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Stocks edge lower on interest rate fears

The average person is 95 percent eyes and only 5 percent mind when they invest. If you want to become a professional, you need to train your eyes to be only 5 percent and train your mind to see the other 95 percent. – Robert Kiyosaki

All three of the major stock averages edged slightly lower last week as worries surfaced among investors that interest rates may rise at a faster pace than originally thought. Although the September employment report showed that 156,000 new jobs had been created, less than the 175,000 that were expected, the number was strong enough to elicit fears over a possible interest rate hike in December. Adding to these fears were an upward revision in the August job numbers and an increase in hourly wages to an annualized rate of 2.6%. In fact, the odds of an interest rate hike in December rose to 70%. Both the ISM manufacturing index and the ISM non-manufacturing or services sector index also rose in September and were better than expected, lending support for a potential interest rate hike. The latter piece of data was the strongest print of the year as the ISM services sector index jumped to 57 compared to an estimate of 53. Richmond Fed President Jeffrey Lacker also chimed in last week with hawkish remarks stating that a strong case could be made for raising interest rates significantly to keep inflation under control. Other Fed officials even suggested that the Fed could raise rates at their next meeting in November before the U.S. presidential election, although most observers suggest the timing of such a move would be too political. All of this talk of a rate hike last week also hurt the performance of interest-rate sensitive investments such as utilities, telecom stocks and real estate investment trusts or REITs. Despite these concerns, economic growth is expected to improve and result in better corporate earnings, providing support for stock prices as we head into the third quarter earnings season this week.

Last Week

Economic data released last week was mostly mixed. Construction spending fell and was worse than expected while U.S. auto sales also fell in September even though overall sales were still strong at almost 18 million vehicles. Factory orders rose slightly and exceeded expectations and weekly jobless claims dropped below 250,000, a signal that the labor market continues to experience very few layoffs and remains strong.

The Energy Information Administration (EIA) said that U.S. crude oil inventories declined for the fifth straight week and the price of oil eclipsed $50 a barrel for the first time since June. Gold suffered through a tough week, losing over 3% in one day on fears of rising interest rates.

For the week, the Dow Jones Industrial Average dropped 0.4% to close at 18,240 while the S&P 500 Index fell 0.7% to close at 2,153. The Nasdaq Composite Index declined 0.4% to close at 5,292.

This Week

Both September import prices and the producer price index (PPI) are expected to show that inflation remains under control, with import prices flat and only a modest increase in the PPI. After a weak August, retail sales are expected to rebound strongly in September with a gain of 0.6%. The preliminary read on the October consumer sentiment index should be above 90 and higher than the number in September.

Minutes from the most recent Federal Reserve meeting will be released, Fed Chair Janet Yellen will address a business gathering and several Fed officials will speak about Fed monetary policy and the economic outlook.

Alcoa will lead the unofficial start to the third quarter earnings season this week. Other notable companies on the agenda include Delta Airlines, CSX, Wells Fargo, CitiGroup and PNC Financial Services.

Portfolio Strategy

The continuation of easy monetary policies by global central banks led to strong third quarter returns for domestic equities as well as international and emerging market stocks. The S&P 500 Index posted a quarterly return of 3.8% while the MSCI World ex-U.S. Index was up 6.9%. The Bank of Japan’s decision to continue quantitative easing and the Fed’s decision at its September meeting to leave interest rates unchanged eliminated some uncertainty and investors became more comfortable owning riskier assets. On a year-date basis through the end of September, REITs and small cap stocks have been the big winners with returns of 12% and 10%, respectively. Dividend-oriented stock funds have also performed well with returns ranging from 8% to 10%, compared to 7.2% for the S&P 500 Index. In the large cap sector, growth stock funds rebounded in the third quarter and outperformed value, but value funds still hold a commanding lead on a year-to-date basis. This advantage has also been true in the small cap sector where value stocks have returned 12% compared to 8% for growth stocks. Among individual sectors that comprise the S&P 500 Index, the best performing ones this year have been energy, telecommunications, utilities, materials and technology, all posting double-digit returns. The worst performing sectors have been health care, consumer discretionary, consumer staples and financials, although financial stocks rallied in the third quarter on the prospect of higher interest rates. International stocks also snapped back in the quarter as valuations of European companies became compelling after the Brexit vote in June. Developed market international equities are now up about 3% for the year while emerging market stocks have jumped 18% as fears that China’s economy was slowing have faded.