S&P 500 four-week winning streak ends as Fed minutes spook investors

We need a mutual fund industry with both vision and values. A vision of fiduciary duty and shareholder service, and values rooted in the proven principles of long-term investing and of trusteeship that demands integrity in serving clients. – John Bogle, founder of the Vanguard Group 

All good things eventually come to an end and this past week, both the S&P 500 Index and the Nasdaq Composite Index had their four-week winning streaks snapped while the Dow Jones Industrial Average closed modestly lower. Tress don’t grow to the sky and after suffering through their worst first half performances in decades, the S&P 500 has rallied 15% from its mid-June low and the Nasdaq has rebounded 20% during the last two months. Both averages were overdue for some profit-taking as the rally in stocks may have come too far, too fast. With second quarter earnings season winding down and more than 90% of S&P 500 having reported their profit results, the news has been mostly positive as nearly 80% of them have topped expectations. The major retailers reported last week and the results were mixed. Home Depot and Walmart beat analysts’ earnings estimates while Target fell way short but maintained its earnings outlook for the year. Lowe’s also announced better than expected earnings but its sales were lower than forecast. The market also focused on the release of the minutes from the Federal Reserve’s July policy meeting, which showed that Fed officials would not consider pulling back on interest rate hikes until inflation was reduced substantially. They remain committed to bringing down inflation to their 2% target and admitted that they see few signs that inflation is abating. Although inflation data in July saw some improvement and enough for the market to price in only a 50-basis point (a basis point is one hundredth of one percent) Fed hike in rates in September, the Fed is likely to implement another 75-basis point increase.  Hawkish comments by some Fed officials probably unnerved investors and prompted them to lighten their equity positions after the market’s recent run. China’s central bank also cut interest rates unexpectedly last week, raising concern that the world’s second largest economy was experiencing a slowdown after retail sales and industrial production data for July were both lower than expected.

Last Week

Retail sales in July were flat compared with estimates of a slight gain, but excluding automobiles, sales increased moderately. U.S. leading economic indicators in July fell for the fifth straight month, suggesting recession risks are rising in the near-term with economic weakness spreading more broadly throughout the economy. July housing starts fell to a 17-month low and were lower than expected while July existing home sales were at the slowest pace since November 2015. Weekly jobless claims were 250,000, down 2,000 from the previous week and below the estimate of 260,000.

For the week, the Dow Jones Industrial Average fell 0.2% to close at 33,706 while the S&P 500 Index lost 1.2% to close at 4,228. The Nasdaq Composite Index declined 2.6% to close at 12,705.

This Week

The second estimate for second quarter GDP growth is expected to show that the economy contracted by an annual rate of 0.9%, marking two straight quarters of declines, which some define as a recession. July durables goods orders are forecast to increase modestly but by less than in June while July new home sales are expected to also be less than in June and down more than 40% from the summer of 2020. The July core personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, is expected to increase 4.7% year-over-year, down slightly from June.

The most prominent companies scheduled to report second quarter earnings this week are Nvidia, Palo Alto Networks, Zoom Video Communications, Intuit, Salesforce, Autodesk, Dell Technologies, Toll Brothers, Advance Auto Parts, Macy’s, Nordstrom, Williams-Sonoma, Burlington Stores, Dollar General, Dollar Tree, Dick’s Sporting Goods, Ulta Beauty, Gap, J.M. Smucker and Medtronic.

Portfolio Strategy

Although the S&P 500 Index has rallied from being down over 20% earlier in the year to a loss of about 10% through the close of business on Friday, it’s still been a difficult year for investors as bond returns have also been negative. One category of ETFs that has outperformed the S&P 500 Index this year has been dividend ETFs – those funds that invest in companies with above-average dividend yields as well as those that invest in companies that have a consistent history of dividend growth. Most of these ETFs fall into the large cap value category, which invest in companies that appear undervalued relative to the overall market and have lower  price earnings ratios and higher dividend yields. They tend to hold their value better during a down market and, at the same time, give investors higher income. Two of the largest ETFs that pay high dividends include the iShares Core High Dividend ETF (HDV) and the Vanguard High Dividend Yield ETF (VYM). The former tracks the Morningstar Dividend Yield Focus Index, has a current yield of 3.7% and has a positive year-to-date return due to its 19% allocation to the energy sector. The latter ETF replicates the FTSE High Dividend Yield Index, has a current yield of 2.9% and is only down 1% for the year. For ETFs that invest in companies that increase their dividend each year, two of the largest are the Vanguard Dividend Appreciation ETF (VIG) and the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). The Vanguard ETF tracks the S&P U.S. Dividend Growers Index and invests in companies that have a record of growing dividends year over year. The ProShares ETF replicates the S&P 500 Dividend Aristocrats ETF and invests in companies that have increased their dividend payments each year for at least 25 years. Both of these ETFs have outperformed the S&P 500 Index so far this year.