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The annual speculation about what September and October hold for U.S. stocks is well underway. Whether these two months deserve their reputation as scary for investors is certainly open to debate.

But, with vacations having ended, investors are once again focused squarely on their portfolios, and there are plenty of issues to ponder. The Federal Reserve’s quantitative easing program, QE3, winds down next month; the crisis in Ukraine threatens to deteriorate; and Europe is inching closer to deflation.
 



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Investor attention was focused squarely on the Federal Reserve last week. The minutes from the July meeting of the Federal Open Market Committee (FOMC), which were released on Wednesday, seemed to indicate that the debate over when to first raise interest rates is beginning to intensify.

The Fed has taken note that the rate of unemployment has fallen faster than it expected. And although the unemployment rate is only one of a range of metrics the Fed employs to determine whether it has achieved its policy mandate of full employment, it has declined close enough to what is considered full employment to raise the voices of the FOMC hawks. The Fed is currently focused on the June 2015 timeframe for the likely date of the first rate hike. But the minutes revealed a growing debate about whether an earlier date might be appropriate.



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This tagline for the 1978 movie Jaws 2 effectively dredged up all of the suppressed fears among beachgoers that had been exposed by the original Jaws movie three summers prior. With summer now winding down, and with shark sightings in local waters, last week’s market action was reminiscent of this cinematic sequence.

After receding for most of the week on reports of diplomatic and humanitarian progress in Ukraine, geopolitical risk aversion came roaring back to life on Friday, after unconfirmed reports of a government attack on a Russian army convoy that had crossed into Ukrainian territory. After an early morning rally that followed gains in four of the previous five trading sessions, stock prices suddenly turned lower, as the supposed news from Ukraine broke, one hour into trading.


 



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In the vacuum of a light economic calendar, an earnings season that is now 90 percent complete, and with investors turning their attention to the last few weeks of summertime leisure, stocks struggled to overcome geopolitical concerns last week. But a strong rally on Friday, in response to news that offered some hope of easing tensions in Ukraine, the S&P 500 managed to carve out a small gain of 0.3 percent.
 
Eurozone markets followed a similar daily pattern, but the late-week rally was not sufficient to overcome earlier weakness, and the EuroStoxx index closed sharply lower for the second straight week, losing 2.1 percent, after falling 3.2 percent the previous week. Not helping was mixed economic news and the measured policy stance of the European Central Bank.
 



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First, a look at last week.
 
Stocks faltered after a strong second quarter GDP report triggered concerns that the Fed might be forced to tighten sooner than expected. After the slightly softer, but still good, jobs report on Friday, a measure of stability returned to equities. But the damage had been done, and for the week the S&P 500 shed 2.7 percent, leaving the index 3.2 percent below its July 24 closing high of 1988.
 
Beyond the second-quarter rebound, last week’s economic data was generally, but not uniformly, encouraging. Manufacturing activity and consumer confidence rose to start the third quarter, and motor vehicle sales were robust. And the economy generated more than 200,000 jobs for the sixth straight month in July, resulting in the first increase in the labor force participation rate in four months.
 



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Companies have been keeping a tight grip on their current employees. This indicates that they are seeing an uptick in their business, and are more confident in the economic outlook. This dynamic is likely to coincide with a stronger pace of hiring (which we have already witnessed over the last few months) and suggests another solid month of job growth is likely for July.

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While Portugal’s Banco Espírito Santo scare may have provided a convenient scapegoat for the market’s temporary wobble last week, the reality is that it likely had little to do with U.S. stocks shedding 0.9 percent, their worst performance since early April.

More likely, last week’s selloff had more to do with investors returning from the long holiday weekend and taking another look at the strength of the June jobs report and reassessing its impact on the pace of future Fed policy. There were also likely some jitters ahead of the start of second quarter earnings season. With valuations and sentiment elevated, the role of earnings becomes even more important in supporting equity prices.
 



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Despite failing to establish another new record weekly close, stocks managed to hold onto most of the gains from the previous week’s record. A range of economic reports contained mostly good news last week, with the notable exception of the pace of personal consumption in May, which raised some concern over the state of the consumer sector. Otherwise, the data was mostly encouraging, and reinforced the idea that second quarter activity may have rebounded to a 3.0-3.5 percent annualized pace. The flip side of the consumer spending report showed a rise in disposable personal income, which pushed the national savings rate to 4.8 percent, its highest since last September.

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