Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes. – John Bogle
With the help of a 300 plus point gain on Wednesday, the Dow Jones Industrial Average posted its fourth consecutive weekly gain and ended the week slightly above 21,000. It wasn’t that long ago that the Dow surpassed the 20,000 milestone. The surge in stock prices mid-week came after President Donald Trump delivered what many consider to be his best speech before a joint session of Congress on Tuesday night. While the speech was short on specifics on tax reform, deregulation and fiscal stimulus, it was very presidential and seemed to assure Americans that it will be just a matter of time before his pro-growth policies are implemented. Not only did Trump’s speech provide the spark to ignite the market’s surge, but economic data released last week was also mostly positive. Although the second estimate of fourth quarter gross domestic product (GDP) matched the first estimate of 1.9%, consumer spending was revised sharply higher, a positive trend for the economy as consumer spending accounts for about two-thirds of economic activity. Recent labor market tightness and signs of rising inflation could even prompt the Federal Reserve to raise interest rates as early as its meeting next week. Many Fed officials have already warned that a Fed rate hike may be coming soon and on Friday, Federal Reserve Chair Janet Yellen confirmed that possibility in a speech. She reiterated that three interest rate hikes probably are appropriate this year and concurred that if economic data continue to meet expectations, it would be prudent to raise rates sooner rather than later. With core inflation at 1.7%, only slightly below the Fed’s 2% target, and job growth higher than what is needed to maintain a 4.8% unemployment rate, it would not be surprising to see the Fed to pull the trigger this month. In fact, the odds of a rate hike at the next Fed meeting on March 14th and 15th have risen to 80%, but an interest rate increase is largely priced into the bond market already.
For the most part, economic data reported last week was favorable as the February ISM manufacturing index rose to nearly 58 (a reading above 50 denotes expansion) and the ISM non-manufacturing or services sector index also hit this level. Durable goods orders in January were also better than expected and the consumer confidence index in February reached its highest level since 2001 as consumers expressed optimism about business conditions, the near-term economic outlook, personal finances and jobs. The personal consumption expenditures price index (PCE), the Fed’s preferred inflation gauge, rose in January, making the increase over the last 12 months 1.9% from 1.6% in December. Finally, weekly jobless claims dropped by 19,000 to 223,000, the lowest level in 44 years and another indication that the labor market remains strong.
The Federal Reserve’s Beige Book, a collection of anecdotes about the economy in all of the Fed districts, showed that economic growth remains “modest-to-moderate”, and that businesses remain optimistic about the economy over the near-term. In comments about the stock market’s current valuation, Warren Buffett said that it is not in bubble territory and that prices are “on the cheap side” given low interest rates.
For the week, the Dow Jones Industrial Average rose 0.9% to close at 21,005 while the S&P 500 Index gained 0.7% to close at 2,383. The Nasdaq Composite Index added 0.4% to close at 5,870.
The key piece of economic data this week will be the February employment report, which is expected to show that about 185,000 new jobs were created and that the unemployment rate dipped to 4.7% from 4.8%. Other economic reports of note include January factory orders, expected to rise modestly, and February import prices, expected to edge up slightly. The European Central Bank (ECB) announces its decision on interest rates and China releases data on consumer and producer prices.
As earnings season winds down, the most notable companies scheduled to report this week include H&R Block, Dick’s Sporting Goods, Valspar, Urban Outfitters, Bob Evans Farms and Verifone Systems.
In addition to the distinct possibility that the Federal Reserve will raise interest rates three times this year, municipal bond investors are also faced with the prospect of individual tax reform and reduced tax rates. One of President Donald Trump’s pro-growth initiatives has been simplifying the tax code and possibly limiting the tax-exempt status of municipal bonds. However, it appears that the new administration’s first priority is corporate tax reform so changes to the individual tax code may be placed on hold. The odds of reducing or eliminating the tax-exempt status of municipal bonds also appear slim as attempts to accomplish this in the past have failed. Any reduction of tax rates in the past has had only minimal effects on municipal bond prices. As a rule, municipal bonds provide investors with a low-risk way to diversify a portfolio and limit the volatility when stocks become overpriced and too risky. The vast majority of municipal bonds are also high-quality and are negatively correlated to equities, performing well when stocks underperform. Municipal bonds are also much cheaper than they were about a year ago as the yield on a 10-year, AAA-rated municipal bond is about 2.4%, equivalent to a 4% taxable yield for investors in a high tax bracket. The fact that they are cheaper means they yield more. This tax-exempt yield of 2.4% is only slightly less than the current yield of 2.49% on the 10-year Treasury, which is also subject to Federal income taxes.