Fed Chair Yellen fails to calm investors, stocks close lower

You shouldn’t own common stocks if a 50% decrease in their value in a short period of time would cause you acute distress. – Warren Buffett

Both the Dow Jones Industrial Average and the S&P 500 Index snapped a 5-day losing streak on Friday but it wasn’t enough for stocks to overcome posting modest losses for the week. Gains of about 2% for these benchmarks lifted stocks from levels on Thursday that have not been seen since 2014. Lately the stock market has tracked the price of oil and Friday was no exception as oil soared 12% on reports that OPEC was willing to agree on production cuts. News of a cease-fire in Syria was also thought to be a catalyst for bringing Saudi Arabia to the table for an OPEC deal. Only time will tell if there is any truth to these developments and investors are wise to remain skeptical until they can either be confirmed or denied. Economic data last week also seemed to be at odds with the recent volatility and losses experienced in the stock market. Retail sales for January were stronger than expected and jobless claims last week dropped to the lowest level since mid-December. In her testimony before the House and Senate, Fed Chair Janet Yellen acknowledged that current conditions in the economy were less supportive of growth but said that there are ample reasons to expect moderate growth this year. Among these are rising incomes, increased consumer spending and improved business investment spending outside the energy sector. She also expects the labor market to improve and the inflation rate to eventually rise to the Fed’s target of 2%. While the subject of negative interest rates came up, the legality of such a policy was called into question and such talk is very premature given the present state of the economy. Negative interest rates are currently being used in Europe and Japan with varying degrees of success and would likely adversely affect banks if they were implemented in the U.S. With banks facing possible loan losses from the energy sector and already compressed net interest margins, it is highly unlikely the Federal Reserve would venture down this path. As Fed Chair Janet Yellen has said repeatedly, any future rate hikes will be dependent on the economic data.

Last Week

The labor market continues to strengthen as the number of job openings rose to 5.6 million in December, the second highest on record. The number of hires rose, which is a positive sign for job seekers and the number of quits also rose, a sign that workers are more confident in securing another job. January retail sales increased 0.2%, better than expected, and sales were revised higher in December. Excluding gasoline sales, retail sales were twice as strong and showed that consumers remain optimistic about the economy. Import prices in January recorded the biggest drop since last August due to cheaper oil.

The yield on the 10-year Treasury had been as low as 1.60% last week before moving higher and ending the week at 1.75%. Fears of slowing economic growth, low oil prices and investors seeking a safe haven in the midst of recent stock market volatility were reasons for the strength in the Treasury market.

For the week, the Dow Jones Industrial Average lost 1.4% to close at 15,973 while the S&P 500 Index dropped 0.8% to close at 1,864. The Nasdaq Composite Index fell 0.6% to close at 4,337.

This Week

U.S. markets are closed on Monday in observance of Presidents Day. Both the January producer price index (PPI) and the consumer price index (CPI) are expected to fall slightly on lower food and energy prices. January housing starts are forecast to dip slightly due to harsher weather but remain relatively strong. January industrial production is expected to rebound after posting a weak reading last month and January leading economic indicators should remain virtually flat.

The release of minutes from the January Federal Open Market Committee (FOMC) meeting will probably show that officials are concerned about slowing global economic growth and increasing credit risk, making a March interest rate hike highly unlikely.

Among the most prominent companies scheduled to report quarterly earnings this week include Devon Energy, Duke Energy, Marathon Oil, Deere & Co., Waste Management, Newmont Mining, Applied Materials, Express Scripts and Wal-Mart Stores.

Portfolio Strategy

Recent data from the Bureau of Labor Statistics would suggest that the labor market is gaining strength and not indicative of an economy that is deteriorating. Recent activity in the stock market, though, suggests just the opposite as recession fears have gripped investors and sent them scurrying for cover. A look back at the January employment report shows that the unemployment rate dipped to 4.9%, the lowest reading since 2008 and that the economy has created an average of about 230,000 new jobs over the last three months. Average wages have now risen 2.5% over the past year and data last week on the total number of job openings was also encouraging. While most data on the labor market tend to be lagging indicators, weekly initial claims for unemployment insurance are a leading indicator. Claims from week to week can be volatile, but last week’s number was at the lowest level since mid-December and claims have held below 300,000 for almost a year. More people are working and their wages have begun to rise, putting more money in peoples’ pockets that should help boost consumer spending. Low gasoline prices should also serve as a tax cut and provide consumers with additional discretionary spending power. Although the decline in the stock market has put a dent in household net worth, a strong housing market has increased the value of their home, which, for most people, is their biggest asset. These conditions should bode well for the economy and enable GDP growth to accelerate during the year after only a modest gain in the fourth quarter.