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Stocks close lower on Fed taper anxiety, weak retail sales

If you can follow only one bit of data, follow the earnings – assuming the company in question has earnings. I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow or next week is only a distraction. – Peter Lynch

After closing at record highs on Monday with the S&P 500 Index doubling in value from its pandemic-low close on March 23rd, 2020, it was downhill from there as all of the major stock averages finished lower for the week. The 100% rally in the S&P 500 was the fastest bull-market doubling off a bottom since World War II, but stocks could not sustain the momentum as concerns increased over the spread of the Delta variant of Covid-19 and the effect that might have on global growth. Worries began on Monday when China reported July retail sales that were well below expectations and continued the next day when U.S. retail sales in July fell much more than expected as government stimulus effectively ended. Minutes from the July Federal Reserve meeting only added to the anxiety as some Fed officials were in favor of reducing the amount of their monthly bond purchases before year-end. They agreed that the economy had reached its goal on inflation and was close to its goal on job growth, but insisted that employment had not met the “substantial further progress” benchmark that the Fed has set before it would raise interest rates. While the spread of the Delta variant has created uncertainty over the economy, the Fed doesn’t see any interest rate hikes for at least another year or so. Retail sales may have been weak, but all of the major retailers reported strong quarterly earnings last week. Walmart and Target easily beat revenue and earnings estimates and Target raised its earnings forecast for the rest of the year and announced a $15 billion stock buyback program. Similarly, Home Depot and Lowe’s also reported better than expected earnings and Lowe’s raised its sales forecast for the year. Although the stock market rallied on Friday to trim some of the losses for the week, volatility will likely continue with the possibility of Fed tapering and the spread of the Delta variant. The markets may turn more cautious since growth rates are peaking and the Federal Reserve is transitioning to less accommodative monetary policies.

Last Week

Industrial production unexpectedly rose in July but housing starts in July fell and were well below forecasts. Weekly jobless claims totaled 348,000, below estimates of 365,000 and down 29,000 from the previous week and leading economic indicators for July exceeded expectations. The National Association of Home Builders/ Wells Fargo Housing Market Index fell to its lowest level in over a year as rising costs of materials and skilled labor have caused home prices to soar, affecting demand.

For the week, the Dow Jones Industrial Average fell 1.1% to close at 35,120 while the S&P 500 Index declined 0.6% to close at 4,441. The Nasdaq Composite Index lost 0.7% to close at 14,714.

This Week

Both July existing home sales and new home sales are expected to approximate those reported in June as both have declined from the beginning of the year as home prices have increased. July durable goods orders are forecast to increase by roughly the same amount as in June and the second estimate of second quarter GDP is expected to match the first estimate of 6.5%.

Federal Reserve Chairman Jerome Powell is scheduled to speak at the Kansas City Fed’s Jackson Hole conference on Thursday.

Among the most notable companies scheduled to report second quarter earnings this week are Best Buy, Nordstrom, Burlington Stores, Dollar General, Dollar Tree, Gap, Advance Auto Parts, Toll Brothers, Medtronic, Bank of Montreal, Royal Bank of Canada, Intuit, HP Inc., Autodesk, Dell Technologies, and Palo Alto Networks.

Portfolio Strategy

The biggest losses for the stock market last week occurred on Wednesday after the minutes from the July Federal Reserve meeting were released and indicated that tapering of the monthly bond purchases could happen this year. This week the Fed will again be the primary focus for investors when its annual Economic Policy Symposium begins on Thursday. In many recent speeches and interviews, Fed officials have begun to recommend that the monthly purchase of $120 billion in U.S. Treasury securities and mortgage-backed securities be gradually reduced if the economy remains strong enough. However, the spread of the Delta variant of Covid-19 could slow the economy and play a huge role in determining the timing and magnitude of the taper. For this reason, Federal Reserve Chairman Jerome Powell will have to walk a tightrope and be flexible in laying out a plan to reduce the asset purchases. If the Delta variant becomes more serious than expected and the economy slows, the Fed will have to maintain its monthly bond purchases for a longer period of time. On the other hand, if the virus weakens and the economy strengthens, the Fed would be in a position to taper its bond buying program and wind it down sooner rather than later. In this case, the purchases would no longer be justified or needed. Like he has in the past, Powell will probably say that the Fed will be data dependent in making its decision to taper the monthly bond purchases and mindful of both the spread of the Delta variant and its potential effect on the economy. Tapering of the bond buying program could take months but once it ends, interest rate hikes could be the next step in becoming less accommodative.