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S&P 500 winning streak ends as Fed rate hike looms

The minute you get away from the fundamentals – whether it’s proper technique, work ethic, or mental preparation – the bottom can fall out of your game, your schoolwork, your job, whatever you’re doing. – Michael Jordan

The S&P 500 Index celebrated the eight-year anniversary of the bull market this past week but closed modestly lower, snapping its winning streak at six weeks as the Federal Reserve will almost certainly raise interest rates at its meeting on March 14th and 15th. On March 9, 2009, the S&P 500 Index notched its bear market closing low and has gained 250% since then, a remarkable run that has been aided by ultra-low interest rates and easy Fed monetary policies. Strong jobs data last week from several sources has now raised the odds of a rate hike to over 90% as the Fed begins to normalize monetary policy in what many believe to be the first of possibly two or three additional rate hikes this year. ADP released the first jobs report on Wednesday and it showed that 298,000 private sector jobs had been created in February, far more than expected and the result of businesses anticipating the new administration’s pro-growth policies and hiring more aggressively. Although weekly jobless claims were higher than estimated on Thursday, it marked the 105th consecutive week that they were below 300,000, a sign that the labor market remains healthy with very few layoffs. The most important jobs data came on Friday and it did not disappoint. The government reported that 235,000 jobs had been added in February, better than expected but not strong enough to prompt the Federal Reserve to raise the federal funds by more than a quarter of a point. The January jobs report was also revised higher and the unemployment rate edged lower from 4.8% to 4.7%. The only disappointing part of the employment report was wage growth, which rose at an annualized rate of only 2.8%. In addition to the near-certainty of an interest rate increase, investors also had to contend with falling energy prices which weighed on stocks. The price of a barrel of oil fell over 9% last week to close below $50 for the first time this year as concerns rose about increased supply. Recent economic data has been mostly positive so an interest rate hike by the Federal Open Market Committee (FOMC) this week should come as no real surprise to investors or the markets.

Last Week

In addition to the jobs data last week, factory orders in January were stronger than expected as the manufacturing sector recovery appears to be gaining momentum. Manufacturing accounts for about 12% of the U.S. economy. The U.S. trade deficit in January jumped to $48.5 billion, its highest level in almost five years.  Import prices in February rose slightly while productivity in the fourth quarter rose modestly.

The European Central Bank (ECB) and President Mario Draghi kept interest rates unchanged as all of   the measures of underlying inflation remain low. Draghi said that if the economic outlook worsens, the ECB stands ready to increase its asset purchase program to stimulate growth.

For the week, the Dow Jones Industrial Average fell 0.5% to close at 20,902 while the S&P 500 Index dropped 0.4% to close at 2,372. The Nasdaq Composite Index slipped 0.2% to close at 5,861.

This Week

After both increasing 0.6% in January, the producer price index (PPI) and the consumer price index (CPI) are forecast to remain virtually flat in February. Retail sales for February are expected to be lackluster after posting a relatively strong month in January. February housing starts should be better than the previous month due to unseasonably warm weather throughout much of the country. Leading economic indicators for February are expected to increase modestly while the March University of Michigan consumer sentiment index is expected to top the previous month and show that consumers remain confident about the economy.

The Federal Reserve is widely expected to raise the federal funds rate to a range of between 0.75% to 1% and Fed Chair Janet Yellen will give a news conference after the meeting. The Bank of Japan and the Bank of England will also announce their decision on interest rates.

It will be a light week for quarterly earnings reports as Oracle, Adobe Systems, Williams Sonoma, Tiffany and Dollar General are the most notable companies scheduled to report.

Portfolio Strategy

In its attempt to eventually normalize monetary policy and begin to raise interest rates, the Federal Reserve had established two official objectives: full employment and a target inflation rate of 2%. Last week’s strong employment report that topped the most optimistic projections for jobs and the dip in the unemployment rate to 4.7% essentially satisfied the first condition. For all practical purposes, the economy is at full employment as the labor market has tightened considerably. On the inflation front, the Fed’s preferred measure has always been the personal consumption expenditures price index (PCE), which rose in January and has increased 1.9% over the last 12 months, just a shade below the Fed’s target. In recent weeks, a number of Fed officials have commented that conditions have been met for a rate hike and Fed Chair Janet Yellen has also intimated that a rate hike would be appropriate at the next meeting. Another factor having an influence on the Federal Reserve might be the rally in the stock market since the election, due in large part to the expectation of stronger economic growth fueled by President Donald Trump’s pro-growth policies of tax reform and lower taxes, deregulation and increased fiscal spending. While it appears that a rate increase is all but certain, what is uncertain are any comments or remarks that will be made by Fed Chair Janet Yellen about the economy and future interest rate hikes and their effect on the stock market.