When everything seems to be going against you, remember that the airplane takes off against the wind, not with it. – Henry Ford
After reaching record high levels the previous week, the broad-based S&P 500 Index pulled back last week despite better than expected retail sales and a drop in jobless claims. In a difficult week for stocks, the Dow Jones Industrial Average registered losses every day while the S&P 500 year-to-date total return is now slightly negative. The reasons for the weakness in stocks were twofold: rising tensions in Ukraine over Crimea’s future and weaker than forecast economic data from China. With it becoming increasingly likely that the Crimeans will vote to secede from Ukraine and join Russia, there were fears that a diplomatic solution would not be reached and that a possible trade war involving sanctions might ensue between Russia and the West. Factory production, retail sales and exports also were relatively weak in China and caused concern that growth in the world’s second largest economy may be slowing. While industrial production rose a robust 8.6% year over year, that increase represents the weakest increase since 2009. With economic data in the U.S. obfuscated by the weather and earnings season winding down, investors had no choice but to turn their attention overseas for clues about the direction for stocks. And, unfortunately, they did not like what they saw. It will be up to Fed Chair Janet Yellen at the Federal Reserve Open Market Committee meeting this week to reassure investors that the Fed remains accommodative and to calm their jittery nerves.
In a sign that hiring could soon pick up, jobless claims fell to a three month low as the number of people that applied for unemployment benefits dropped by 9,000. For the first time in three months, retail sales actually rose by 0.3%, which was slightly better than expected. Unfortunately, both numbers for December and January were revised lower and over the last twelve months, retail sales have only risen by 1.2%. Sales are expected to accelerate in the spring, though, as household balance sheets are in much better shape due to rising home values and a strong stock market.
U.S. wholesale prices as measured by the producer price index (PPI) declined by 0.1% in February, compared to expectations of an increase of 0.2%. Excluding the volatile food and energy components, the core rate rose 0.1% and has risen just 0.9% over the past twelve months.
For the week, the Dow Jones Industrial Average fell 2.4% to close at 16,065 while the S&P 500 Index declined 2% to close at 1,841. The Nasdaq Composite Index lost 2.1% to close at 4,245.
The FOMC will hold a two-day policy meeting this week and it’s likely that there will be another $10 billion reduction in the amount of the monthly stimulus program. In her first meeting at the helm, all eyes will be focused squarely on Janet Yellen to ascertain any changes in Fed policy going forward. On balance, the economic data due out this week should be positive and supportive of an economy that is growing modestly with little or no inflation. In fact, the consumer price index (CPI) is only expected to rise 0.1%. Housing starts and existing home sales for February should continue to provide optimism about an improving housing sector while industrial production and leading economic indicators are also expected to increase slightly.
The NCAA men’s basketball tournament begins this week and to make March Madness even more exciting than usual, the Oracle of Omaha, Warren Buffett, has offered $1 billion to anyone that can pick a perfect bracket, the odds of which are about one in 5 billion.
Among the more prominent companies that will be reporting earnings this week include Adobe Systems, Oracle, FedEx, Nike, General Mills, Con Agra and Darden Restaurants.
With stocks weak across the board last week and poised for more volatility this week with Ukraine and China still weighing on investor sentiment, Janet Yellen and the Federal Reserve will likely hold the key for the markets as she assesses the state of the economy and issues forward guidance. While it is a foregone conclusion that Fed tapering will likely continue as advertised, what is somewhat unclear is their approach with regard to future interest rate changes. Previously, the Fed had indicated that it would consider interest rate hikes only if the unemployment rate dipped to 6.5% and inflation rose to 2%. With the unemployment rate currently at just 6.7% but understating the true rate of unemployment due to a low labor-force participation rate, the Fed may have to clarify its position and perhaps change its thinking with regard to specific numerical targets. If it is successful in convincing investors that interest rates will remain low into 2015 in the face of stronger growth and an improving economy, then stocks could regain their momentum and rise in tandem along with the rise in corporate profits. With the S&P 500 Index trading at about 15.5 times estimated earnings for 2014, the market is fairly or reasonably valued as long as earnings grow as forecast and interest rates remain at relatively low levels. The 10-year Treasury yield is now at 2.65% and has traded in a range of between 2.53% and 3.03% since the start of the year. If the Fed can do its part in reassuring investors of its intentions to keep rates low, then it will be up to corporate earnings to propel the market higher.