The week ended with a surprise to many as the Fed boosted its discount rate after market close on Thursday. In its press release, the Fed characterized the move as normalization in the relationship of the discount rate to the fed funds target rate. “Normalization” now appears to be the Fed’s PR phrase for its exit strategy. Indeed, “normalization” is less frightening—and more accurate—than “tightening.” But a return to normalcy also is the wish of many—businesses, consumers, and policymakers. Economic data this past week indicated that the return will be gradual but that progress is being made.
Recap of US Markets
Equities made net gains for a second week in a row. The week got off to a good start on Tuesday (with markets closed Monday for Presidents’ Day) on good earnings news from Merck and Barclays and on a better-than-expected Empire State manufacturing index. Dollar weakness boosted commodity stocks. Equities moved higher on Wednesday mostly on favorable company news. Deere and Whole Foods reported earnings that beat estimates. There was heavy duty economic news in the morning and afternoon. The housing starts report was only modestly positive for stocks as starts rose but permits declined. The Fed’s FOMC minutes had only one surprise—increased discussion of raising the discount rate soon—but that cut back the day’s gains.
Equities gained further on Thursday despite economic news that was not favorable. Initial jobless claims spiked, producer price inflation jumped—including at the core level, and the index of leading indicators slowed. Somewhat offsetting was a positive report from the Philly Fed on mid-Atlantic manufacturing. Lifting stocks were several better-than-expected earnings reports—including Proctor & Gamble. But Wal-Mart dampened the mood a bit with a drop in same-store sales. After close, the Fed announced a 25 basis point increase in the discount rate to 0.75 percent, causing stocks and equity futures to dip in after-hours trading. But by open on Friday, traders decided that the Fed intended the move to be merely technical and a non-event in terms of impact on credit markets. Also, a surprisingly soft CPI report alleviated fears about the possibility of the Fed accelerating its exit from an expanded balance sheet.
Equities were up this past week. The Dow was up 3.0 percent; the S&P 500, up 3.5 percent; the Nasdaq, up 2.8 percent; and the Russell 2000, up 3.4 percent.
For the year-to-date, major indexes are mostly down as follows: the Dow, down 0.2 percent; the S&P 500, down 0.5 percent; and the Nasdaq, down 1.1 percent. The Russell 2000, however, is back in positive territory, up 1.0 percent since the end of 2009.
For the week ahead, markets will be watching credit markets overseas as Greece is likely to conduct a debt auction. Also, Fed Chairman Ben Bernanke could set markets in motion with his semiannual testimony before Congress on Wednesday and Thursday.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.