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Federal Reserve rescues stocks

Investors attribute successes to their own brilliance, and they attribute failures to bad luck. If you keep doing that, at the end of the day you think you’re a genius. – Nicholas Barberis

Federal Reserve Chairman Ben Bernanke rode to the rescue of the stock market last week with his announcement that the Fed would maintain its highly accommodative monetary policy for the foreseeable future. While there might have some lingering doubt about his official stance with regard to the stimulus program, he made it perfectly clear that the economy still needed central bank assistance. He cited low inflation running well below the Fed’s 2% target as well as stubbornly high unemployment of 7.6% as the primary reasons why tapering will have to wait. Minutes released from the Fed Open Market Committee meeting indicated a fairly even split between Fed officials who favored ending the bond-buying program late this year and those who favored continued buying well into 2014. While Fed officials also expressed concern over how Fed policy was being conveyed to the investing public, Fed Chairman Bernanke allayed those concerns in one fell swoop and made geniuses out of investors as the Dow closed at a new all-time high on Friday. 

Last Week 

In addition to the gift from the Fed, the economic news for the week was also encouraging. U.S. consumer credit rose sharply in May on an increase in credit card use. If this upward trend continues, it would signal an upturn in consumer spending, which accounts for about two-thirds of GDP. Auto loans and student loans were particularly strong and U.S. retailers best same-store sales forecasts for June. Initial earnings reports for the second quarter were also positive. Although Alcoa reported a net loss of $119 million, the news was cheered on Wall Street as it beat analyst estimates for the quarter. JP Morgan Chase and Wells Fargo also reported better-than-expected earnings. JP Morgan, the largest U.S. bank by assets, saw second quarter profit rise 31% while Wells Fargo, the largest U. S. mortgage lender, reported a 20% increase in second quarter earnings. Even the bond market reversed course and stabilized as the 10-year Treasury yield closed the week at 2.60%.

Not all of the news was positive, though. The IMF lowered its global growth outlook to 3.1% in 2013 and 3.8% in 2014 while its outlook for U. S. growth was trimmed to 1.7% in 2013 and 2.7% in 2014. Similarly, a Chinese minister estimated 2013 GDP growth of 7% for that country, which was below official forecasts. In company news, shares of Boeing fell sharply last week as an empty 787 Dreamliner caught fire at Heathrow Airport and another one was forced to return to Manchester.

For the week, the Dow Jones Industrial Average rose 328 points or 2.17% to close the week at 15,464. The S&P 500 gained 48 points to end the week at 1,680, an increase of 2.96%. The Nasdaq actually preformed the best as it rose 121 points to close at 3,600 or a rise of 3.47%.  

This Week 

The trickle of earnings reports last week turns into a torrent this week as a flood of companies make their announcements. Among the prominent companies scheduled to release earnings include Citigroup, Johnson & Johnson, Coca-Cola, Abbott Labs, Goldman Sachs, IBM, Google, Microsoft and GE, to name just a few. These reports as well as the guidance that companies issue regarding earnings going forward will likely determine whether or not the stock market adds to its recent gains. There are a number of economic reports due out this week that also may play a role in deciding the future direction of stocks. Among these are retail sales, the consumer price index, housing starts, industrial production and leading economic indicators, all for the month of June. Retail sales could be particularly strong due to autos and gasoline and the CPI could rise 0.5% due also to higher gas prices.

Fed Chairman Ben Bernanke will grace the market with his presence again this week as he is scheduled to appear before the House Financial Services Committee with his semiannual testimony on monetary policy. Expectations are that he will continue to reiterate his desire to maintain the Fed’s $85 billion-a-month bond-buying program aimed at keeping interest rates at extremely low levels. In addition to favorable earnings reports and guidance from companies this reporting season, the stock market also needs the bond market to cooperate by keeping a lid on any possible interest rate increases.

Portfolio Strategy 

With clarification coming from the Federal Reserve last week regarding its continued easy monetary policy, investors should breathe a sigh of relief and look at investments that have dropped in price and appear to be oversold. High quality municipal bonds, investment grade corporate bonds, real estate investments trusts (REITs), utility stocks and high dividend-yielding stocks all have been beaten up in the recent bond sell-off and seem to offer attractive value. Companies that are expected to increase their dividends or have a history of increasing their dividends also should be considered for investment.

While some sectors of the stock market, such as consumer staples, health care and certain consumer discretionary stocks have done well this year, other sectors of the market such as technology, industrials, materials, energy and financials have lagged and should improve as the economy begins to gain momentum. Financials could be the beneficiaries of higher interest rates and a steeper yield curve as banks typically take in deposits and pay low short-term interest rates while, at the same time, lend long at interest rates that are substantially higher. The wider difference in 2-year and 10-year rates can lead to higher profits, provided that banks are willing to lend and the demand for credit is in place.