Market Drivers: Housing, Bernanke, Quad Witching

English: Wedding of Prince William of Wales an...

English: Wedding of Prince William of Wales and Kate Middleton (Photo credit: Wikipedia)

After starting off the week on a positive note, markets took a dive following the midweek FOMC meeting announcement. Fear of rising interest rates and stimulus rollback prompted a steep selloff in bonds, equities and commodities. As of Thursday, the DJIA has logged 7 straight days with triple digit swings. Here are three things that have been driving the market this week.

Housing Market

With all of the talk about the potential for rising interest rates, some think it could be a catalyst to spur a surge in home buying. Since growth in housing tends to have a multiplier effect across other areas in the economy, traders watch this data closely. New home construction creates demand for lumber, metals, etc., as well as creating employment opportunities.  Once completed, new homes need to be furnished, leading to demand for appliances, furniture and electronics to name a few.  Here is a snapshot of some of the housing related numbers from the week:

  • Housing starts increased 6.8% in May to 914,000 on a seasonally adjusted annual basis, up from 853,000 in April, but below estimates that called for a jump to 950,000. The gain in May was owed almost entirely attributed to multi-family units, which surged 21.6%. Single-family starts rose just 0.3% to 599,000.
  •  Building permits hit a seasonally adjusted annual rate in May of 974,000, in line with estimates calling for 983,000, but 3.1% below the level of permits issued in April.
  • The housing starts report said the number of homes under construction increased 2.3% to 620,000.
  • The housing market index was up 8 points this month to 52. The monthly point gain is the largest since the 2002 recovery with the index level above 50 for the first time since the 2006. (For reference, a plus 50 reading indicates that home builders, as a group, are more optimistic than pessimistic.)

Fed Announcement

While there was nothing new that came out of the FOMC meetings this week, the markets still had quite a reaction once the results were made public. In his statement, chairman Ben Bernanke led off by saying that “if the Fed's updated economic forecasts out today are correct, the FOMC may moderate purchases later in 2013 and end them around mid-2014 if the economic data warrants it.” However it was also indicated that for now the Fed will continue to buy agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. Overall “The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate." In the wake of the news stocks, bonds, and commodities all sold off in evidence of increasing fear that an end to the Fed’s stimulus programs is drawing nearer, and the dreaded "taper" was closer than investors had previously thought. By midday on Thursday the DJIA had shed over 400 points since the announcement.

Quad Witch /  Russell Rebalance

Two upcoming events are creating heightened volume and potential volatility as the week moves forward - the Quad Witch Expiration on Friday and the Russell Reconstitution. First the “Witch”.  A Quad Witch is a trading day that occurs four times per year where contracts for 1.) stock index futures, 2.) stock index options, 3.) single stock options and 4.) single stock futures all expire.  The combined effect of derivative traders exercising their “in the money” options and taking delivery on their futures contracts makes this one of the most turbulent and heavily traded days of the year. This added volume then creates opportunities for investors to either add to (or liquidate) stock positions, which in turn creates even more volume. 

We also have the annual Russell Index reconstitution taking place, with changes being final after the close of trade on June 28th. Each year Russell rebalances its indexes simultaneously in an effort to accurately reflect the changing market. Additions, deletions, or shifts between the different indexes often creates large order imbalances creating arbitrage or trading opportunities in the market.

Weekly Bonus : Royal Stimulus?

What better way to stimulate an economy than by having a “royal” baby?  Well analyst are predicting that the anticipation and arrival of Prince William and Kate Middleton’s baby could do just that. Initial estimates are saying that the “baby fever” could boost the local economy by 240 million pounds ($380 million). The boost will come in the form of increased tourism, retailers offering royal themed baby items, and even food for “baby parties.” There is also the well-known Kate Effect, the phenomena where anything the Duchess wears or is associated with gets swept off the shelves. The theory is that there will be a comparable Baby Effect with any items surrounding the child being eagerly snapped up as well. In all it could provide a nice stimulus to the British economy.

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