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S&P 500 Index up 1.5% on ECB stimulus plan

The most important quality for an investor is temperament, not intellect… You need temperament that neither derives great pleasure from being with the crowd or against the crowd. – Warren Buffett

In a widely expected move that certainly lived up to all of the hype, the European Central Bank (ECB) delivered as promised its massive bond-buying program last week and the stock market cheered the news. Both the S&P 500 Index and the Dow Jones Industrial Average climbed more than 1% as ECB President Mario Draghi made good on his assurances that he would do “whatever it takes” to lift Europe’s economy out of the doldrums and reverse worrisome deflationary trends. Under the ECB plan, the central bank left interest rates unchanged and will purchase $67.6 billion a month in assets, including government bonds, beginning in March and lasting at least through September 2016. However, this timetable is somewhat arbitrary and the European Central Bank added that the program’s length will depend on economic data and could run longer if inflation doesn’t pick up. Immediately after the announcement, 10-year yields in the euro-zone fell to their lowest level ever. If you think that the current yield of 1.80% on the 10-year U.S. Treasury is low, compare this with yields in these European countries: 10-year German Bunds at 0.36%, French bonds at 0.54% and Spanish bonds at 1.37%. This discrepancy in yields could serve to attract fixed income investors to U.S. government bonds, pushing bond prices higher and yields even lower and buying time for the Federal Reserve by delaying the much-anticipated interest rate hike in June. If nothing else, this move by the ECB is likely to make European equities more attractive relative to its bonds and push investors into stocks, much like what happened to U.S. stocks as the Fed embarked on its bond-buying program. All of the major central banks in the world have now implemented polices to spur economic growth and fight deflation. With money flowing into risky assets, these policies could have unintended consequences down the road if markets become overheated and valuations become stretched.

Last Week

Housing data released last week was generally positive. Housing starts for new U.S. homes rose 4.4% in December, completing the highest annual total in seven years. Existing home sales last month also increased in line with expectations. U.S. leading economic indicators for December rose 0.5%, suggesting that momentum in the economy is building and there should be steady growth in the first part of 2015.

In overseas news, the International Monetary Fund (IMF) reduced its outlook for global growth for 2015 and 2016, projecting 3.5% growth this year and 3.7% next year. China reported that its gross domestic product (GDP) increased 7.4% in 2014, in line with estimates but the weakest economic growth since 1990.

For the week, the Dow Jones Industrial Average gained 1% to close at 17,672 while the S&P 500 Index jumped 1.6% to close at 2,051. The Nasdaq Composite Index added 2.7% to close at 4,757.

This Week

The economic calendar this week is relatively sparse. New home sales for December are expected to rise modestly while December durable goods orders should post a small increase. Consumer confidence for January should rise as the positive effects of lower oil and gasoline prices are felt throughout the economy.  The first estimate of fourth quarter GDP growth is expected to be 3.3%, compared to 5% in the third quarter and bringing annual growth for 2014 to 2.5%. The Federal Reserve ends its two-day meeting on Wednesday and no major changes are expected in its policy statement.

Corporate earnings reports for the fourth quarter will be the primary focus this week as the earnings season gets into full swing. Among the companies reporting are Microsoft, Google and Apple in the technology sector, Pfizer, Amgen and Abbott Labs in the health care sector, 3M, Caterpillar and Boeing in the capital goods sector, Du Pont and Dow Chemical in the materials sector, Procter & Gamble and Visa in the consumer sector, Chevron in the energy sector and AT&T in the telephone utilities sector.

Portfolio Strategy

For just the fourth time in over fifty years, the dividend yield of the S&P 500 Index (2.0%) moved higher than the yield on the 10-year Treasury (1.8%) last week. If history is a guide, this could be a sign that it might be an opportune time to invest in stocks. Interest rates in the U.S. have fallen even as the Federal Reserve ended its massive bond-buying program aimed at suppressing rates a few months ago. The yield on the 10-year Treasury is already down about 35 basis points this year and the average rate on a five-year bank certificate of deposit is only slightly better than 1%. Much of the decline in rates has been due to a stronger dollar, weak oil and commodity prices and slowing economic growth in Europe. The quantitative easing plan implemented by the European Central Bank last week has already caused government bond yields in Europe to fall to their lowest levels ever. With yields on fixed income investments reaching historically low levels and offering little in the way of income, it might make sense for yield-hungry investors to consider dividend stocks. Stocks of large-cap companies that consistently raise their dividends have outperformed the overall market over long periods of time. Some of these companies also have current dividend yields that are over fifty percent higher than the yield on the 10-year Treasury. In fact, many of these same companies offer higher yields on their common stock than they do on their intermediate-term corporate debt. In a year when the market is likely to be choppy and more volatile, individual stocks, mutual funds or exchange-traded funds (ETFs) that offer above-average dividend yields could offer some downside protection and provide for potentially higher total returns.