For One Day at Least, Markets Love Janet Yellen

The market’s weak start to the year is slowly becoming a memory as investors used Janet Yellen’s testimony as an excuse to push up economically sensitive stocks like Boeing (BA), Goldman Sachs (GS), Johnson & Johnson (JNJ), Chevron (CVX) and International Business Machines (IBM).

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The S&P 500 rose 1.1% to 1,819.75, extending its winning streak to four days. Its four-day rise of 3.9% is the largest such gain since Jan. 2013. The Dow Jones Industrial Average, meanwhile, advanced 192.98 points, or 1.2%, to 15,994.77. Just one Dow stock, Cisco Systems (CSCO), finished in the red.

Boeing rose 2.4% to $130.16 after fellow airplane manufacturer Airbus issued a rosy 20-year forecast, while Goldman Sachs gained 2.1% to 164.39% after making changes to its management committee. Chevron advanced 1.7% to $113.58 as oil rose, while Johnson & Johnson gained 2.1% to $92.97 and International Business Machines advanced 1.5% to $179.70.

The market’s reaction to Yellen’s testimony was far different her first day on the job, when the Dow Jones Industrials plunged more than 300 points. And the love comes despite Yellen saying almost exactly what the markets thought she would. CRT Capital’s Ian Lyngen explains:

So where are we?  In the same spot, with the Fed having 1) a dual mandate that is very much on her mind, 2) a path to QE tapering that is unwavering unless economic circumstances change in a way the market doesn't anticipate, 3) a UNR threshold of 6.5% that is truly meaningless at this stage of the Fed cycle, 4) inflation that remains well below the Fed's desired levels, and, cutting to the original chase, 5) "a great deal of continuity" in the FOMC's approach to monetary policy.

What she didn't mention is equally important like new measures to be incorporated into the Fed's mandate – which is not her place to change anyway – or targets like nominal GDP that have at least been bandied about as possible or even more arcane ideas like changing interest rates on required reserves.  Yellen was refreshing in her lack of nuance or subtlety so we can get on with things.

So why the big gain? Perhaps, investors craved continuity. Perhaps, as Bloomberg suggests, Yellen’s confidence in the U.S. economy’s ability to withstand tapering was infectious. The Wall Street Journal chalks it up to confidence that the late-January selloff has ended. No matter. Stocks rallied.

But while Yellen was busy building a rally, some worrisome issues hovered beneath the surface. The People’s Bank of China, for instance, is stuck with a monetary conundrum that’s easily as complex as that of the Fed’s: How to cut back on credit without blowing up its economy. Societe Generale’s Patrick Legland thinks the risks of it not being able to are growing:

Investors seem to be getting more cautious about the outlook for Chinese growth. A year ago, investors thought the worst reasonable case for Chinese growth was 6%. This has now fallen by 0.4% to 5.6%…

[But] China's ambitious deleveraging plans increase the risk of a hard landing, which could take year-on-year growth to 2%. Investors are still underestimating the risk…

Chinese credit and, to a lesser extent, equity markets would be very vulnerable to a hard landing; emerging markets would also be hit, while the dollar would benefit from a flight to quality.

And while monetary policy got the attention today, we should note that earnings season is nearing its end. It’s been one of “the best earnings season in years,” says Ned Davis Research’s Ed Clissold and team–which could be bad news for the market. They write:

By several metrics the current earnings season is on track to be the best in years. Of the 342 S&P 500 companies that have reported, 73.1% have beaten expectations, the second-highest rate in the last two years. Consensus estimates are for single quarter year/year operating EPS to jump 26.3% in 4Q13, the most since 4Q10. Yet the market is off to its worst start in four years. How can this be?

Clissold offers five reasons including macros issues like the taper and emerging-market selloff, the market’s high valuation, earnings comparisons to periods that were artificially weak and tepid revenue growth. “The weak start to the year has left the market oversold but has not changed the likelihood that the best part of the earnings story has probably happened already,” Clissold writes.

If earnings can’t push stocks higher, what will?