Stocks close lower on Fed rate hike decision

You only have to do a few things right in your life so long as you don’t do too many things wrong. – Warren Buffett

The old stock market adage buy the rumor and sell the news was evident last week as stocks rallied ahead of the Federal Open Market Committee (FOMC) meeting only to relinquish those gains after the decision was made not to raise interest rates. While this was the outcome that was generally expected by traders that track federal funds futures, the Fed offered no guidance on what would have to happen in order for them to hike interest rates in the future. Prior to this policy statement, the Fed had cited measures of labor market conditions and indicators of inflation pressures and expectations as the primary factors to consider for a rate hike. Based on these two mandates, the verdict has been split. The unemployment rate has fallen to 5.1% and job growth has been strong. However, the personal consumption expenditure (PCE) price index, the Fed’s preferred measure of inflation, has been running well below the core consumer price index (CPI). In their policy statement last week, the Fed also considered international economic and financial conditions in their decision-making process and concluded that recent developments overseas could restrain economic growth in the U.S. and put downward pressure on inflation. Their comments were referring to slowing growth in China and weak economies in Europe and Japan. If China decides to devalue its currency again or if the Bank of Japan (BOJ) or the European Central Bank (ECB) adopts additional easing measures, the Fed’s decision to hike would only become more difficult. The Fed now seems to be placing as much emphasis on global economic conditions as on the U.S. economy in their desire to be “data dependent”.  Until third quarter corporate earnings season begins in a few weeks, the market is likely to be volatile in the absence of any significant economic data or news. Earnings still drive stock prices and a good test for the stock market will be whether or not the slowdown overseas has hurt corporate profits.

Last Week

U.S. retail sales were up modestly in August while core retail sales (excluding autos, gas, building materials and food services) rose 0.4% after an upwardly revised 0.6% gain in July. Industrial production fell slightly more than expected in August as automakers cut back sharply on production after a double-digit increase in July. The consumer price index (CPI) slipped 0.1% in August and in the 12 months through August has risen only 0.2% as sluggish wage gains and a strong dollar have kept inflation well under control. Jobless claims fell to the lowest level since mid-July and August leading economic indicators were up, suggesting moderate economic growth through year-end.

Despite not raising interest rates last week, Fed Chair Janet Yellen said that most Fed members still expect the central bank to hike rates before year-end. The FOMC meets on October 27^th and 28^th and again on December 15^th and 16^th.

For the week, the Dow Jones Industrial Average fell 0.3% to close at 16,384 while the S&P 500 Index lost 0.2% to close at 1,958. The Nasdaq Composite Index, on the other hand, rose 0.1% to close at 4,827. 

This Week

In economic news, both existing home sales and new home sales in August should be at levels consistent with an improving housing market while August durable goods orders are expected to decline slightly. The final reading of second quarter gross domestic product (GDP) is forecast to remain at 3.7%.

Chinese President Xi Jinping will come to Washington for a state visit to discuss China’s slowing economy and cyber-security with President Obama. Pope Francis also is scheduled to visit Washington as well as New York and Philadelphia.

Among the most prominent companies scheduled to report earnings this week are General Mills, ConAgra Foods, CarMax, Autozone, Nike, Carnival and Accenture. 

Portfolio Strategy

While the stock market reacted negatively to the Federal Reserve decision not to raise interest rates, the bond market cheered the news and rallied last week. The yield on the 10-year Treasury (which moves opposite to the bond price) fell to a low of 2.13% on Friday from 2.29% just before the Fed made its announcement. The dovish tone to the Fed’s remarks and their acknowledgement that global economic growth has been slowing has now pushed back projections for a Fed rate hike to December. With miniscule yields on short and intermediate-term Treasuries, investors are faced again with the difficult task of finding bonds and other investment vehicles that have above-average yields without too much additional risk. Investment grade corporate bonds are one option that offers a yield advantage over comparable Treasuries with the same maturity. Typically, intermediate-term corporate bonds rated BBB by Standard and Poor’s and Baa by Moody’s have yields of at least 3%. These ratings are at the lowest rung of the scale for bonds to still be considered investment grade issues. For those investors with a higher risk tolerance, real estate investment trusts or REITs and utility stocks also offer attractive yields that, in most cases, exceed those on Treasuries. The fear of an interest rate hike by the Federal Reserve had caused the performance of these investments to suffer recently because they are sensitive to rising rates. For the time being, though, these investments should perform well as it appears that interest rates will remain low for the foreseeable future, or at least until the Federal Reserve increases the federal funds rate.