Stocks to see more volatility in the run-up to Fed rate hike

LAST week, stocks continued the 2015 tantrum: jumping up and down furiously without apparent direction when you'd think there would be a celebration.

This week, there could be a stockmarket rally in the form of a delayed reaction to the May jobs report.

The Dow Jones Industrial Average and other major indexes finished with a slight loss on the week. And yet a big move in the bond market in the wake of Friday's jobs report has caused a corresponding shift in the stock market that hints at broader gains to come.

US employers added 280,000 people to their payrolls in May, one of the largest hiring sprees since the end of the Great Recession, according to the Labor Department. Even more promising for the consumer spending-dependent US, the report showed wage growth. That report effectively settled the argument over whether the recent wobbles in the US economy would be enough to derail recovery.

Treasury yields, which are used by banks as the guideline for rates on everything from mortgages to personal loans, suddenly soared as the bond market pre-empted the Federal Reserve.

"What investor bond vigilantes are doing is they're starting to price in maybe that the first-quarter GDP (gross domestic product) was a bit of an aberration and that economic growth is going to be better later in the year ... that keeps the Fed in place for a September liftoff on the (benchmark) funds rate," said Phil Orlando, chief equity strategist with money manager Federated Investors.

Treasurys, Mr Orlando added, are getting "crushed", with the yield on the 10-year Treasury moving from near historic lows in April to its highest point in about six months on Friday. The revival of the bonds has revived a stockmarket leader: the financial sector.

In 2007, Wall Street - and even Main Street - banks were effectively the largest and richest casinos the world had ever seen. Billion-dollar bets were placed by even junior bank employees without hesitation. For bigger banks, profits were counted in the tens of billions and every quarter brought a record profit.

After the 2008 crash, the casinos were cleaned out, and the only game left on Wall Street was penny-ante poker, chipping small percentages out of clients' stock and bond trades. Earnings reports and conference calls no longer revolved around boosting outlooks or record volumes; the only buzzword left was "cost cuts", which meant cutting everything from bonuses to photocopy budgets.

Wall Street banks and Main Street banks were reduced to doing what they were originally founded to do: brokering deals and lending money. The ultra-low interest rates and slow economic growth made it impossible to increase loan fees and grow profits.

Banks went so far as to warn that they would have to begin laying off employees if rates did not move soon. Well, rates have started to move; stock markets in China and, to a lesser extent, the US, have caught fire. The great financial casinos are reopening.

Leadership from the financial sector is traditionally a good sign for the broader market: the banks form one of the largest sectors and have business with every other industry. Many other sectors sold off on Friday because of the fear that rising interest rates would hurt them.

Utilities - the electricity generators prized by investors for their dividends, and whose shares were among the best performers last year because of the unexpected extension of the low-rate era - and fellow big dividend payers such as real-estate investment trusts and telecommunications companies were among the biggest losers on Friday. This makes sense: the retirees who piled into utilities because they could not live off interest payments in the bond market will eventually jump back into Treasurys.

Other sectors that sold off, such as retailers, however, could have more to gain from wage and jobs growth than they have to lose from rising rates. This week's retail sales report could reveal that wage-earners are already putting this increase in financial resources to work.

"We are forecasting a very strong May and June bounce in retail sales, related to the fact we think consumers are going to start to cash in this energy dividend," said Mr Orlando.

For him, rate worries are overdone.

"There's a misapprehension that an interest rate hike at this point in the cycle is bad," said Mr Orlando. "We think it's very good ... it confirms in our mind if they're going to lift interest rates for the first time in nine years, they must truly believe the economy is strong enough to (subsist) on its own without this extraordinary monetary policy."

Mr Orlando pointed to another market "tantrum" in 2013 when former Fed chair Ben Bernanke warned markets that the Fed would gradually wind down its bond purchase programme. Before the changes began, the market's reaction was dubbed the "taper tantrum"; but stocks rallied sharply in the second half of the year. It was the inverse of the reaction that stock markets are often said to have to good news: traders sold the rumour of the taper, and bought the news.

The same thing could happen this year. When the rate hike finally comes, likely in September, stocks could rally.

Until then, there could be a lot of ups and downs.

"I just think volatility is going to continue till the Fed gives us really solid direction as to when they're raising rates," said Joe Kinahan, chief derivatives strategist at TDAmeritrade.