Through the close of the markets on Thursday, February 3, 2011, the Standard & Poor’s 500 was up 2.41%; the Dow Jones Industrial Average was up 2.02%; the NASDAQ up 2.49%, and the Russell 2000 up 2.99%. It was a strong week led by solid earnings reports. Tuesday’s increase in the Institute for Supply Management’s (ISM) Manufacturing Index from 58.5 to 60.8 for January is strong evidence that the recovery accelerated early this year, and factory output could exceed expectations. Overall, it was a strong report and suggests manufacturing is poised for strong gains this quarter. The ISM Services Index also hit a new high for the recovery in January rising by 2.3 points to 59.4, pointing to further strengthening in the economy outside of manufacturing in February.
However, we are seeing many signs of inflation. This week we saw prices rise on sugar, cotton and copper. Raw materials like steel and wheat were up 37% and 57%, respectively. The materials and energy sectors were up 4.55% and 4.51% respectively. We are seeing reports of people buying in anticipation of needs, a trend we have not seen since the 1970s.
Durable goods companies, like food and clothing manufacturers, can push the increased cost of raw materials through to the customers, but nondurable goods companies often cannot as there is strong price competition in the market. We feel long-term investors should look for companies that can weather inflationary times, for example, stocks in the consumer staples or materials sectors. Food and agricultural commodity processor Archer Daniels Midland Co. (NYSE: ADM) reported Tuesday that earnings rose 29% as the company took advantage of surging export demand for grains.
In anticipation of inflation, we are seeing interest rates rising. We have been able to find bonds maturing in 2019 with tax equivalent yields of more than 5%. In fact, we have been able to find taxable municipal bonds yielding near 5%. In some cases, rates have been so desirable that we have purchased high-quality municipal bonds in an IRA! When you hold tax-free municipal bonds in an IRA, you usually achieve lower returns on your assets. This is because the tax-free nature of municipal bonds makes them trade at higher prices (lower yields) in the market.
On Tuesday, it was reported that state tax revenues for fourth quarter 2010 grew at the fastest rate in almost five years because of steadily improving economies and higher tax rates. Forty-one states reported tax collections increased 6.9% on average. Often-troubled California led the pack with a 32% rise in income tax revenue. Indiana and Massachusetts also saw income tax revenue jump more than 15%. Georgia income taxes were up 6.24%, while corporate income taxes were up 51.5%. Our state sales taxes were up 5.43% for an overall 7.4% increase for the state.
Treasury bond interest rates rose sharply this week with the two-year Treasury yielding 0.69%, which is the highest level since the summer 2010. The five-year Treasury bonds soared 0.23% to yield 2.15%. The 10- and 20-year Treasury bonds are yielding 3.52% and 4.64%, respectively. For smaller investors, it was a good week for buying Treasury bonds. Snow storms in both Chicago and New York slowed the large investment firms; thus, there were fewer buyers in the marketplace. It allowed smaller investors a little more time to research the bonds and make purchases. We suggest bond investors hold out for yields near or at 5%. If you cannot find a bond yielding near 5%, we suggest keeping your money short in CDs, until rates rise. We feel long-term investors should have their money in equities, as the stock markets generally weather inflation well.