Stocks surge on dovish Fed statement

Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well. – Warren Buffett

After tumbling by 3.5% the previous week, the S&P 500 Index came roaring back last week and recouped almost all that it had lost as investors were encouraged by the Federal Reserve’s comments on interest rates. It’s difficult to believe that a change in wording could have such a powerful impact on perceptions but that is exactly what happened in Fed Chair Janet Yellen’s briefing. As many observers had expected, the Fed eliminated the “considerable time” language with regard to when interest rates would be raised and replaced it with the phrase that the Fed “can be patient” when beginning to tighten monetary policy. Fed officials also cited a reduction in inflationary pressures in 2015 as a reason to be patient on possible rate increases. The most widely predicted date for a rate hike continues to be June 2015 and in the Fed statement, officials stated that no increase would happen for at least the next couple of months and that any decision to do so would be dependent on the data. No specific timetable was given. If these comments all sound strangely similar to previous comments from the Federal Reserve, they undoubtedly are. The fact that investors interpreted the Fed’s remarks so positively is a surprise as many of the concerns that led to the market swoon last week are still present, namely low oil prices, a falling Russian currency, deflationary trends and weakening global economies. But it’s also the season when Santa Claus comes to town and maybe, just maybe, this jolly old elf had something to do with the rally and merriment on Wall Street last week.

Last Week

For the most part, the economic news last week was positive as industrial production in November recorded the largest percentage gain since May 2010. November U.S. housing starts and permits also suggested that the underlying trend is indicative of an improving housing market. Consumer prices fell by 0.3% in November, the largest drop since December 2008, as oil prices plunged. U.S. leading economic indicators rose by 0.6% last month and signals that the economy should experience moderate growth through the winter months.

In an effort to reverse the slide in the ruble, the Central Bank of Russia raised interest rates to 17% as low oil prices and sanctions against Russia have taken their toll on the economy. It would seem that Vladimir Putin’s only rational response to removing financial sanctions is to withdraw from eastern Ukraine.

For the week, the Dow Jones Industrial Average soared 3% to close at 17,804 while the S&P 500 Index jumped 3.4% to close at 2,070. The Nasdaq Composite Index gained 2.4% to close at 4,765. Small cap stocks as measured by the Russell 2000 Index were the best performing asset class, up 3.8%.

This Week

While this week will be relatively quiet due to the Christmas holiday, there is a slew of economic data scheduled on Tuesday. The final GDP number for the third quarter should be revised higher to 4.2% from 3.9%, a positive sign that the economy continues to improve. November durable-goods orders are expected to be strong on increased aircraft orders and consumer sentiment numbers should be higher due to low gas prices and better jobs data. Both personal income and spending should also show healthy increases based on job gains and slightly higher hourly earnings.

Only a few companies are due to report earnings this week and of those, Walgreen is the most prominent and is expected to beat analysts’ revenue expectations.

Portfolio Strategy

With the Dow Jones Industrial Average and the S&P 500 Index now trading back near their all-time highs after last week’s surge, many investors may be in for a surprise when they see that their annual portfolio return is less than that of these major averages. The reason for this disparity is diversification as many asset classes have underperformed these benchmarks, either posting single digit returns or actually declining in market value. Among these disappointing major asset classes are high yield or junk bonds, small cap stocks, commodities, metals, energy and international and emerging market equities. A portfolio whose expected return is appropriate based on one’s risk tolerance, time horizon and investment goals is not one that is necessarily designed to beat the index every year. While over long periods of time all asset classes are expected to generate a positive rate of return, over shorter time periods the returns are more variable and subject to the ups and downs of the market. Ideally, the investments in a portfolio should be non-correlated, which means that the asset classes do not all go up or down at the same time. Such a portfolio is said to be well-diversified and benefits an investor by helping to avoid big setbacks in the market as well as by helping to manage investment risk.