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Stocks post solid gains on positive earnings, guidance

In our view, though, investment students need only two well-taught courses – How to Value a Business and How to Think about Market Prices. Your goal as an investor should simply be to purchase, at a reasonable price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. – Warren Buffett

The major stock averages posted solid gains in the wake of favorable French election results a week ago Sunday and a slew of better than expected first quarter corporate earnings reports. Both the Dow Jones Industrial Average and the S&P 500 Index turned in their best performance in months while the Nasdaq Composite Index closed above the 6,000 level for the first time ever. Investors breathed a collective sigh of relief after the election in France as Emmanuel Macron, a centrist candidate, and Marine Le Pen, a far-right candidate, emerged victorious and will advance to a presidential runoff on May 7th. It is widely expected that Macron will easily defeat Le Pen, who is in favor of France exiting the European Union. The markets surged on the news and never looked back as quarterly earnings results continued to be impressive. Of the S&P 500 companies that have already reported earnings, over 75% of them have beaten profit estimates while over 65% have also topped revenue estimates. First quarter earnings are expected to increase 11% and so far the positive results have come from companies in all sectors and industry groups. Companies in the technology-laden Nasdaq Composite Index such as Alphabet (formerly Google), Intel, Amazon and Netflix have led the way as evidenced by the record close of this benchmark above 6,000, but other blue chips such as PepsiCo, Procter & Gamble, United Technologies, Caterpillar and McDonald’s also surpassed expectations. In addition to offering stellar profit results, the vast majority of companies have also been issuing favorable earnings guidance going forward, prompting analysts to raise their full year estimates. But the week was not without its disappointments. Preliminary first quarter gross domestic product (GDP) increased at only a 0.7% annual rate, the weakest growth in three years, as consumer spending was sluggish and businesses invested less on inventories. Weather may have contributed to the slowdown as well as problems calculating data that seem to affect only the first quarter. President Trump also released his much-anticipated tax plan but it drew mixed reviews and was short on specifics. The anemic growth in the first quarter may be a wake-up call for the Trump administration as it struggles to implement its pro-growth agenda.

Last Week

March new home sales rose to an 8-month high and were better than expected as sales have increased for three straight months. The tight labor market has boosted employment opportunities and supported the housing market. Although weekly jobless claims were higher than expected, the 4-week average number of claims fell to a 2-month low due to the tightening labor market. Durable goods orders increased less than expected and core capital goods also came in light as there was a loss of momentum in the manufacturing sector. Both consumer confidence and the Michigan consumer sentiment index fell slightly in April but were still very strong even though consumers were less upbeat about the economy and the job market.

President Trump’s tax plan calls for three tax brackets (10%, 25% and 35%), no alternative minimum tax or AMT, no estate tax, far fewer deductions and a corporate tax rate of 15%. In overseas news, the European Central Bank (ECB) decided to leave its benchmark interest rate at zero percent and its overall monetary policy unchanged.

For the week, the Dow Jones Industrial Average jumped 1.9% to close at 20,940 and the S&P 500 Index climbed 1.5% to close at 2,384. The Nasdaq Composite Index soared 2.3% to close at 6,047.

This Week

The employment report for April is expected to show that about 188,000 new jobs were created, far more than the 98,000 jobs in March, and that the unemployment rate edged higher from 4.5% to 4.6%. The April ISM Manufacturing Purchasing Manager’s Index (PMI) should be consistent with last month’s reading and solidly in expansion territory. March construction spending and factory orders, on the other hand, are expected to be less than the previous month. At its meeting on Wednesday, the Federal Reserve is expected to leave interest rates unchanged.

There will be no shortage of earnings reports again this week as Merck, Pfizer, CVS Health, MasterCard, MetLife, Apple, Facebook, Berkshire Hathaway, Devon Energy, ConocoPhillips, Emerson Electric, CBS and Time Warner are the most notable companies on the agenda.

Portfolio Strategy

With tepid economic growth in the first quarter, stretched valuations in the stock market and uncertainty over passage and implementation of the Trump administration’s pro-growth agenda, investors would be wise to diversify their portfolios by investing in international markets. The S&P 500 Index is currently trading at a significantly higher multiple than international developed market and emerging market indices. While the Federal Reserve is still accommodative, it has begun to raise interest rates with the goal of eventually normalizing monetary policy. This could be a headwind for U.S. markets in contrast to markets in Europe and Japan where central banks are at a different point in the cycle and interest rates are far lower. The percentage of products and services that are produced or sold by S&P 500 companies overseas has also been steadily declining and that trend is likely to continue. The law of averages seems to favor international equities as well. The bull market in the U.S. just celebrated its eight-year anniversary in March and returns have been much higher than those in developed overseas markets during this time. Diversification in these markets not only reduces the risk of a portfolio but it also increases the potential for higher returns. Long-term fundamentals look solid in international markets and valuations are certainly more attractive than those in the U.S., where much of the good news is already priced into the market.