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On Tuesday, the stock market experienced its biggest decline in a month (which isn't really saying much based on the lack of volatility seen since mid-May) on the back of a confluence of negative inputs. One of the primary issues that traders fretted over were comments made by Mario Draghi. In essence, the markets heard the ECB President suggest that his bank may begin to wind down and/or take steps to reduce monetary stimulus. As I opined yesterday, the result was a global selloff in the bond market based on the fear that the central banks all walking back their stimulus efforts at the same time might trigger the big, bad bond bear that analysts have been expecting for years now.

However, in keeping with the strictly sideways trend that has been largely intact for the past four months, stocks reversed course Wednesday, erasing the entirety of Tuesday's decline and then some. In fact, the venerable S&P 500 index closed yesterday just 12 points (or about 0.5%) from its most recent all-time high. So much for the return of the downside volatility that was the talk of the town on Tuesday, right?

The impetus for the quick reversal in stocks appears to also be tied to Mr. Draghi. More specifically, the intent of Super Mario's comments.

Recall that on Tuesday, the ECB president said the improvement in the euro-area economy creates room to pull back unconventional measures without tightening the bank's current policy stance.

What He Meant To Say Is...

But, according to an ECB official, who asked not to be named due to the fact that internal discussions among ECB officials are confidential, the markets basically misinterpreted Draghi's speech at the ECB Forum on Tuesday in Sintra, Portugal.

The official says that Draghi's comments were intended to strike a balance between recognizing the currency bloc's economic strength and warning that monetary support is still needed.

So, on Tuesday, the markets focused on the first part of the statement relating to pulling back on the bank's "unconventional measures" - aka QE. But on Wednesday, traders recognized the effort to "walk back" Super Mario's comments and reversed course.

Although the ECB officially declined comment, the bank's Vice President, Vitor Constancio, scrambled to set the record straight. In a CNBC interview Wednesday, Constancio said that Draghi's remarks were "totally" in line with ECB policy and that the market's response was puzzling.

The ECB VP stressed that despite the current economic upswing, inflationary pressures remain subdued. And while an improving economy normally results in higher prices and wages, this does not appear to be the case at the present time in the EU. And since the ECB's primary objective is an inflation target, there is no need to adjust the bank's monetary policy.

Constancio emphasized this point by saying that the ECB plans to stay the course here. "If we want to bring inflation to our target of below but close to 2 percent then we have to persist in the type of monetary policy that we have been adopting."

Although there were other positive inputs in the market yesterday such as Goldman raising its year-end price target on the S&P, further improvement in oil, and Trump telling GOP senators that they are getting "very close" to an agreement on a healthcare plan, the idea that the ECB has no plans to change their QE operations (which are scheduled to run through the end of 2017) allowed traders to breathe a sigh of relief.

Watch Those Bonds

It is interesting to note that the bond traders didn't appear to completely buy the story as the yield on the US 10-Year rose on Wednesday and is up again in the early going this morning. The 10-year yield has moved from 2.137% on Monday (which was the low of the year) to 2.281% - in less than 4 trading sessions.

Thus, from my perch, traders appear to be either (a) "going the other way" for a trade (lest we forget, the trend in yields had been straight down since May 11) or (b) discounting the inevitable end to the ultra accommodative stances from both the ECB and the Bank of England.

So, I, for one, will be keeping a close eye on the bond market for the foreseeable future.

Publishing Note: I will be taking a mid-year break from the keyboard next week and will not publish Daily State reports.

Thought For The Day:

Only put off until tomorrow what you are willing to die having left undone. - Pablo Picasso

Current Market Drivers

We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).

      1. The State of the U.S. Economy
      2. The State of Earning Growth
      3. The State of Trump Administration Policies


Wishing you green screens and all the best for a great day,

David D. Moenning
Chief Investment Officer
Sowell Management Services

Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.

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