Stocks rode the D.C. seesaw last week as the broad
market fell, rose, and ultimately finished flat on the week amid daily, if not
hourly, conflicting comments from senior political leaders. Large-company share
prices, however, dropped more than 1% for the week.

With
the third-quarter-earnings reports season not beginning until this week,
investors remain fixated on the partisan battle over the federal budget and the
government’s need to raise its debt-ceiling authority. As of Friday, the
partial government shutdown was in its fourth day.

The
market’s rebound on Friday demonstrated how closely investors were watching
Washington, as stock prices rallied on media reports suggesting that Speaker of
the House John Boehner was perhaps more flexible than previously thought in
working to increase the U.S. debt limit before the estimated Oct. 17 deadline.
Technically, in the event that deadline isn’t met, the federal government
probably wouldn’t run out of money until the end of the month.

The
Dow Jones Industrial Average lost 186 points, or 1.2%, to 15,072.58, a second
consecutive weekly drop. But the S&P 500 index finished essentially
unchanged at 1690.50. The Nasdaq Composite index bucked the trend, rising 0.7%,
or 26 points, to 3807.75.

“It
was a manic-depressive market,” says Paul Nolte, a portfolio manager with
Dearborn Partners. There’s hope of a handshake on the debt ceiling, but the
competing sound bites from Democrats and Republicans aren’t helping, he says.

With
shares off just about 2% from highs, the market hasn’t reacted much to the
stalemate, he adds, and certainly less painfully than the 10%-plus slide back in
August 2011. That’s when Standard & Poor’s downgraded U.S. debt amid the
wrangling over lifting the ceiling. As things stand, the debt ceiling is more
pressing than the budget (Source: 
Barrons Online).

The stock market jumped sharply last week, making up
for a lack of trading volume with enthusiastic price bidding. The likelihood of
an attack on Syria faded, and investors turned festive, sending share prices up
2% to 3%. Stocks completed a rare seven-consecutive-day win streak last
Wednesday.

A
few weeks ago, a U.S. missile attack on Syria seemed imminent, but that’s on
hold after Moscow-brokered talks began last Thursday on a plan for Syria to
surrender its chemical weapons. With U.S. sabers sheathed for now, investors
are calmer, but the ups and downs in these talks will probably lend some
unwelcome volatility in the next few weeks.

To
some extent, last week’s big rally was also a function of the growing
acceptance of a bullish view that the Federal Reserve will not remove as much
bond-buying stimulus as it signaled back in June. The Fed’s $85 billion in
monthly bond buying has been a major factor in the stock market’s rally over the
past two years by keeping interest rates artificially low.

The Dow Jones Industrial Average climbed 454 points,
or 3%, to 15,376.06. It’s down 2% from record highs set last month. The
Standard & Poor’s 500 index gained 33 points. That’s about 1% below the
all-time high of 1709.67 hit on Aug. 2. The tech heavy Nasdaq Composite index
gained 1.7%, or 62, to 3722.18.

“I’m getting a sense that the market believes
the Fed tapering will be lighter than previously thought,” says Joseph
Amato, president of fund manager Neuberger Berman. The Fed’s policy-setting
committee meets Sept. 17-18, and that “will clearly be the driver of
near-term market sentiment,” he says.

In general, the tapering consensus appears to be
coalescing around an expectation that the Fed will indicate a $10 billion to
$20 billion reduction in bond buying. That would be much less than the $40
billion curtailment that the Fed signaled last June. If the Fed meets market
expectations, that will probably send stocks higher, Amato adds.

Brian Reynolds, chief market strategist at floor
broker Rosenblatt Securities, agrees. Such an outcome would likely push the
S&P 500 index through the 1700 level, where it has met some resistance in
the run-up of the past two weeks.

Stocks
haven’t been able to top the August high because traders are pulling in their
horns ahead of the Federal Open Market Committee meeting. If the Fed meets
consensus, the old highs will be taken out in a few weeks, Reynolds predicts.

He calls scenarios where the Fed delays any tapering
or where it follows through on the larger $40 billion reduction “low
probability outcomes.” In the former case, the market would probably bolt
higher, but in the latter case, there would likely be a “big
selloff.” (Source:  Barrons Online).

Most of the time, the U.S. stock market
looks to 3 factors to support its upward trend – let’s grade each of the
factors:

CONSUMER
SPENDING:  I grade this factor a C (neutral).

THE
FED AND ITS POLICIES:  I continue to grade this factor an A+ (extremely favorable) because the
FED cannot do much more than it is doing to support the stock market and asset
prices.  

 BUSINESS
PROFITABILITY:  I graded this factor an A (very favorable).   

 NOTE: 
the above grades are unchanged from last week.

Stocks finished the week generally mixed in light
trading, with mega-caps lagging the market. Traders mostly shrugged off a
technical glitch at the Nasdaq, which halted that exchange for three hours
Thursday.

The market traded down Wednesday ahead of the
release of the minutes from the U.S. Federal Reserve’s July policy-setting
meeting, and middling rallies on Thursday and Friday weren’t enough to overcome
the earlier losses among the big caps.

With
few macroeconomic data releases and little new in the way of policy hints out
of the Fed, investors switched their focus mainly to corporate news from
companies like Microsoft (ticker:
MSFT) and retailer Abercrombie (ANF).

The Dow Jones Industrial Average managed to climb
back above 15,000 Friday, to close at 15,010.51, down 71 points, or 0.5%, on
the week. The S&P 500 index inched up eight points to 1663.50. The Nasdaq
Composite index gained 1.5%, or 55 points, to 3657.79. The small-cap Russell
2000 index jumped 14 points, or 1.4%, to 1038.24.

The
market’s negative reaction to the Fed minutes was surprising, says Liz Ann
Sonders, chief investment strategist at Charles Schwab, because it wasn’t
particularly “new news.” However, the drops are more understandable
in light of high bullish sentiment among investors coming into the week.

As a contrary short-term indicator, she says
sentiment remains “too frothy,” even if it has cooled. The Schwab
strategist is cautious about the near term and expects more of a pullback and
volatility. “I’d like to see a further reversal of sentiment” before
getting more positive, she adds.

Investors might be obliging. Last week, individuals
pulled $12.3 billion out of equity exchange-traded funds, the first outflow in
eight weeks and the largest in five years, according to a report Friday from
Bank of America Merrill Lynch chief investment strategist Michael Hartnett.

Next week might be quiet, but in September there are
going to be headwinds in the form of a Fed policy meeting on the 17th and 18th,
in a month when many expect the central bank to begin tapering its quantitative
easing, notes Jack Ablin, chief investment officer of BMO Private Bank.

Then there are critical German elections on the
22nd, and the ninth month has historically been a tough period for stocks, he
notes (Source:  Barrons Online).