Federal Reserve uncertainty affecting stocks

No matter how thin you slice it, it’s still baloney. – Alfred E. Smith

Will they or won’t they? That still seems to be the question on all investors’ minds after minutes of the Fed’s July 30-31 policy meeting were released last Wednesday. Sandwiched between mixed housing data on existing and new home sales for July, results of the Fed minutes took center stage in an otherwise quiet week. While it is a forgone conclusion that the Fed wants and fully expects to start reducing its $85 billion-a-month bond-buying program, the question about when and how much still remain a mystery and the subject of much speculation. The uncertainty was evident in the performance of the stock market on Wednesday as stocks dropped after release of the Fed minutes, then moved into positive territory and finally ended the day in the red. It is precisely this uncertainty that is causing weakness in the bond market and unnerving stock investors. If the Federal Reserve admittedly has no crystal ball when it comes to the economy, how can anyone else be expected to predict the future? In an environment such as this, the emphasis should be on patience and caution and allowing the economic data to decide whether the asset purchases should be curtailed or not. Something the Fed has been saying all along but which has fallen on deaf ears.  

Last Week

While U.S. existing home sales jumped 6.5% to a three-year high, which was well above analyst expectations, the news on new homes sales was just the opposite. New home sales dropped 13.4% in July to the lowest level in nine months, which raised fresh doubts about the strength of the housing recovery. The fact that mortgage rates have surged since May also is causing worry among Fed officials that the housing sector will be adversely affected because higher rates increase the cost of purchasing a new home. On the bright side, though, U.S. jobless claims held to a six-year low despite rising by 13,000 last week.

In other news, Microsoft’s CEO Steve Ballmer announced that he would retire within one year, which brought much cheer from investors as its stock rose 7% on the day of the announcement. It was a good thing this news came on Friday as the Nasdaq market actually suffered a trading glitch the day before that caused trading to be halted for three hours. This mishap again raised concerns about electronic and high-speed trading and the need for reform.

For the week, the Dow Jones Industrial Average dropped 71 points to close the week at 15,011, a decline of 0.5%. The S&P 500 tacked on 8 points, or 0.5%, to end the week at 1,664 and the Nasdaq index rose 1.5% or 55 points to close the week at 3,658. 

This Week

As the summer vacation season winds down, the week ahead brings little in the way of potential market-moving data. Durable-goods orders for July are scheduled to be released by the Commerce Department and are expected to fall about 4%, compared to a rise of 4% in the last period, which saw a big increase in aircraft orders. August consumer confidence is also expected to drop, in part because of the modest correction in the stock market and lower stock prices. The revised second quarter GDP number also will be released and is expected to show an increase of 2.2%, compared to 1.7% previously. This improvement should be due to better than expected trade deficit figures. Rounding out the data, personal income and consumption for July will likely register modest declines from June.

As far as earnings reports in the coming week, the list of companies gets shorter and shorter. Prominent among them are specialty retailers such as Tiffany, Williams-Sonoma, Joseph A. Bank Clothiers, Coldwater Creek and Zale. Their reports will help investors evaluate the strength of consumer spending and economic growth in the months ahead.

Portfolio Strategy

After two consecutive down weeks in the stock market, investors breathed a collective sigh of relief as stocks closed mix last week and stabilized ahead of what promises to be an event-filled September. All eyes will be on the Fed at their meeting on Sept. 17^th and 18^th and the pivotal German elections take place the following week. This coupled with anticipated disagreement over the debt ceiling and a possible government shutdown could make for an interesting September. The jobs report for August is also due out the first week of September and will provide the last piece of key economic data before the Fed has their meeting.  

Fed officials are less sanguine about near-term economic growth and cite factors such as the spike in mortgage rates, higher oil prices, slower growth in key U.S. export markets and the possibility of continued fiscal restraint as reasons to be very cautious on reducing the Fed stimulus program. The employment outlook is also murky as job growth has been steady but not strong enough to make a meaningful dent in the unemployment number. With all of these concerns combined with the potential market-moving events scheduled for September, it seems the Fed has no choice but to delay the inevitable (i.e. tapering) or implement just a token amount to appease the hawks. Whatever the outcome, investors would be wise to stay the course and not make any rash decisions in anticipation of what might or might not happen.