After the brief downside correction as discussed in last week’s column, the market returned to the basic pattern it has followed for most of this year, namely to continue to go higher, as for the twenty-second time in 2014 the S&P attained new closing all-time best-ever levels. It rallied for six straight days, the first time it had done so since mid-April, and it was joined in this upside endeavor by the Dow Jones Industrial Average, which also attained its highest-ever closing level on Friday as it also advanced for six straight days, the first time it had accomplished this since last December.
Ironically, the two indexes achieved these feats against a backdrop of worsening civil war in Iraq and the accompanying rise in oil prices, which could have a negative effect on consumer spending this summer if energy costs remain at current elevated levels. In fact, every day that the news media reported on the ISIS extremists taking control of this city or that and crude oil prices jumping in concert with this news, the market basically shrugged its shoulders and kept pushing to the upside. This benign reaction to the always potentially explosive Middle East stands in sharp contrast to the negativity in equities during the spring due to the Russian-Ukrainian border tensions which eventually turned out to be a big nothing as far as investors in this country were concerned. Those nervous nellies at that time perhaps learned their lessons this time that the underlying fundamentals of the market are strong, as Fed Chair Janet Yellen spoke about “policy accommodation,” which is a code word for keeping interest rates at record low levels for the foreseeable future. She also mentioned rising property and equity values and an improving global economy allowing for the U.S. economy to achieve “above average” growth, in her words at last week’s press conference following the release of the F.O.M.C.’s latest statement on interest rates.
The Fed basically expressed confidence that the U.S. economic recovery was on track and did hint at a slightly more aggressive pace of interest rate increases starting late next year, as for instance they predicted that the federal funds rate will be 1.13 percent at the end of 2015 and 2.5 percent a year later. At the same time, they did lower their long-term projections for the federal funds rate, which was proof of their diminished expectations for a nation climbing out of a severe crisis as it struggles with demographic headwinds like declining labor force participation.
To no one’s surprise, the central bank stayed on schedule by continuing to taper the latest stimulus program to the tune of $35 billion a month of bond purchases starting in July. During her remarks, Mrs. Yellen said that there were reasons to be confident in the short-run as a result of resilient household spending and an improving jobs market. Even though the Fed cut its growth forecast for this year down to 2.2 percent, she added that this was the result of “transitory” factors like the severe winter weather and that a recovery was surely underway.
“Economic activity is rebounding in the current quarter and will continue to expand at a moderate pace,” and she added that the “economy is continuing to make progress towards our objectives” of full employment and two-percent inflation.
What probably got the market so motivated to the upside were her comments that the Fed is likely to “reduce the pace of asset purchases in further measured steps” and that it expects interest rates to stay low for “a considerable period of time” after the bond buying ends. As a result of the old “Don’t Fight the Fed” scenario, the Dow closed at 16,947 on Friday, just short of another nice round number and the S&P ended at 1963, also higher than it has ever been before both set back very nominally on Monday.
Economic reports released this past week generally showed an economy on that moderate growth path as mentioned by the Fed, as weekly jobless claims declined by 5,000 down to 312,000, the June Philadelphia Fed Manufacturing Index, May Leading Economic Indicators and May existing home sales all rose by more than expected, with only May housing starts coming in below expectations. The May Consumer Price Index did rise by the most since February 2013 at an annual rate of 2.1 percent, which is actually above the Fed’s 2 percent inflation target, but Chairman Yellen dismissed this as “noisy,” in her words, as the Fed’s preferred inflation measure, known as the PCE, or Personal Consumption Expenditures deflator, has shown less of an increase because it places more weight on health-care costs and less on housing.
Also helping investor psychology is the projection that after a first-quarter earnings advance of 5.5 percent, profits for the second quarter, which is about to come to an end, are expected to show a gain of 7.5 percent and for the entire year earnings are predicted to be ahead by slightly more than this amount. The reporting period for companies whose fiscal second quarter ended in late May is already underway and important stocks such as ADBE and FDX have done better with the bulk of these reports appearing by the middle of July.
Last week I mentioned that this has been one of the calmest markets in recent memory, as the S&P has now gone 47 days without a move of one percent in either direction, and one has to go all the way back to 1995 for a longer period of time when this lack of volatility was with us. At that time the streak lasted for 95 days and since the advent of the S&P in 1928 there have been 30 such streaks where the S&P stayed this calm for 40 days or longer. For those historians out there, the calmest such market periods occurred in 1963, 1964 and 1965 where the S&P actually went 155 to 175 days without this kind of movement, so what we are seeing today could continue for a while based on what has taken place in the past. Let us hope that this is in fact the case, because the worst thing that investors want to see is the pernicious influence that large market moves, especially to the downside, can have on stock buying behavior.