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Stocks Move Lower as Fed Still Looks to Raise Rates in 2015

Stocks fell this week as markets continued to try and reconcile the Fed’s actions with recent economic data and corporate results. The S&P 500 was down 1.4% from the prior week’s close, its second straight week of declines. The Dow Jones Industrial Average fared better over the last five days with a drop of just 0.4% while biotech stocks got hammered and dragged the NASDAQ Composite down 2.9%. For the year all the major U.S. indices are now in the red, with the S&P losing 4.8% in 2015.

Stocks overseas declined as well, as the MSCI EAFE developed index declined 3.1% and the emerging markets index dropped 4.9%. A strengthening dollar is partly to blame, as the U.S. currency gained 1.5% for the week on a trade weighted basis. China’s Hong Kong H shares saw declines in excess of 3% while the mainland A share market in Shanghai was just about flat.

Despite some intraweek volatility U.S. Treasury yields ended the week within three basis points of last Friday’s close. The yield on the ten year Treasury hit a high of 2.22% on Monday and a low of 2.08% on Thursday before ending the week at 2.16%.

In a speech Thursday evening Fed Chair Janet Yellen commented that a rate hike likely remains appropriate “sometime later this year” and reiterated that “the more prudent strategy is to begin tightening in a timely fashion and at a gradual pace.” This came just one week after the FOMC voted to keep rates on hold. Markets continue to doubt the Fed’s conviction on the matter as fed funds futures put an 18% chance of a rate hike next month and a 43% chance for one in December.

Economic data out this week was once again a mixed bag. On the housing front existing home sales came in below expectations while new home sales were slightly above. Durable goods orders were down MoM, but flat after excluding the volatile transportation sector. The final revision to Q2 GDP came in above consensus with growth occurring at an annualized rate of 3.9% (that number is expected to drop to 2.4% in Q3). While one of the consumer sentiment readings was out and beat expectations, it still fell to an 11 month low.

The latest corporate scandal with the potential for billions of dollars in fines dropped late last week and in a change from the trend over the past few years the accused comes from the auto sector and not the banks. The maker of the People’s Car, i.e. Volkswagen, is accused of egregiously cheating on the emissions certification process for its self-professed “Clean Diesel” cars sold under the VW and Audi name. Rather than relying on the brilliant “German engineering” for which the company is known, the automaker simply installed a software algorithm which gamed the test. Basically it worked like this – when the EPA does an emissions test on a car it places the car on rollers so it does not go anywhere, revs the engine under various conditions, and then measures what exactly comes out of the tailpipe. VW knew this and installed two separate engine management programs, one that ran while the car was stationary and created very little pollution, and the other that actually operated in the real world and puffed like a chain smoker.

At this point you may be thinking, what’s the big deal and why all the fuss? Especially considering most Americans don’t like diesel cars and the idea of a deceitful corporation is not exactly new? Well, first off it turns out that the cheat program was not unique to the 500,000 or so diesel cars sold in the U.S. but rather may apply to 11 million vehicles sold worldwide. Second is the degree of deception that took place, which was überdimensional (i.e. huge) to say the least, and the extent to which VW went in denying the allegations. Already the CEO has resigned (although still stands to collect a “pension” that may exceed $50 million), the company has set aside over $7.2 billion to cover losses, and the stock price fell more than 28% in just the past five days. That amounts to a decline in market cap of roughly $23 billion. And things could get worse for VW too, as the maximum fine from the EPA is $37,500 per car (which is almost $19 billion in total) and the DOJ has launched a criminal investigation into the matter as well.

In other corporate news, Bloomberg ran an article highlighting the recent struggles of the world’s largest fast food restaurant chain, McDonald’s. It noted that for the first time in more than 30 years the golden arched proprietor will have an annual net decline in its number of U.S. stores as the company plans to close 59 more than it opens. The company has hit a rough patch in recent years due to increased competition from more upscale “fast casual” outlets and backlash from franchisees over the difficulty of serving an ever growing and more complex menu. Revenue has declined in eight out of the last ten quarters and the company’s stock has underperformed the S&P 500 since 2012.

And finally, while you have probably already heard, the annual Permanent Fund Dividend amount was announced this week and came in at a record $2,072. ADN was quick to point out that it is not a record when adjusted for inflation, which is true, but nevertheless the combined $1.3 billion influx into the Alaska economy will be a welcomed boost. The cumulative dollar amount for an individual who has received every single distribution since 1982 will stand at $39,099.41 one direct deposits start on October 1st.

And speaking of the Permanent Fund, there is a two day board meeting scheduled next week which will be held at the downtown Anchorage Westmark. As always it is open to the public and you can check out the agenda here.

 

Nicholas Case
Senior Investment Analyst

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