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S&P 500 closes above 2000 on earnings, economic data

When I was young I thought that money was the most important thing in life; now that I am old I know that it is. – Oscar Wilde

Positive economic data and better than expected second quarter corporate earnings again trumped geopolitical tensions as the S&P 500 Index closed at yet another record high, this time above the 2000 level. For the month of August, this broad-based index rose almost 4%. Despite accusations from Ukraine that Russian troops had invaded the eastern part of their country, investors chose instead to focus on fundamentals and were not disappointed. So far, second quarter earnings have risen almost 12% while revenue growth has been 6%. These strong results have surpassed analyst estimates and have been one of the primary reasons why stocks have continued their record climb. Most of the economic data released last week was also encouraging. U.S. durable goods orders recorded their largest monthly increase ever on strong demand for aircraft. Not to be outdone, U.S. second quarter GDP also was revised higher to 4.2% as business investment surged and consumers opened their wallets. The increase in business investment was primarily the direct result of much better corporate profits in the second quarter. Improving economic data did not alter the trend of the 10-year Treasury, however, as persistent geopolitical worries and weak economic data abroad caused the yield to tumble to 2.3%. But, for now, low interest rates, an accommodative Federal Reserve and stronger economic data and earnings estimates bode well for the stock market. Although September has historically been the worst performing month for stocks, in years when the stock market has a positive return through August, September actually has averaged a slight gain. With a year-to-date gain of 8%, there’s a good chance the month won’t be so bad after all.

Last Week

The strong durable goods number for July included an increase in transportation orders of almost 75% as Boeing received 324 orders for commercial aircraft. Excluding the transportation orders, durable goods orders actually fell 0.8%. Consumer confidence reached 92.4 in August, exceeding expectations and providing optimism for retailers about future trends in consumer spending. Jobless claims came in below the 300,000 level again and remain near an 8-year low, a positive sign for the labor market. The Chicago purchasing managers index (PMI) jumped much higher than expected in August, signaling continued expansion in the manufacturing sector.

For the week, the Dow Jones Industrial Average added 0.6% to close at 17,098 while the S&P 500 Index rose 0.75% to close at 2,003, a record high. The Nasdaq Composite Index gained 0.9% to close at 4,580.

This Week

In this holiday-shortened week, the most significant piece of economic data will be the employment report on Friday. The consensus estimate is for August nonfarm payrolls to total 220,000 and for the unemployment rate to decline to 6.1% from 6.2%. It will also be important to look closely at the type of jobs that are created as well as whether or not average hourly earnings increase, which could have implications for inflation and the timing of the Federal Reserve’s interest rate hike. Also on tap this week are the ISM manufacturing index for August and July factory orders, both of which should confirm continued improvement in the manufacturing sector.

In overseas news, both the Bank of England and the Bank of Japan are expected to leave interest rates unchanged at their respective policy meetings while the European Central Bank (ECB) could reduce rates slightly in an effort to jumpstart the euro zone economies.

With the second quarter earnings season winding down, there are only a handful of familiar companies scheduled to report, such as Toll Brothers, H&R Block, Joy Global and Verifone Systems.

Portfolio Strategy

Up until this point, it has been a great year for bond investors as rates have unexpectedly fallen since the beginning of the year, providing a fairly attractive total return for fixed income investments. With the Fed’s bond-buying program set to end in October, it’s possible that the Federal Reserve could also make an announcement at its September meeting about its plan for future interest rate hikes. While it seems to be a foregone conclusion that such increases won’t happen before June 2015, any timetable set forth by the Fed could cause sudden volatility in the bond market, a spike in interest rates and a subsequent loss of principal. To protect a bond portfolio from interest rate risk, maturities should be short to intermediate term in length and overall duration should be shortened. An attractive alternative to bonds are real estate investment trusts or REITs, which offer an above average yield and by law, must pay out 90% of their taxable income to REIT shareholders. The safest way to play the REIT market is through a diversified mutual fund or an ETF. One of the best REIT ETFs is the Vanguard REIT ETF, which is held in most client portfolios and has about a 13% weighting in health care REITs. With aging baby boomers that will need more care and a rise in insurance coverage, these health care properties should do well without much risk. The Vanguard REIT ETF is a low-cost fund with a current yield of almost 4% and a year-to-date total return of about 19%.