Stocks post modest losses on Fed rate hike fears

Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. – Warren Buffett

Economic data and quarterly corporate earnings reports took a back seat last week to the speech on Friday by Fed Chair Janet Yellen at the Federal Reserve’s annual conference in Jackson Hole, Wyoming. After trading near the flat line through the close of business on Thursday, stocks fell on Friday and ended the week with modest losses. In her remarks, Yellen was optimistic about the economy and believed that the case for an increase in the federal funds rate had strengthened in recent months. While economic growth in the first half of the year has been only about 1%, her contention was that growth was accelerating in the current quarter. Many investors remain skeptical, however, especially after second quarter gross domestic product (GDP) was revised downward last week to 1.1% as economic growth remains sluggish. The Fed continues to be data dependent, though, and positives such as a strong job market and inflation approaching 2% are offset by worries over low business investment and declining productivity. Stock market reaction was muted after her speech as she offered no prediction as to the timing and number of interest rate hikes between now and year-end. That all changed, though, when Fed Vice Chair Stanley Fischer weighed in and said that two rate hikes – one in September and one in December – were distinct possibilities. Stocks quickly lost ground as the probability of a September rate hike prior to his comments had been virtually nil. One would think that talk of an imminent rate hike would mean that the economy is firing on all cylinders and would translate into higher corporate profits and stock prices. But most investors remain unconvinced as to the strength of the economy and will only believe Janet Yellen’s contention when they see the actual data that supports stronger economic growth.

Last Week

None of the economic data released last week was important enough to move the markets either way and, for this reason, stocks remain directionless as trading volume remains light. New home sales hit a 9-year high in July but existing home sales fell more than expected. On balance, the outlook for housing remains bright as wages are increasing and interest rates are near historic lows. Durable goods orders for July were better than expected and weekly jobless claims last week were at levels consistent with a strong labor market.

For the week, the Dow Jones Industrial Average fell nearly 1% to close at 18,395 while the S&P 500 Index dropped 0.7% to close at 2,169. The Nasdaq Composite Index declined 0.4% to close at 5,218.

This Week

It promises to be a fairly busy week in terms of economic reports, with the most significant report occurring on Friday with the release of the August employment report. Most economists are expecting 180,000 new jobs to be added with the unemployment rate edging lower to 4.8%. Other data on the agenda include July construction spending and factory orders, both of which are expected to increase modestly. The ISM manufacturing index for August is forecast to remain at about 52, a level that denotes continued expansion in the sector. August consumer confidence is also expected to remain high, a good sign for consumer spending.

With the earnings season winding down, there are few companies left to report their quarterly profits. Among the most notable are H&R Block, Abercrombie & Fitch, Bob Evans Farms, Campbell Soup, Broadcom and Joy Global.

Portfolio Strategy

One of the best-performing asset classes this year has been real estate investment trusts or REITs, which are companies that purchase office buildings, hotels, shopping centers, storage facilities and other real property. REITs are not subject to income tax provided that 90% of their income is paid out to shareholders in the form of dividends. Through the close of business on Friday, the Vanguard REIT ETF, which tracks the MSCI U.S. REIT Index, was up 12.82% for the year and has a current dividend yield of 3.50%. One of the reasons that REITs have performed so well has been investors’ insatiable appetite for yield in a low interest-rate environment. A reason that REITs could continue to do well occurs after the close of business on August 31^st. After this date, the S&P Dow Jones Indices and MSCI will transfer real estate securities from the financial sector and reclassify them as their own, separate sector. This change should increase the demand for REIT stocks and REIT exchange-traded funds and, in turn, boost their performance. For individual investors, a passive index fund such as the Vanguard REIT ETF makes sense since it offers broad diversification and a low expense ratio. REITs are also typically classified as an alternative investment since they not correlated with equities, adding a further level of diversification and a way for investors to reduce overall portfolio risk.