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S&P 500 closes modestly lower on hawkish comments by Fed officials

Big money is made in the stock market by being on the right side of the major moves. The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not. – Martin Zweig, was an American stock investor, investment adviser and financial analyst  

After posting its best performance since March the previous week, the technology-laden Nasdaq Composite Index was the worst performer last week as it tumbled 1.6% due mostly to hawkish comments by several Federal Reserve officials. The Dow Jones Industrial Average was flat while the S&P 500 Index lost less than one percent. Economic data was decidedly mixed, but the October producer price index (PPI) offered hope that inflation may have peaked following a favorable consumer price index (CPI) reading a week earlier. Although still high, the headline PPI rose a better-than-expected 8% year-over-year as there actually was a drop in the services component of the index, the first outright decline in that measure since November 2020.  Retailers dominated the third quarter earnings reports last week and the results there were also mixed. Walmart, Home Depot and Lowe’s all topped revenue and earnings expectations and either affirmed or raised their full year earnings forecasts. Target, however, reported disappointing quarterly results and slashed its fourth quarter outlook. The biggest reason for the weakness in the stock market, though, was comments by a plethora Federal Reserve officials about future interest rate hikes. San Francisco Fed President Mary Daly predicted that the federal funds rate would hit 5% and said that “pausing is off the table right now”. More hawkish comments came from St. Louis Fed President James Bullard who commented that the current fed funds rate is still not restrictive enough and that monetary policy has only had a limited effect on inflation. He said that a peak or terminal rate for the federal funds interest rate could be 5% to 7% to squash inflation. It was a credit to the market that the losses weren’t greater and a positive sign that stocks could move higher near-term or at least until mid-December when the Fed meets again and the November consumer price index is released.

Last Week

The Leading Economic Index fell nearly one percent in October, much worse than expected, and has now fallen for eight consecutive months amid high inflation and rising interest rates as well as deteriorating prospects for housing construction and manufacturing. October housing starts also fell from the prior month but not as much as expected while October existing home sales declined for the 9th straight month as higher interest rates and surging inflation kept prospective buyers on the sidelines. Weekly jobless claims were 222,000, a drop of 4,000 from the previous week. The National Association of Home Builders (NAHB) sentiment index in November fell to the lowest level in a decade as builders face higher costs for labor and materials and lower demand from homebuyers due to higher mortgage rates.

For the week, the Dow Jones Industrial Average closed flat at 33,746 while the S&P 500 Index fell 0.7% to close at 3,965. The Nasdaq Composite Index dropped 1.6% to close at 11,146.

This Week

Durable goods orders for October are expected to increase modestly in line with orders in September and October new home sales are forecast to decline from the prior month in keeping with a weak housing market. The Federal Open Market Committee (FOMC) releases minutes from its monetary policy meeting in early November.

The markets will be closed on Thursday in observance of Thanksgiving and will close early on Friday.

The most notable companies scheduled to report third quarter earnings this week are Autodesk, Analog Devices, HP Inc., Agilent Technologies, Zoom Video Communications, Dell Technologies, Urban Outfitters, Nordstrom, Burlington Stores, Best Buy, Dick’s Sporting Goods, Dollar Tree, J.M. Smucker, Deere and Medtronic.

Portfolio Strategy

With a paucity of key economic data this week and third quarter earnings season winding down, the most significant event to watch could be the release of the minutes from the November Federal Reserve meeting. This past week, a number of Fed officials spoke about current monetary policy and their view on where interest rates might be headed. Most of the comments were hawkish, suggesting that the Fed has a long way to go to bring inflation down to its 2% target. Federal Reserve Vice Chair Lael Brainard, though, offered some dovish comments by saying that a slower pace of rate increases seems appropriate, but that additional hikes would be necessary after the expected 50-basis point (a basis point is one hundredth of one percent) increase in December. After four 75-basis point hikes this year, the current federal funds interest rate is between 3.75% and 4.0%. The fact that the 10-year Treasury yield of 3.80% is below the top end of the range for the fed funds rate is a sign that Fed policy has been tight. More worrisome could be the inverted yield curve, or the difference between the 2-year Treasury yield of 4.50% and the yield on the 10-year Treasury. With long-term interest rates lower than short-term ones, there is a greater likelihood of a recession, although this relationship must last at least a quarter to signal one. It’s very possible that the Fed could slow the pace of rate hikes but lengthen the time needed to achieve a terminal rate, at which time it would finally pause. The federal funds futures market is forecasting a peak rate of between 5% and 5.25% by March with no further increases after that. The question then is whether or not that is sufficiently high enough to reduce inflation to the Fed’s target.