What the Federal Reserve’s FOMC Meeting Means for the Market

Chris Versace

Chris Versace is a financial columnist and equity analyst with more than 20 years of experience in the investment industry.
Federal Reserve Building

Greece has been the focal point of the headlines and the stock market so far this week with a game of will it or won’t it leave the euro zone. This renewed bout of uncertainty and what it could mean has once again sent turmoil through the markets. That attention-getting situation is once again capturing news cycle share as it looks increasingly like a Greek exit, or “Grexit,” will occur. In talking with compatriots who live in Europe, it’s not a question of if, but more of a question of when.

One of the dangers associated with times like this is that we become so focused on one particular event that we tend to look at the world through blinders and miss other happenings. That “rope-a-dope” strategy served former world heavyweight boxing champ Muhammad Ali well in his 1974 “Rumble in the Jungle” match against George Foreman, but when it comes to the market and your investments, getting distracted or too focused on any one thing or event can be costly.

We also have the June Federal Open Market Committee (FOMC) meeting this week, and this afternoon we’ll get the latest FOMC statement. Yep, today is “Fed Wednesday,” as I like to call it, which means at around 2 p.m. the Federal Reserve will release its June FOMC statement. Closely watched by Wall Street and other financial institutions, the statement contains the Fed’s latest action or inaction on interest rates and veiled commentary on what it’s thinking (or not).

For the last few months, the data we’ve been receiving shows me the expected snapback coming out of the dismal March quarter has been far less than the Wall Street herd has been expecting.

On Monday, we learned the domestic manufacturing economy contracted in May, missing expectations yet again. The reported figure for May industrial production was 78.1 percent.

According to the Federal Reserve report, industrial output fell 0.2 percent after a revised 0.5 percent drop in April. Expectations called for a 0.3 percent increase in the index for May. Taking a step back, we find this to be the sixth consecutive month of month-over-month decline in industrial production. Stated another way, we have not seen a month-to-month increase in industrial production since last November.

A number of manufacturing-related industries correlate closely to industrial production, which makes it a report I follow closely. Digging into the May report, we see the mining industry has been taking it on the chin with declines each month during the last several months. That trend is not good for companies such as Caterpillar (CAT), Joy Global (JOY) or Kennametal (KMT). Utility production levels had been on the down slope in March and April as milder weather finally broke the winter chill. But given the hot temperatures in May — this past May was one of the hottest on record in the Washington, D.C., area — utility activity picked up.

What was most bothersome to me was the May drop in manufacturing. According to the Federal Reserve’s findings, manufacturing activity declined 0.2 percent in May. If we exclude the booming auto sector, manufacturing fell 0.3 percent last month. This joins several other indicators — new truck orders, truck tonnage and weekly railcar data among them — that, when combined, paint a picture showing a second-quarter snapback following the dismal first-quarter gross domestic product (GDP) report that is not shaping up as many had expected. The vector might be in the right direction, but the degree of velocity is simply not matching up.

We can throw another log — in the form of May Housing Starts — onto that less-than-expected fire. As we learned yesterday, overall May Housing Starts fell 11.1 percent month over month, with single-family housing starts clocking in at 5.4 percent below April and well below January levels. While the bulls will point to a pickup in building permits, I’m not quite sold on any rebound in housing, for several reasons.

First, there are the obvious demographic factors — nearly 30 percent of Americans have no retirement savings, and a preference exists among Millennials to rent rather than own. These realities make me wonder if there is more to a 2015 slide in household formation than just the weather.

Second, margins at the homebuilders are being smacked, and smacked hard, as they pull out all the stops, offering concessions and incentives to lure prospective buyers following the overbuilding of houses on speculation that occurred previously. How rampant is the use of these enticements?

The best example of this came at Hovnanian Enterprises (HOV), which delivered 1 percent fewer homes in the March quarter but saw its gross margins drop more than 400 basis points with management fingering incentives and concessions. Hovnanian wasn’t alone — Meritage Homes (MTH), MDC Holdings (MDC), Standard Pacific, D.R. Horton and PulteGroup all saw margins impacted by these practices. Call me crazy, but weaker-than-expected demand, coupled with rampant activity that will pressure margins, doesn’t sound like the housing market is about to go “en fuego,” or on fire, after its recent cooling.

Granted, some people will talk of the recent strength in the last two employment reports, but other indicators, such as the labor force participation rate and Gallup’s payroll to population index, show we have much further to go in terms of job creation. Moreover, the continued strength in the dollar and conditions described above are weighing on corporate America and its view on the rest of 2015. According to the Business Roundtable second-quarter 2015 CEO Economic Outlook Survey, CEOs have cut their expectations for economic growth, hiring and capital spending for the balance of 2015. This morning, FedEx (FDX) shared that its outlook “assumes continued moderate economic growth.”

What does it all mean? The expected economic snapback following the dismal 1Q 2015 GDP print is not shaping up as expected. Factor in the Greek uncertainty, the impact of continued dollar strength year over year, low to no inflation — a key item for the Fed — and it means we should expect no changes coming out of today’s FOMC statement.

The Fed now has more reason to hold off raising rates in the short term.

Coming out of the FOMC statement, the question will be: when do we expect the next rate hike? Will it be late in 2015, or will the summer data show it could slip into 2016, an election year?

In case you missed it, I encourage you to read my e-letter column from last week about the effects of mergers on the market. I also invite you to comment in the space provided below.

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The week ended on a positive note with the Dow Jones up 0.79%, the S&P 500 rising 0.78% and the NASDAQ up 0.83%.The MCSI Emerging Markets Index flatlined to end the week down 0.15%. Big gainers in your Alpha Investor Letter portfolio included Skyworks Solutions Inc. (SWKS), which added 4.00%; the PureFunds ISE Cyber Security ETF (HACK), which climbed 3.27%; the iShares MSCI Philippines (EPHE), which jumped 3.21%; and Markel

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