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DJIA gains 2% on strong earnings, economic data

Put not your trust in money, but put your money in trust. –Oliver Wendell Holmes

The Dow Jones Industrial Average and the S&P 500 Index recorded their best weekly performance of the summer as both economic data and corporate earnings were positive catalysts. With an easing of geopolitical tensions between Ukraine and Russia, the focus was on the economy and earnings and both continued to impress investors. Housing data was particularly encouraging and suggested that the housing recovery is back on track. U.S. housing starts and permits surged in July while existing home sales were much better than expected. A measure of homebuilder confidence for August also was a pleasant surprise as it registered its highest level in seven months. Proof of all this good news was found in Home Depot’s quarterly earnings as it easily topped analysts’ estimates and even raised its earnings outlook for the rest of the year. Manufacturing data also contributed to the positive atmosphere as release of several indices indicated stronger than expected expansion. If that wasn’t enough, jobless claims fell and are now hovering around post-recession lows. The Federal Reserve did not rain on the parade either, as the minutes from the July meeting suggested that more evidence was needed before making a decision to raise interest rates.  And Fed Chair Janet Yellen echoed those sentiments at the Jackson Hole Fed Conference by stating that slack in the labor market was making it difficult to assess the true unemployment rate, leaving open the timing of any rate increases. Although trading volume in stocks was abnormally light last week, it was a relief to see geopolitical risks take a back seat to earnings, fundamentals and the economy, all of which have been turning in impressive results lately.

Last Week

The consumer price index (CPI) rose 0.1% in July and has increased only 2.0% in the twelve months through the end of July. Rising food costs in the month were offset by declining energy prices and labor market slack and anemic wage growth have helped to alleviate any price pressures. Leading economic indicators also increased 0.9%, easily beating expectations of a 0.6% rise.

While two members of the Bank of England voted to raise interest rates in that country, there were no clues either from the Fed minutes or Janet Yellen’s speech as to the timing and pace of any interest rate hikes, much to the chagrin of investors. Until there is irrefutable evidence that the economic recovery is here to stay, the Fed will probably keep rates near zero for the foreseeable future, most likely until mid-2015.

For the week, the Dow Jones Industrial Average climbed 2% to close at 17,001 while the S&P 500 Index rose 0.7% to close at 1,988. The Nasdaq Composite Index added 1.6% to close at 4,538.

This Week

Among the key economic data this week, new home sales for July should rebound strongly after a weak June, further solidifying the housing recovery. Durable goods orders for July could also surprise on the upside as airplane orders booked by Boeing could be large. Personal income data for July should be strong based on improvements in the labor market, but consumer spending is likely to be weaker on sluggish retail sales.

Retailers will again take center stage this week as companies such as Best Buy, Tiffany & Co., William-Sonoma, Dollar General and Abercrombie & Fitch are scheduled to report quarterly earnings.

Portfolio Strategy

To raise interest rates or to not raise interest rates was the question that all investors wanted an answer to as the Federal Reserve addressed the issue twice last week. With the 2-year Treasury yielding a paltry 0.50% and the 10-year Treasury yielding only 2.40%, most observers feel that it is inevitable that interest rates will rise sometime in the future. However, the Fed provided little or no guidance on the timing or magnitude of an increase and left investors scratching their heads at the vagueness and uncertainty of their remarks. It is widely assumed that once the Fed lays out a specific timetable for raising interest rates, that investors will dump their bonds, causing bond prices to fall and rates to rise. While this scenario could happen, global economic data continues to be weak, despite the fact that the U.S. economy is strengthening. Deflationary pressures in Europe have served to suppress government bond yields around the world. For example, the 10-year German Bund yields less than 1%, making the 10-year Treasury yield look downright attractive by comparison. Geopolitical risks around the world also have kept a lid on interest rates as investors seek out fixed income investments as a safe haven. While interest rates may eventually rise, any increase should be gradual and months down the road, giving fixed income investors peace of mind and providing stability to their portfolios by reducing the overall risk.