Stocks gain on Fed policy announcement, strong retail sales

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists. – Benjamin Graham

It was a tale of two markets this past week but when the closing bell sounded on Friday, the bulls had come out victorious as the major stock averages all closed higher. The technology-heavy Nasdaq Composite Index was the best performer with a gain of nearly 4% while the S&P 500 Index advanced nearly 2%. At the start of the week, the Federal Reserve announced that it would buy individual corporate bonds in order to support the credit markets. This move was more evidence that the Fed was committed to using its full range of monetary policy tools to improve liquidity and support the economy. But Fed Chairman Jerome Powell in his testimony before the Senate Banking Committee cautioned that a full economic recovery depended on control of the novel coronavirus. On that subject, there was also good news last week as a widely available steroid drug called dexamethasone was found to reduce Covid-19 deaths in hospitalized patients by up to one third. This discovery was seen as a major breakthrough in the treatment of the virus. Investors also cheered news that the Trump administration is considering a $1 trillion infrastructure proposal that includes money for roads and bridges as well as 5G wireless infrastructure and rural broadband. Getting both sides of the aisle to agree on such a proposal, though, could prove difficult in an election year. The stock market reversed course toward the end of the week as investors took profits when it was learned that coronavirus cases were rising in at least nine states with a particular resurgence of cases in Florida, California, Texas and Arizona. Apple also announced that it was reclosing 11 of its stores due to an increase of Covid-19 cases. The market has been pricing in a lot of good news and it could be due for a breather in the coming months. The economic recovery is likely to be uneven and the market will probably reflect that by being choppy and volatile as corporate earnings will have to live up to fairly optimistic expectations.

Last Week

May retail sales were another reason for the stock market gains last week as they rose nearly 18%, well above forecast and the biggest monthly increase ever. Leading economic indicators in May increased modestly after declining in both March and April as economic activity began to pick up again with an improved labor market, a better housing market and a strong stock market. Homebuilder sentiment recorded its biggest monthly increase ever in May, a sign that the housing market is rebounding due to low interest rates, rising consumer confidence and tight inventory. Weekly jobless claims were 1.508 million, which were higher than expected.

For the week, the Dow Jones Industrial Average rose 1% to close at 25,871 while the S&P 500 Index gained 1.9% to close at 3,097. The Nasdaq Composite Index soared 3.7% to close at 9,946.

This Week

The final reading for first quarter gross domestic product (GDP) is forecast to be a contraction of 5% while durable goods orders in May are forecast to rebound strongly after declining in March and April. May existing home sales are expected to be less than in April while May new home sales are expected to be higher than in the previous month. For the most part, housing prices remain relatively strong despite the weak economy.

The most prominent companies scheduled to report their quarterly earnings this week are Nike, Accenture, Darden Restaurants, McCormick, Rite Aid and Winnebago Industries.

Portfolio Strategy

For investors in search of income from their investments, it’s been a struggle to find attractive yields as Treasuries with maturities of 10 years or less yield less than 1% while the yield on the S&P 500 Index is slightly less than 2%. However, real estate investment trusts or REITs, which are companies that purchase properties such as office buildings, apartment buildings, hotels, shopping centers, health care facilities and storage facilities, are not only an investment that offers attractive yields but the potential for some capital appreciation as well. Since the stock market bottomed on March 23rd, REITs have rebounded about 46% from their lows compared to about 40% for the S&P 500. As a rule, REITs are required to pay out more than 90% of their taxable income to investors in the form of dividends. The coronavirus pandemic has obviously taken its toll on shopping centers and commercial real estate, but the damage should be short-lived as real estate values rebound with an improving economy. For shopping centers and malls, though, the rise of online retailing may be problematic longer-term. While there have been some dividend cuts since March, the majority of REITs have been able to maintain their dividends and yields. The best and most cost-effective way to invest in REITs is through an exchange-traded fund or ETF. The Vanguard REIT ETF (VNQ) is one such fund that invests in about 180 companies across all industry groups and tracks the performance of a particular REIT index. The current distribution yield of this fund is 4.1% and its average annual return over the last 10 years has been 8.85%. In addition to its healthy yield, this fund helps diversify the risks of holding stocks and bonds as REITs typically perform quite differently from the overall market.