (private label, fewer quantities purchased).

Why I think the market could rally into, and during, Bernanke's press conference tomorrow:

The market was undoubtedly spooked by the downbeat tone of Bernanke on the economy last go around, and since then the potential for further tapering of the FOMC's annual output projections (it will be important to see why a reduction is done; is it related to 2Q Japan knock-on effects, or is the Fed stepping back from its second half growth resumption thesis) has been priced into to risk assets.  Economic data, particularly those assessing the manufacturing sector, suggest the Fed will mark down its growth estimates.  Bernanke even signaled the possibility in a speech two weeks ago by uttering the words "uneven" and "frustratingly slow" when discussing the recovery.  Assessment: the market knows what's coming in this arena.

At the first press conference, inflation was hot and stock prices, in hindsight, were reaching a short-term peak.  This time, stock prices (a favorite of Bernanke as rising prices induce the wealth effect) are under pressure and commodities have sold off, creating a different platform for Bernanke to speak about future Fed policy.  In other words, there is the possibility that Bernanke has a Jackson Hole Moment: Part 2 and conveys a more dovish policy approach relative to April, basically signaling ever so coyly additional bond purchases.  The fact is that the execution on part of the Fed's dual mandate, achieving maximum employment, is now in question following the soft May non-farm payrolls number and tick up in the unemployment rate (at 9.1%, the rate has increased for two consecutive months).  It would be hard for the Fed to justify lowering its annual central tendency output projections, once again, while remaining steadfast in expecting continued economic improvement in the second half of the year via intensification in job creation.  Members may have a greater inclination to act given a shift in the balance of risks (acting versus not acting).  

Brian Sozzi
Wall Street Strategies

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