Stocks close mixed as Fed considers tapering bond purchases

There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor – the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know. – William Bernstein

It was a mixed bag for the stock market last week as the S&P 500 Index and the Dow Jones Industrial Average closed modestly lower while the Nasdaq Composite Index managed to post a small gain as investors bid up higher priced growth stocks. Despite recent data that suggested higher inflation down the road, bond yields were also little changed as the 10-year Treasury yield ended the week at 1.63%, just 0.01 percentage point lower than the previous week. Retailers dominated the quarterly earnings reports and the results were encouraging as Walmart, Target, Home Depot and Macy’s were among the companies that beat earnings forecasts. In fact, as earnings season winds down with more than 90% of S&P 500 companies having reported their results, a remarkable 86% of them have beaten analysts’ estimates, which is the highest percentage of positive earnings surprises since 2008. Strong quarterly earnings, though, were offset by cautious comments by Fed officials from the minutes of the Federal Reserve meeting in April. Members agreed that they would consider reducing the amount of monthly bond purchases if there was a strong economic recovery. Comments showed that the Fed had upgraded their view of the economy, saying that growth had strengthened and inflation was rising. But even with expectations of nearly 10% GDP growth in the second quarter, Fed Chairman Jerome Powell said that the economic recovery is “uneven and far from complete” and still not showing the “substantial further progress” that the Fed expects. Fed officials also believed that near-term price pressures as indicated by the April consumer price index (CPI) would subside and that inflation would eventually ease. They are so confident in their inflation outlook that they are willing to allow inflation to run above their 2% target in order to achieve an average around that level. Time will tell whether or not the Fed’s continued accommodative monetary policies are the right answer for an economy that seems to be gaining momentum.

Last Week

Housing data was particularly weak as April housing starts were well below forecasts and April existing home sales fell for the third straight month as the supply of homes for sale dwindled. High demand for homes and limited supply has pushed home prices higher, affecting affordability. Leading economic indicators in April were strong for the second consecutive month, suggesting that the economy’s strong momentum should continue with the possibility of accelerating growth. Weekly jobless claims were 444,000, less than expected and the lowest amount since March 2020.

For the week, the Dow Jones Industrial Average declined 0.5% to close at 34,207 while the S&P 500 Index dropped 0.4% to close at 4,155. The Nasdaq Composite Index rose 0.3% to close at 13,470.

This Week

April durable goods orders are expected to increase but less than in March while new home sales in April are also forecast to be less than in the March but still at a healthy level. The Consumer Confidence Index for May is expected to be slightly less than in April as consumers remain wary of rising inflation. Revised first quarter gross domestic product (GDP) is expected to remain the same at 6.4%.

Among the most prominent companies scheduled to report first quarter earnings this week are Urban Outfitters, Nordstrom, American Eagle Outfitters, Dick’s Sporting Goods, Abercrombie & Fitch, Best Buy, Gap, Costco Wholesale, Dollar General, Dollar Tree, AutoZone, Toll Brothers, Agilent Technologies, Dell Technologies, HP Inc., and Medtronic.

Portfolio Strategy

With earnings season winding down and most of the economic data to be released this week considered to be relatively insignificant ahead of the Memorial Day weekend, investors may focus on the personal income and spending data on Friday, which includes the core personal consumption expenditures (PCE) index. This is the Federal Reserve’s preferred measure of inflation and was up 1.8% through the end of March, slightly below the Fed’s 2% target rate of inflation. In light of the surprisingly high consumer price index reading in April, this piece of economic data could be key in determining the direction of the markets over the near-term and could possibly change the Fed’s monetary policy. Through the twelve months ending in April, the consumer price index rose 4.2%, which was much higher than expected and was accompanied by the producer price index which was also hotter than forecast. A higher than anticipated reading for the personal consumption expenditures (PCE) index could cause the Fed to rethink its monthly bond buying program and reduce the amount of securities it purchases, which currently stands at $120 billion a month. Most observers believe that an actual reduction in the monthly bond purchases would not occur until early 2022 and the Fed has forecast no increase in the federal funds rate until 2023 at the earliest. However, forecasting is more art than science and it is very difficult to make accurate predictions about the future without past and present data.  An old Wall Street adage is don’t fight the Fed, meaning that investors should invest in line with the actions of the Federal Reserve, i.e. invest more aggressively when interest rates are low and more conservatively when rates are high or heading higher. The Fed has maintained an easy monetary policy since the start of the pandemic, but a more normal monetary policy that includes higher interest rates could ensue if inflation expectations rise.