How The Stock Market Will React To Bernanke's Big Speech Tomorrow

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On Wednesday morning, at 10 AM ET, Federal Reserve Chairman Ben Bernanke will testify on the outlook for the U.S. economy before a Joint Economic Committee of Congress.

Along with the subsequent release of the minutes from the FOMC’s April 30-May 1 monetary policy meeting, due out at 2 PM, the Bernanke testimony is the main event on the calendar for markets this week.

Because the stock market rally that began in November has yet to see any sort of meaningful downward correction, it has lent to the sense that the market just keeps going up, undeterred by weak economic data and the like.

As such, the stock market will likely be a topic of interest for the JEC, and it may wish to put the question to Bernanke: are stocks in a bubble?

In a preview of the testimony, Miller Tabak Chief Economic Strategist Andrew Wilkinson identifies two things the stock market will want to hear from Bernanke, and how the Fed chairman may respond to a grilling on stocks:

There are two things the equity market would appreciate hearing from Mr. Bernanke on Wednesday. First, while progress is progress, it remains painfully slow. Such recognition will create the feeling amongst investors that quantitative easing is here for longer. Bond yields would decline in response while stocks would rally and the dollar would fall on the notion that it is surrendering its future yield advantage.

Second, for it to build on already heady gains – the market closed 1,000 points off its March 2009 lows on Monday – the stock market needs a green light from Mr. Bernanke. Any reference to future bubbles building in “certain” asset classes or financial markets will be cause for a sell off in stocks. However, the Fed has developed ‘asset patrol committees’ in the aftermath of the financial crisis whose role it is to monitor developments in financial markets and send up distress flares when unusual correlations begin. Thus far they have only spotted minor solar flares in some asset markets, but nothing to worry about.

If Mr. Bernanke is grilled on the topic of the advancing stock market, we expect he will explain it in terms of a revaluation of earnings potential as a consequence of several years of financial repression rather than blaming it on ‘irrational exuberance’. He has said it before and we expect him to say it again, the stock market is hardly overvalued despite its recent rise.

As we noted last week in a note, several Fed speakers have revisited the difficulty in pushing the flow of credit to would-be-homeowners – those with less than stellar credit. It does not make sense for Mr. Bernanke to upset the applecart despite the fact that equity traders seem to have adopted another mantra in May as they party like its 1999.

In short, anything but optimism from Bernanke on stocks would probably come as a surprise.

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