Stocks post gains as Dow, S&P 500 close at record highs

Further, security prices are greatly affected by investor behavior; thus we can be aided in investing safely by understanding where we stand in terms of the market cycle. What’s going on in terms of investor psychology, and how does it tell us how to act in the short run? We want to buy when prices seem attractive. But if investors are giddy and optimism is rampant, we have to consider whether a better buying opportunity mightn’t come along later. – Howard Marks

The Dow Jones Industrial Average closed higher for the 11^th consecutive day on Friday to notch its longest winning streak since 1992 and ended the week at a record high. The S&P 500 Index also hit an all-time high on positive comments from the Trump administration, positive quarterly earnings reports and strong housing data. All three major stock averages as well as the Russell 2000 Index of small cap stocks have gained more than 10% since the election. The stock market seemed to get the biggest lift last week from comments by Treasury Secretary Steve Mnuchin, who said that he expects significant tax reform to be passed by Congress before the August recess. He said the goal of the new administration is a minimum of 3% economic growth on a sustained basis. President Donald Trump, never shy about making bold promises, also said that his proposed tax plan would “massively lower” taxes for the middle class and reduce corporate tax rates. While Trump’s economic proposals have been long on bluster and short on details, hopefully that will change on Tuesday when he is scheduled to outline his fiscal policy plans before a joint session of Congress. In addition to these positive comments about tax reform and reduced taxes, economic data released last week for the housing sector were also favorable. Economic reports were in short supply but existing home sales in January rose to their highest level in a decade and new home sales were also strong. On the earnings front, Home Depot and Wal-Mart Stores bucked the recent weakness in retail earnings by beating analysts’ estimates and reporting strong same-store sales. Home Depot also issued positive guidance for the rest of the year and Wal-Mart raised its dividend.  Right now the wind seems to be at the stock market’s back as fundamentals remain positive and investors climb aboard, fearing that they may miss out on the recent rally.

Last Week

Although weekly jobless claims rose by 6,000 to 244,000 last week, layoffs remain very low and the four-week average, which smooths out volatility, actually dropped to 241,000, the lowest level since July 1973. U. S. consumer sentiment hit 96 in February, in line with expectations, as people remain optimistic about the economy and its prospects for the future.

Minutes from the most recent Federal Reserve meeting suggested that it might be appropriate for Fed officials to raise the federal funds rate again fairly soon if data on jobs and inflation meet or exceed expectations. Many members were optimistic about the economy but wanted more clarity about the fiscal plans of the new Trump administration. The next Fed meeting is scheduled for March 15^th, but May is probably more likely than March for an interest rate hike, but economic data will hold the key.

For the week, the Dow Jones Industrial Average climbed 1.0% to close at 20,821 while the S&P 500 Index added 0.7% to close at 2,367. The Nasdaq Composite Index edged up 0.1% to close at 5,845.

This Week

Economic data that will be reported this week should confirm a vibrant economy. Durable goods orders for January are expected to rebound strongly after posting a modest decline last month. The second reading for fourth quarter gross domestic product (GDP) is forecast to remain unchanged at 1.9%. Both the February ISM Manufacturing Purchasing Managers Index (PMI) and the Chicago PMI are expected to be solidly in expansion territory. January construction spending is also expected to bounce back and be much stronger than in December. Finally, consumer confidence in February should remain elevated as unemployment remains low, wage growth is picking up and the stock market continues to make new highs.

Among the most prominent companies to report quarterly earnings this week are Berkshire Hathaway, Target, Lowe’s, Best Buy, Staples, Dollar Tree, Costco Wholesale, Kroger, AutoZone, Broadcom and Autodesk.

Portfolio Strategy

With the Dow Jones Industrial Average and the S&P 500 Index perched at all-time highs, equity valuations have become rather frothy relative to the average historical price earnings ratio, which is about 15 times earnings. Based on projected earnings for 2017, stocks trade at a multiple of over 18 times those earnings, the highest forward P/E ratio since 2004. Other valuation measures also appear to be excessive. The cyclically adjusted price earnings (CAPE) ratio developed by Robert Shiller, professor of economics at Yale University, compares current stock prices to average earnings over the past 10 years adjusted for inflation.  This ratio currently is at the highest level since 2002. One of the drawbacks of this valuation measure, though, is that it does not take into account the current level of bond yields, which are near historic lows. The increase in stock prices in recent weeks has come despite comments from Fed Chair Janet Yellen and other Fed officials that suggest an interest rate hike may occur soon. The odds of a rate hike have actually risen to about 40% at the Federal Reserve meeting in March. Stocks have also risen on optimism over Trump’s proposed policies on tax reform, deregulation and increased fiscal spending, all of which are considered inflationary. Meanwhile, recent action in the bond market suggests that economic growth is not poised to accelerate as the yield on the 10-year Treasury has fallen to 2.32%, its lowest yield since November. With talk of an imminent interest rate hike and pro-growth economic policies by the Trump administration, one would think that the yield on the 10-year Treasury would have increased. Time will only tell whether the stock market or the bond market is accurately forecasting what lies ahead.