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S&P 500 drops nearly 5% on spike in coronavirus cases, Fed outlook

In the business world, the rearview mirror is always clearer than the windshield. – Warren Buffett

Concerns that the stock market had come too far, too fast and was significantly overbought were realized last week as the major stock averages posted their biggest weekly declines since March 20th. While it is difficult to point to a specific reason why stocks suddenly reversed course on Thursday, most observers cited a spike in coronavirus cases in some states that are reopening their economies from lockdowns. New cases and hospitalizations increased dramatically in Arizona, Texas and California and investors were also concerned that recent protests across the country could lead to even more infections. Although stocks were able to recoup some of their steep losses on Friday, the S&P 500 Index still shed nearly 5% for the week and is now down almost 6% year-to-date after briefly turning positive for the year on Monday. The technology-heavy Nasdaq Composite Index fared much better as it dropped only 2.3% for the week and actually closed above 10,000 for the first time ever on Wednesday. Despite the losses for the week, the major stock averages had rebounded more than 40% from their lows back in March prior to last week. The other concern that investors had last week was the realization that the economy and the labor market may take longer to return to normal than first thought. As expected, the Federal Open Market Committee (FOMC) in its meeting last week kept interest rates unchanged with the federal funds rate at between 0% and .25% and indicated that it does not expect to raise interest rates through 2022. This policy should remain in place until the Fed is confident that the economy can recover and is on track to achieve maximum employment and price stability. The Fed also predicted that the economy will contract by 6.5% in 2020 before expanding by 5% in 2021 and said it will increase its bond holdings by buying more Treasuries and mortgage-backed securities each month in order to keep interest rates suppressed. Fed Chairman Jerome Powell emphasized that the pace of economic recovery was dependent on the path of the coronavirus, a sobering reminder that without a proven treatment or vaccine for the virus, the economy could suffer.

Last Week

The producer price index (PPI) in May rose more than expected on higher food and energy costs and has risen slightly less than 1% during the past year. Excluding food and energy, the so-called core PPI was up only slightly in May. The consumer price index (CPI) in May fell slightly as demand remained weak amid the recession caused by the Covid-19 pandemic. In the 12 months through May, the CPI has barely edged higher as inflation remains benign. Weekly jobless claims were 1.54 million, less than expected, and have now fallen for the tenth straight week, although the numbers continue to be very large. The University of Michigan consumer sentiment index was better than expected as consumers were optimistic about the economy reopening and better job prospects.

For the week, the Dow Jones Industrial Average lost 5.6% to close at 25,605 while the S&P 500 Index dropped 4.8% to close at 3,041. The Nasdaq Composite Index declined 2.3% to close at 9,588.

This Week

Retail sales in May are expected to increase and rebound strongly after posting a huge drop in April. May housing starts and industrial production are also forecast to post much better numbers than in April as the economy slowly recovers. Leading economic indicators for May are expected to increase about 1%, which is encouraging after a 4% plus drop in April.

Federal Reserve Chairman Jerome Powell is scheduled to testify before Congress on the central bank’s semi-annual monetary policy report.

As earnings season winds down, there are only a handful of notable companies scheduled to report earnings and these include Groupon, Oracle, Kroger, Smith & Wesson Brands, CarMax, H&R Block and Lennar.

Portfolio Strategy

Optimism over the potential positives of the economy reopening could be offset this week by the Congressional testimony by Federal Reserve Chairman Jerome Powell as well as a continued increase in the number of coronavirus cases across the country. Last week’s Federal Open Market Committee (FOMC) meeting showed that the economic recovery will be slow and not the V-shaped recovery that many investors had been hoping for. Stocks had risen over 45% from their lows back on March 23rd but the Fed gave a grim assessment of the economy and reminded investors that monetary policy will have to remain very accommodative in order for the economy to recover. Investors may have been spooked by the fact that the Fed doesn’t anticipate raising interest rates through 2022, a sign that full employment and inflation at its 2% price target could be a long way off. Not only did sentiment turn negative in the stock market, but the yield on the 10-year Treasury fell to only 0.70%, well off its high of 0.95%, as investors feared a slower economic recovery. Expectations are that Powell will probably reiterate in his testimony much of what the Fed disclosed last week and he may provide more clarity on the Fed’s plan to purchase additional bonds. A bigger concern may be the status of the coronavirus as a number of states reported an increase in the number of cases. The pace of the economic recovery is dependent on containing the virus and not letting it spread and this uncertainty may limit any further stock market gains.