Stocks higher despite Yellen’s remarks

To be a successful business owner and investor, you have to be emotionally neutral to winning and losing. Winning and losing are just part of the game, – Robert Kiyosaki, American investor and self-help author, author of Rich Dad Poor Dad, the best-selling personal finance book of all time

In her first Federal Open Market Committee (FOMC) meeting as Fed chair, Janet Yellen suggested that interest rates might rise sooner rather than later and temporarily caused commotion in both stocks and bonds. Although the tone of her remarks was in keeping with her dovish views, her response to a question at a press conference after the meeting about the timing of any interest rate hikes caught investors off guard. She said that the Fed funds rate would probably be increased six months after the end of the bond-buying program, which likely places such a move in the spring of 2015 instead of the summer. The forecast now puts the Fed funds rate at 1.00% by the end of 2015 and 2.25% by the end of 2016, still at historically low levels but up from previous targets of 0.75% and 1.75%, respectively. Earlier in the day she had said that rates would remain near zero for a “considerable time” after the bond purchases end, wording that investors seemed to prefer as the timing is open to interpretation and less finite. Putting an exact timetable on an interest rate hike sent prices of Treasury bonds and stocks lower as investors feared the worst. Although the stock market rebounded and bond prices regained some of their losses, investors were reminded that quantitative easing will not last forever and that interest rates will inevitably rise, perhaps sooner than they had hoped.

Last Week

While Janet Yellen and the FOMC meeting was the center of attention last week, there was plenty of economic data to decipher as well and most of it was positive. Industrial production was better than expected and reinforced a belief that the severe winter weather was the cause of weak economic data. Other manufacturing indexes that were released during the week were strong and confirmed this view. Housing data was mixed as U.S. housing starts fell slightly last month but housing permits rose to the highest level since last October.

Although the number of people filing for unemployment benefits increased last week, the four-week moving average for new claims actually fell and was at the lowest level since November. This average is a better, more reliable measure and suggests that the labor market continues to improve. News on the inflation front was also favorable as the consumer price index (CPI) rose only 0.1%. For the past twelve months, consumer prices have risen a meager 1.1%.

The NCAA basketball tournament began and after only the first round, I’d be very surprised if anyone is still in the running for the $1 billion prize offered by Warren Buffett for a perfect bracket in light of all of the upsets, none more shocking than third-seeded Duke losing to Mercer.

For the week, the Dow Jones Industrial Average climbed 1.5% to close at 16,302 while the S&P 500 Index rose 1.4% to close at 1,866 after reaching an intraday high of 1,883 before settling lower. The Nasdaq Composite Index increased 0.7% to close at 4,276.

This Week

The most important piece of economic data to be released this week will be the final estimate of the Commerce Department of fourth-quarter GDP. Most economists predict that growth will be revised upward to 2.7% from 2.4%, another sign that the economy is growing modestly despite the adverse effects of winter. Durable goods for February should also rebound and show an increase of 1% after declining by the same amount the previous month. While jobless claims are likely to increase for the second consecutive week, the end of winter and the onset of warmer weather should lead to more hiring in the months ahead.

As quarterly earnings reports slow to a trickle, the most notable companies due to make their announcements include Walgreen, Carnival, Accenture, Gamestop and McCormick & Co.

Portfolio Strategy

The last time that the Federal Reserve suggested that it would begin to taper its bond-buying program known as quantitative easing, the bond market sold off sharply and yields rose across the board. This occurred back in the spring of 2013 as the Fed hinted at removing the punch bowl. While the response of the bond market this time to Janet Yellen’s comment about the timing of an interest rate hike was much more muted, it nevertheless got the attention of investors. To be sure, the yield on the 10-year Treasury began the week at 2.65% and ended the week at 2.75%, a modest increase compared to the dramatic rise from about 1.60% to 2.60% in May and June of last year. While her remarks may have been inadvertent, they served to brace the market for higher rates in the future and possibly a change in Fed policy. But economic data going forward will likely dictate Federal Reserve policy and if that data remain weak, then interest rates will probably stay low for  “considerable time”, which is what the Fed chair originally said before she was asked to clarify her response. The start of 2015 is still a long way off and a lot can happen between now and then.