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The Markets This Week

June 23, 2014 | Weekly Commentary

Stocks racked up another set of gains last week, as both the Dow Jones Industrial Average and Standard & Poor’s 500 index notched new all-time highs on Friday. In contrast to the response to the Ukrainian political and military crisis, investors have so far paid little attention to the fighting in Iraq and resulting higher oil prices. Small-caps outperformed large-caps, suggesting the risk-on trade was in full swing.

With relatively few economic news reports released, most of the action took place on Wednesday, when the Federal Open Market Committee meeting was held. In the press conference afterward, Federal Reserve Chair Janet Yellen tamped down inflation worries, and her comments suggested the rise in interest rates that nearly all investors are expecting will take place later rather than sooner.

Last week, the Dow rose 171 points, or 1%, to 16,947.08. That’s a new high, and the 11th this year. The S&P 500 rose 27 points, to 1962.87, also an all-time high, and its 22nd such close this year. The Nasdaq Composite index rose 57 points, or 1.3%, to 4368.04. The Russell 2000 index jumped 26 points, or 2.2%, to 1188.40.

The FOMC meeting reassured investors on a number of issues, in particular that the Fed’s rate outlook hasn’t changed much. The $10 billion per month tapering of its bond-buying program continues, interest-rate tightening is not imminent, and when it does come, it will be gradual. Yellen said that economic activity was rebounding, even as the Fed cut its U.S. 2014 gross-domestic-product projection to 2.1% to 2.3% from 2.8% to 3%, on Wednesday

She also downplayed inflation fears, calling the recent figures showing rising consumer prices “noisy.”

HIGHER INFLATION MIGHT force the Fed to hike rates earlier than was anticipated, but the market chose to focus on the “noise” comment, says Ryan Larson, head of equity trading at RBC Global Asset Management. That effectively pushed the ongoing debate about the beginning of interest-rate hikes toward a second half of 2015 event, he adds.

Nevertheless, with market complacency seemingly so high, both investors and the Fed should pay more attention to inflation, argues Liz Ann Sonders, chief investment strategist at Charles Schwab. Inflation data, such as the consumer price index, has ticked up steadily for three months, she notes, so the Fed’s low level of concern and the market’s quick acceptance of Yellen’s comment “surprised me a little.”

Sonders remains bullish and believes inflation isn’t a problem, but the potential for a market scare exists. With near-term sentiment optimistic, an inflation surprise could be a trigger for a pullback, she says.

The same could be said for the deteriorating situation in Iraq, though investors are doing their best to ignore it. The more time goes by without the U.S. dropping bombs or getting further involved, the better it is for the market, says Larson.

However, that can change in a hurry, says Kenneth Polcari, director of New York Stock Exchange floor operations for O’Neil Securities. It looks like a difficult situation to resolve, and “the market isn’t paying attention because it hasn’t imploded yet. When it gets worse, it will pay attention.”

(Source: Barrons Online)

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