Taking higher risks, such as borrowing to invest or investing in shares rather than interest-bearing securities, should, over time, magnify your returns. – Paul Clitheroe
The S&P 500 Index closed modestly higher last week after the Federal Reserve left interest rates unchanged and issued mostly dovish remarks about the future course of any rate hikes. For the second consecutive week, though, the stock market gave back some of its gains on Friday as investors turned their attention to Greece and increasing concerns that the country might default and exit the euro zone. Talks with European finance ministers earlier in the week failed to produce a deal for Greece and the European Union will hold an emergency summit on Monday to try and reach an agreement. The clock is ticking as Greece faces a deadline of June 30th to repay its debt. The dark cloud hanging over Greece overshadowed comments by the Federal Open Market Committee (FOMC), which were viewed positively by investors. The Fed anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is assured that the inflation rate reaches 2 percent. While the unemployment rate has fallen to 5.5%, low wage growth has helped keep the inflation rate in check. Energy prices well below their year-ago levels and weak economic growth have also contributed to a lack of inflationary pressures. The Fed’s expectation for GDP growth this year has been reduced to about 2% from 3% at the start of the year. This has created a dilemma for the Fed. In its effort to normalize monetary policy as soon as possible, it runs the risk of sending a fragile economic recovery into recession. What is important from the Fed’s point of view is the pace of any interest rate increases and not the necessarily the timing of the initial rate hike. Whether the first interest rate increase is in September or December, Fed Chair Janet Yellen foresees a very gradual tightening process and keeping rates lower for longer.
In terms of economic news last week, the data offered both good news and bad news. On the bright side, the home-builder confidence index rose to a nine-month high and weekly jobless claims fell, the 15th straight week that they have been below 300,000 and a sign of a firming labor market. On the negative side, May industrial production unexpectedly fell as a strong dollar and energy spending cuts weighed on manufacturing and mining output. The May consumer price index (CPI) rose 0.4%, the largest gain in over two years, due primarily to a surge in gasoline prices. However, over the last twelve months, the consumer price index has been unchanged.
For the week, the Dow Jones Industrial Average rose 0.7% to close at 18,015 while the S&P 500 Index gained 0.8% to close at 2,109. The Nasdaq Composite Index climbed 1.3% to close at 5,117.
While there are a number of economic reports on tap this week, the primary focus will be on Greece and whether or not a deal can be reached with its creditors. The European Union holds an emergency summit on Monday to resolve the debt crisis and prevent a default by Greece and an exit from the euro zone. The Greek prime minister expressed optimism late Friday that an agreement would be reached, but expect investors to remain anxious if negotiations drag on without a successful outcome.
As far as the economic data is concerned this week, May existing home sales and new home sales should be fairly strong and confirm an improving housing sector. May durable goods orders are expected to fall slightly but should be better than those reported in April. The final reading on first quarter gross domestic product (GDP) is forecast to be the same as the revised reading of -0.7%, but second quarter GDP is expected to rebound and show growth of between 1% and 2%.
As we begin the last week of June, the earnings calendar remains calm until second quarter earnings season begins in early July. Among the most prominent companies scheduled to report include Carnival, Bed Bath & Beyond, Accenture, Monsanto, NIKE Inc., Barnes & Noble and Micron Technology.
While the possibility exists that Greece could default, such an event in and of itself would probably have little effect on the U.S. stock market. What worries investors is the possibility that other nations in Europe with weak finances, such as Italy and Portugal, could follow Greece into bankruptcy and be forced out of the euro zone. It’s this fear of contagion that could spread to other financially troubled countries that keep investors up at night and could lead to a loss of confidence and trust in the system. As the moment of truth draws closer and closer, there has been an increase in the amount of bank deposit withdrawals in Greece, a situation that could also happen to banks located in other countries with similar problems. In recent polls, about 70% of the Greeks said that they would prefer to stay in the euro zone and retain the euro as their currency. As the June 30th deadline to repay its debt fast approaches, Greece must be willing to make concessions and compromise with both the European Union and the International Monetary Fund (IMF). Because of the uncertainty associated with the outcome and consequences of a Greek default, the stock market is likely to remain volatile unless a deal is reached soon.