Fed taper concerns weigh on market

Something that everyone knows isn’t worth knowing. – Bernard Baruch

Apparently investors did not care for the view from up high as both the Dow and S&P 500 descended from their record levels set last week. After rising six consecutive weeks, the Dow finally turned in a losing week as economic data was sparse and second quarter earnings reports slowed considerably. Without any important news to move stocks either higher or lower, two Federal Reserve regional presidents took turns filling the void by opining about the central bank’s monetary policy and the need to curtail the stimulus sooner rather than later. First it was Richard Fisher, a long-time critic of quantitative easing, who said that investors should not count on the Fed to continue its bond buying indefinitely. He then proceeded to make his case for Fed tapering. Then Charles Evans suggested that the Fed should start reducing its stimulus as early as September in light of recent positive economic news. These comments served to remind investors that Fed tapering will occur eventually. But isn’t that something that everyone knew already?

Last Week

The week started off with a bang as the U.S. non-manufacturing or service index grew at its fastest pace in five months, led by retailers, financial firms and educational providers. The U.S. trade deficit in June also shrank to its lowest level since the fall of 2009 and should result in second quarter GDP being revised upward. News on the jobs front was also encouraging as jobless claims, though slightly higher than the previous week, remained near a five-year low. This suggests that the labor market is getting healthier and layoffs are the fewest since the recession ended in mid-2009.

The uncertainty with regard to the timing of the Fed’s bond buying also affected the dollar as it fell to a seven-week low. In overseas news, the Bank of Japan’s governor was optimistic on the prospects for their economy while the Bank of England reiterated its plan to keep interest rates low until the unemployment rate drops to 7%. China also reported that its trade data improved, signaling that its economy has stabilized after two quarters of weak growth. 

For the week, the Dow Jones Industrial Average fell 233 points to close the week at 15,426, a decline of 1.5%. The S&P 500 fared better as it dropped 18 points, or 1.1%, to end the week at 1,691. The Nasdaq finished the week at 3,660, losing 29 points or 0.8%.

This Week

If last week’s economic data was a trickle, this week’s calendar is a torrent as a number of key reports are on tap. Retail sales for July are expected to rise 0.3% as previously strong auto sales take a breather. Both the July producer and consumer price indices should continue to confirm the absence of inflation in the economy. Housing starts in July should be strong and be further proof that the housing market has stabilized and is gradually improving. The chief concern here is higher mortgage rates and what effect they might have on home purchases in the future. Although rates have risen dramatically in a short period of time, they still are low on a historical basis.

This will be an important week for retailers as a number of them report second quarter earnings.  Among the most prominent are Kohl’s, Nordstrom, Macy’s and Wal-Mart Stores, all of which are expected to report better earnings than a year ago. Other blue chip companies scheduled to report earnings include Sysco, John Deere, Applied Materials and Cisco Systems. 

Portfolio Strategy 

While the slippage in the Dow last week brought worries from investors expecting a larger correction, it’s important to keep in mind the positive underpinnings for the stock market. For starters, the earnings season has been better than expected. Of the almost 450 companies in the S&P 500 that have reported quarterly earnings, about 70% of them have exceeded expectations. Although economic growth continues to be modest, it should improve and allow for companies in the S&P 500 to grow revenues by about 5% next year. With inflation still running comfortably below the Fed’s target of 2.5% and the economy consistently adding between 150,000 and 200,000 jobs a month, these conditions should lend support for equities. Also, many investors continue to be skeptical of this bull market, which, from a contrarian’s viewpoint, can be a positive for stocks. Throw in continued recoveries in manufacturing, automobile sales and housing and one has ample reasons to be optimistic about the markets, even with anticipated Fed tapering.

The economic news from overseas also has been improving and provides further ammunition to be optimistic. China’s better than expected exports in July and its goal of maintaining GDP growth in the 7% to 7.5% range are encouraging signs and should keep inflation under control. The United Kingdom and countries in the euro zone are also seeing improvement in their economies as evidenced by strong reports in the purchasing managers’ indexes. Relative to emerging markets, growth in developed countries is the strongest in fifteen years and looks to be sustainable as economic data continues to be positive. Led by the U. S., evidence suggests that improving global growth could provide the backdrop for equity markets going forward.