Stocks drop on rate hike fears, strong dollar, weak oil prices

I rarely think the market is right. I believe non-dividend stocks aren’t much more than baseball cards. They are worth what you can convince someone to pay for it. – Mark Cuban, American businessman, investor and owner of the NBA’s Dallas Mavericks

The major stock averages posted modest losses last week as lower oil prices, a stronger dollar and fears of an interest rate hike by the Federal Reserve weighed on the market. The Russell 2000 Index of small cap stocks bucked the trend, however, and rose more than 1% as these companies generate most of their revenue domestically and are not affected nearly as much by the strong dollar. While a strong dollar should ultimately be considered positive for both the economy and the stock market in the long run, the rapid rise in the greenback could adversely affect first quarter earnings results, especially for multi-national companies that generate most of their revenue overseas. The fact that oil closed below $45 a barrel on Friday also caused worries near-term as earnings for energy companies are likely to be very weak for the first quarter. The International Energy Agency (IEA) said that the price of oil is fragile as U.S. shale oil production continues to increase and Goldman Sachs predicted that oil would fall to $40 a barrel over the near-term. For the most part, overall quarterly profit growth for large companies is expected to be relatively modest. Long-term, though, low oil and gas prices should be a boon to the U.S. economy by putting more money in consumer’ pockets and helping to keep inflation low. The stronger-than-expected February employment report also seemed to have lingering effects as investors fear that the Fed may raise interest rates soon. Unfounded or not, this fear has caused increased volatility in the stock market and gyrations in the bond market as the yield on the 10-year Treasury has ranged from a low 1.68% at the end of January to a high of 2.24% last week. February data announced last week that showed weak retail sales and declining producer prices may influence the Fed’s decision to delay its anticipated rate hike. A premature increase in interest rates could spook the stock market and derail the economic recovery, an outcome that the Federal Reserve clearly wants to avoid.

Last Week

The most important piece of economic data released last week was retail sales, which fell 0.6% in February and marked the third straight month that retail sales have fallen. Harsh winter weather may have been a factor and retailers have not benefited from cheaper gasoline prices as many had expected. The producer price index (PPI) declined by 0.5% in February, the fourth straight monthly decline. Over the past year, the PPI has dropped 0.6%, the first 12-month drop on record, as the price of oil fell more than 50%.

On the heels of the strong employment report for February, jobless claims fell by 36,000 to 289,000 last week and suggested that the pace of hiring remains strong. Wholesale inventories increased more than expected in January and means that wholesalers have little incentive to stock their warehouses, which could weigh on first quarter GDP growth.

For the week, the Dow Jones Industrial Average slid 0.6% to close at 17,749 while the S&P 500 Index fell 0.9% to close at 2,053. The Nasdaq Composite Index dropped 1.1% to close at 4,871.

This Week

The most anticipated event this week will be the two-day meeting of the Federal Reserve, its statement on monetary policy and interest rates and the subsequent news conference held by Fed Chair Janet Yellen. Most observers seem to believe that the Fed will remove the word “patient” from its statement, implying that interest rates could be headed higher sooner rather than later. However, a case certainly could be made that given weak overseas economies, a fragile U.S. economic recovery, weak retail sales data and benign inflationary trends, any rate hike by the Fed could be postponed indefinitely.

The calendar for economic data is light this week with February industrial production expected to rise modestly and housing starts forecast to dip slightly from the same level in January.

Among the more prominent companies expected to report earnings this week are Oracle, Adobe Systems, General Mills, FedEx, Nike, Darden Restaurants, Tiffany & Co. and Cintas.

Portfolio Strategy

The recent surge in the dollar, which is on track for about a 14% gain in the first quarter, has been perceived as a negative for the stock market. The strong dollar has been partly responsible for falling oil prices and could negatively impact first quarter earnings results from large multi-national companies. While this could certainly be true over the near-term, evidence suggests that a strong, stable dollar is good for both the economy and the stock market over the long-term. Since the U.S. imports more than it exports, a strong dollar results in greater purchasing power and lower inflation. As long as the dollar remains firm, global capital will flow into U.S. markets. Profits might be a little lower due to the currency translation but confidence in our market could lead to higher stock multiples. Imported goods that American companies use to make their products are much cheaper and should result in lower-priced   products that can compete in the global marketplace. The combination of a strong dollar and low oil prices has substantially reduced the cost structure of companies, making them much more competitive. The buying power of consumers has also increased as prices for energy, food and other goods and services have declined. Over the past year, the dollar has risen about 20% and during this time, the stock market has risen by double digits, economic growth has been positive, jobs have increased by 3.3 million and the inflation rate has been below 2%. As you can see, the benefits of a strong dollar outweigh the negatives.