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Stocks rally on dovish Federal Reserve comments

An important key to investing is to remember that stocks are not lottery tickets. – Peter Lynch

Dovish comments from the Federal Reserve last week led to a surge in stock prices as the S&P 500 Index rallied over 2% to close just below its previous all-time high. The most anticipated news event of the week did not disappoint as investors cheered both the Fed statement and remarks from Fed Chair Janet Yellen. As most had predicted, the Fed removed the word “patient” from its statement and said there would be no interest rate hike in April. But in doing so, Janet Yellen also clarified that just because the word “patient” was removed does not mean that the Fed will become impatient when determining when to raise interest rates. She acknowledged that inflation was running below expectations and that the Fed was still looking for further improvement in the economy and the labor market before they would consider a rate hike. All of this was music to investors’ ears as it implied that interest rates would stay lower for a longer period of time. The Federal Reserve seems in no real hurry to raise interest rates and will rely solely on future economic data along with financial and international developments before it makes a decision. During her press conference, the Fed chair even commented about investment strategy by saying that stock valuations were high but within their historical range. The markets now are betting on an interest rate hike in September rather than June, which should benefit both the stock market and the bond market. In fact, the yield on the 10-year Treasury fell to 1.93% by Friday while the major stock averages all closed only slightly below record levels. For the time being, investors can breathe a sigh of relief but only until first quarter earnings season begins in about three weeks.

Last Week

The economic data calendar was sparse last week and provided little insight into the health of the economy. On the housing front, homebuilder confidence fell in March and U.S. housing starts fell 17% in February to the lowest level since January 2014. The harsh winter weather was likely responsible for the weakness, which should be temporary as permits for future construction rose 3%. Industrial production for February barely budged and was slightly below expectations.

The Federal Reserve can afford to be cautious with regard to raising interest rates as economists have cut their first quarter GDP growth estimates to as low as 1.2% and their full year projections to between 2.3% and 2.7%. Of the 17 Fed members, 15 of them believe that 2015 is the right year to begin raising interest rates.

For the week, the Dow Jones Industrial Average jumped 2.1% to close at 18,127 while the S&P 500 Index rose 2.7% to close at 2,108. The Nasdaq Composite Index soared 3.2% to close at 5,026, within striking distance of its all-time high of 5,048 reached back in 2000.

This Week

February existing home sales and new home sales will be reported this week and both numbers should be in line with previous months’ totals, indicating a housing market that continues to improve. The consumer price index (CPI) should rise modestly and reflect the recent increase at the pump of retail gas prices. While durable goods orders are expected to be weak, the final reading of fourth quarter GDP should be revised up to 2.4% from 2.2%.

Among the more familiar companies in an otherwise sparse earnings calendar this week are Carnival, McCormick & Co., Accenture, Worthington Industries, Winnebago and ConAgra Foods.

Portfolio Strategy

With the reassuring words from the Federal Reserve last week and the calming influence of Fed Chair Janet Yellen, investors should feel comfortable owning riskier assets, such as equities, high yield bonds and investment grade corporate bonds in the context of a diversified portfolio. Although the strong dollar could put a dent in first quarter earnings and lead to increased volatility near-term, there are many reasons to view the stock market positively, despite the fact that this bull market recently celebrated its sixth year anniversary earlier this month. Sentiment on Wall Street continues to be skeptical of this latest rally in stocks and not overly bullish on its prospects in the near future. Fund managers also are sitting on a lot of cash that is earmarked for stocks and there has not been a rotation from low-yielding bonds into equities. The balance sheets of U.S. corporations have never been stronger as they have loads of cash and much less leverage than in the past. With the recent drop in the 10-year Treasury yield, there are many companies in the S&P 500 Index that are paying a higher dividend than interest from the benchmark government bond. While stocks may seem relatively expensive based on their price earnings ratios, by many measures valuations appear normal when low interest rates are taken into account. Finally, falling oil prices and accommodative monetary policies around the world are good news for companies as well as their stock prices.