Weekly Market Update (March 13 – March 17, 2017)

By Craig Fehr March 17, 2017

Stocks and bonds were higher on the week, with noticeable gains coming immediately after the Federal Reserve (Fed) raised short-term interest rates by 0.25%. While investors have been complacent, we expect volatility to rise to more normal levels in response to speculation over ongoing Fed policy, the potential timing of initiatives from the Trump administration, and other political uncertainties abroad. We expect the Fed to stay patient and slowly raise interest rates as the domestic economy improves. Even if interest rates rise slowly, they’ll still be low. However, it's important to remember that bonds still play an important role in your portfolio because bonds typically rise when stock prices drop. Given the rally in stock prices around the world, you should ensure that your portfolio's mix of stocks and bonds is aligned with your comfort with risk and your long-term financial goals.

Four Takeaways from the Latest Rate Hike

Both stocks and bonds recorded gains this week, with most of it coming after the Federal Reserve (Fed) announced a quarter-point rate hike, bringing the Federal Funds Rate target range to 0.75% - 1.00%. This is the Fed's third rate increase in the current expansion and its second in the last three months. This week's move by the Fed was largely anticipated, putting the markets' focus on the committee's commentary around the pace of additional rate hikes this year. The committee reiterated that it expects to raise short-term interest rates two more times in 2017, with the path for short-term interest rates remaining dependent on incoming economic data.

We'd offer four quick takeaways from last week's move by the Fed:

  1. The Fed has embarked on a new phase of tightening monetary policy, and it's a good thing. Rate hikes are a reflection of underlying economic trends, which have been consistently solid. The labor market continues to improve – marked by healthy job gains and improvement in wage growth - and inflation trends have firmed slightly, virtuous conditions that warrant less stimulus from the Fed and are supportive of ongoing market gains over time.
  2. Rates are going up, but not too fast. While tighter monetary policy is typically implemented to pull the reins on the economy and keep inflation in check, the current economy is far from overheating, and present inflation expectations appear well contained. This means the Fed has the flexibility to normalize rates in a gradual fashion. Despite two hikes in the past three months, rates remain low. In our view, we are still a ways away from rates reaching a level that will begin to choke off economic expansion. In the rate-tightening cycles in the past 30 years, the Fed Funds rate was at an average of 7.8% when a recession emerged.
  3. Rate hikes aren't a disaster for stocks or bonds. Since 1986, in the three years following an initial Fed rate hike, the stock market returned an average of 9.2% per year. And while rising rates are a headwind for bond prices, the average return for bonds during those periods was 6.8%. Importantly, however, the average volatility for bonds was lower than that of stocks, meaning that even when the Fed is hiking rates, bonds still provide portfolio protection against market volatility.
  4. Speaking of volatility, we think there will be more of it ahead. For the past several years, volatility has been quite low. The correction at the beginning of 2016 (driven by earnings weakness resulting from falling oil prices and the rising dollar) was fairly mild and lasted slightly over a month. The pullback from Brexit last summer lasted just a few days. Ultra-low rates from the Fed (as well as other central banks around the world) have provided a perceived backstop against shocks, limiting equity-market volatility. While this backstop is not being eliminated, the reality that the Fed is pivoting toward slowly pulling back on monetary stimulus may mean that political uncertainties (and disappointments), periodic weak economic readings, or other global shocks could spur more frequent dips or pullbacks as this broader bull market continues.

The Stock & Bond Market

Index Close Week YTD
Dow Jones Industrial Average 20,915
0.1% 5.8%
S&P 500 Index 2,378

0.2%

6.2%

NASDAQ 5,901

0.7%

9.6%
Bonds* $107.89

0.5%

0.2%
10-yr Treasury Yield 2.50% -0.08% 0.05%
Oil ($/bbl) $48.70 0.4% -9.3%

Source: Bloomberg. Past performance does not guarantee future results. *Bonds represented by the iShares Core U.S. Aggregate Bond ETF.

The Week Ahead

Next week's economic calendar is relatively light, especially compared with the last two weeks when data including February's jobs report and the Federal Reserve's press release captured investors' attention. Data coming next week include existing and new home sales, which will be released on Wednesday and Thursday, respectively.

Important Information

The Weekly Market Update is published every Friday.

Edward Jones does not provide access to past weekly summaries.

The Dow Jones Indexes are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use.
All content of the Dow Jones Indexes © 2017 is proprietary to Dow Jones & Company, Inc.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against loss.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

This information is approved for use with the public.
It is intended for informational purposes only.
It is believed to be reliable, but its accuracy and completeness are not guaranteed.

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