Dow and S&P 500 Hit All-Time Highs on Fed Stimulus

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Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

The Dow Jones Industrial Average (DJINDICES: ^DJI  ) and S&P 500 (SNPINDEX: ^GSPC  ) have hit all-time highs today, as investors believe the Federal Reserve will keep its low interest rates going longer than previously expected. As of 1:30 p.m. EST, the Dow is up 105 points to 15,723. The S&P 500 is up six points, to 1,768, and the largest exchange-traded fund tracking the S&P 500, the SPDR S&P 500 (NYSEMKT: SPY  ) , is up 0.4% to $176.97.

The Dow and S&P 500 are rising today on the belief that the Federal Reserve's low interest rates will last longer than investors currently expect. In fact, earlier today the Dow hit an all-time high of 15,732, while the S&P 500 came within two points of its all time high of 1,775.22.

The Fed has said for some time now that it will keep the Federal Funds rate near zero and its asset purchases steady until certain targets are met -- that is, unemployment of less than 6.5%, inflation expectations of more than 2.5%, and/or actual inflation of more than 2%.

Investors had believed the Fed might start tapering asset purchases and raising interest rates as early as next year. In June, Federal Reserve Chairman Ben Bernanke said tapering could begin as early as the end of this year, but then backed away from the comments after the markets -- particularly the bond and mortgage markets -- fell in response.

US 30 Year Mortgage Rate Chart

US 30 Year Mortgage Rate data by YCharts.

With unemployment at 7.2% -- near the level of 7% where the Fed said it might start tapering its asset purchases -- four news items yesterday indicate that the Fed might let the Federal Funds rate go on near 0% for longer than the markets expect.

Yesterday, two Fed papers that will be presented at a conference at the International Monetary Fund later this week indicated that it would be better if interest rates were kept near zero for longer than many expect. The first, "The Federal Reserve's Framework for Monetary Policy -- Recent Changes and New Questions," argues that maintaining near-zero interest rates until unemployment hits 6.5% is a good policy but that it would be better if the threshold were even lower, at 5.5%. The paper suggests that the optimal date for raising interest rates could be as late as 2017.

The second paper, entitled "Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy," said the slowly growing U.S. economy calls for "highly accommodative monetary policy, particularly in an environment of what appears to be quite well-anchored inflation expectations."

Inflation has been running low to the point that some are worried about deflation, and one- to two-year inflation expectations remain near 1.5%. Fed watchers believe these two papers could sway voting members of the Federal Open Market Committee to keep rates lower longer.

The third news item yesterday was from San Francisco Fed President John Williams, who said he doubts the unemployment rate threshold will be dropped but noted that it is a threshold, not an automatic trigger. He also stressed that interest rates and asset purchases are separate tools of the Fed, suggesting that the Fed will only change one at a time. It should be noted that John Williams is currently a non-voting member of the Fed.

Finally, Boston Fed President Eric Rosengren spoke on Monday saying he considers 5.25% unemployment to be the full employment rate.

What's an investor to do?
Your investment strategy shouldn't be dependent on the Federal Reserve. Constantly educate yourself, find great companies, and invest for the long term.

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