Vacations Over: Stock Market Takes a Nose Dive

Stocks and bonds tumbled worldwide this week, as investors reacted to stretched valuations and the ongoing fear of the U.S. Federal Reserve’s “tapering.” As early as September, the Fed may reduce its $85 billion monthly rate of bond purchases. The S&P 500 index closed the week at 1,655.84, down 2.04%.

By Dan Denbow, Asst. VP, USAA Investments

The 10-year Treasury yield finished the week at 2.83%, up .25%. Gold enjoyed a strong rally, closing the week at $1,376.87 an ounce, up 4.75%.

This week was heavy on economic news. Through our lens, we see a slow-growing economy, with a rebound in housing but new building activity still at depressed levels, a gradually healing labor market, a relatively weak consumer and low inflation.

VIDEO: Monthly Market Commentary: Vacation’s Over

Housing numbers exhibited some softness, with mortgage applications being affected by the recent backup in interest rates and falling 4.7% for the week ended Aug. 9, the lowest level in more than two years. Housing starts rose at an 896,000 annual rate in July, slightly less than expected but higher than June.

Consumer spending is growing, but at subpar levels. July retail sales were up 0.2%, less than expected, although June’s numbers were revised upward. Consumer sentiment fell in August, as measured by the five-point drop in the University of Michigan survey to 80.0.

The labor market is gradually improving. Weekly initial jobless claims hit a six-year low of 320,000 this week, an encouraging sign.

Inflation remains contained, but we note that it is a lagging indicator, and we wonder whether it can continue to remain low given the Fed’s massive money printing. The consumer price index for July was up 0.2% month over month and up 2.0% year over year. The market’s forecast of inflation for the next 10 years has crept up over the past two months to 2.18%, as measured by the difference between the yield on U.S. Treasury bonds and U.S. Treasury Inflation-Protected bonds.

As we approach September, we expect market volatility to increase, as there are several significant events coming up. The Sept. 17-18 Federal Open Market Committee meeting will be closely watched for signs of tapering, with a majority of market strategists currently forecasting a tapering announcement following that meeting.

The U.S. debt ceiling is approaching, and we expect a heated debate regarding potential spending cuts when Congress reconvenes next month. And depending upon the results of the Sept. 22 German elections, investors may have some renewed clarity regarding the European Union’s policy toward future bailouts for troubled eurozone countries.

It appears that German voters are getting “bailout fatigue” associated with large payments going to countries that are capital-starved, and bailout countries are getting “austerity fatigue” from the spending cuts that are tied to their receipt of receiving financial aid.

 

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