The Charts That Helped Fed President Rosengren Plunge The Stock Market

After watching Boston Federal Reserve President Eric Rosengren speak at the South Shore Chamber of Commerce in Quincy, MA, I concluded Rosengren did not intend to rock the stock market on September 9, 2016. Ironically, the market’s extremely low volatility and lofty levels make the market “vulnerable” to good news. Good news drove Rosengren’s upbeat assessment about the health of the American economy and his deference to the market’s ability to price risk appropriately.

The S&P 500 (SPY) finishes what it started nine trading days ago. This time, the index gapped down, lost 2.5%, closed at its lows, broke the recent trading range, and, for good measure, broke down below support at its 50-day moving average (DMA).

Source: FreeStockCharts.com

September started with a surprisingly and very weak ISM Manufacturing number for August that initially caused selling in the market, but buyers stepped in to take the S&P 500 (SPY ) well off its lows. Over the next two days, the index rallied back to the edge of fresh all-time highs. That rally started with a U.S. jobs report that generated fewer jobs than expected (151,000 vs 180,000). The week before, on August 26, a disappointingly low U.S. 2Q GDP print barely even registered on the S&P 500 as the index rallied for a small gain on the day. Net-net and on the surface, the market was hardly bothered by important economic data points which all reportedly came in weaker than expected.

Rosengren looked back at the data and saw a different story. He saw a GDP report that suggested economic activity would be strong in the second half of 2016. The low GDP numbers came from unanticipated inventory drawdowns from companies hesitant to commit to production because of (global) uncertainties. According to Rosengren, the hesitation is now in the rearview mirror and companies will now rebuild inventories in the second half of 2016. As a result, he expressed confidence in GDP forecasts that range from just below 3% to just above 3%. Rosengren produced the following chart to show the outsized influence of inventory drawdowns on GDP.