The number one idea is to view a stock as an ownership of the business and to judge the staying quality of the business in terms of its competitive advantage. Look for more value in terms of discounted future cash flow than you are paying for. Move only when you have an advantage. – Charlie Munger
Stocks tacked on modest gains last week to run their winning streak to three consecutive weeks and in doing so, both the S&P 500 Index and the Nasdaq Composite Index closed at all-time highs. The biggest factor in the recent strength of the market has been first quarter corporate revenue and earnings, which have mostly beaten analysts’ estimates. Not only have earnings risen 11% in the quarter, but companies have issued positive earnings guidance for the balance of the year. While there were a number of important news items last week, none of them had much impact on the stock market. Congress managed to stave off a government shutdown but President Trump expressed his frustration with government by commenting that what the country really needs is a “good shutdown”. The House of Representatives also finally passed a replacement bill for Obamacare and investors were surprisingly calm ahead of the French election on Sunday, probably because centrist Emmanuel Macron had a big lead in the polls over far-right candidate Marine Le Pen. In other news, the Federal Open Market Committee (FOMC) met and decided to leave interest rates unchanged, which was widely expected after the anemic GDP number reported for the first quarter. The federal funds rate is now in a range of between 0.75% and 1%. The Fed shrugged off the weak growth in the quarter as being transitory and was confident that the economy would accelerate in the second and third quarters. Fed officials also mentioned the recent decline in the core rate of inflation but said that overall inflation was approaching the Fed’s 2% target. As a result, its plan to raise interest rates gradually was still in place and the odds of a rate hike in June increased to about 75%. This news benefited stocks in the financial sector as higher rates are favorable for banks but energy stocks were weak as the price of oil fell to $46 a barrel on tepid demand, excess supply and sluggish economic growth.
The April employment report showed that 211,000 new jobs were created, much more than expected, and far more than the 79,000 created in March, which was revised lower from 98,000. The unemployment rate fell to 4.4%, the lowest level since May 2007, and likely assures that the Federal Reserve will raise interest rates in June. The ISM manufacturing index for April declined slightly and was less than expected while the ISM non-manufacturing index or services sector index topped expectations. Both reports were solidly above the 50 threshold, an indication of continued expansion. Productivity in the first quarter recorded its biggest decline in a year, a sign that the slowdown could impact wage growth.
The core personal consumption expenditures (PCE) index, which excludes food and energy, slipped in March and has risen 1.6% in the 12 months ended in March. This is the Federal Reserve’s preferred measure of inflation for determining whether or not inflation has reached its 2% target.
For the week, the Dow Jones Industrial Average added 0.3% to close at 21,006 and the S&P 500 Index gained 0.6% to close at 2,399, a record high. The Nasdaq Composite Index rose 0.9% to close at 6,100, also a record high.
Both the April producer price index (PPI) and the consumer price index (CPI) are expected to increase modestly after falling in March and signal that inflation remains benign. Retail sales for April are expected to rebound strongly after declining slightly in March. The University of Michigan consumer sentiment index for May should remain elevated as consumers remain optimistic about the economy and the labor market.
Retailers will dominate the earnings reports this week as Macy’s, Kohl’s, JC Penney, Nordstrom and Whole Foods Market are on the agenda. Other notable companies scheduled to report include Walt Disney, Aon, Duke Energy, Tyson Foods, Sysco, Newell Brands and Mariott International.
While April showers bring May flowers, the month of May also brings that old adage “sell in May and go away”, which implies that investors should sell their stocks and go to cash during the summer months as returns are less than they are the rest of the year. Historically, the period May through September has not provided investors with the highest returns. Data show that since 1950, the S&P 500 Index has averaged only a 0.2% gain in May and has averaged modest losses in August and September. The month of June has been flat while there has been only a 1% gain in July. However, when the market has been in an uptrend leading into May, like it has been in recent months, that positive performance is likely to continue, providing investors with even higher returns. Of course, returns are also influenced by positive economic data as well as strong earnings and both have been major drivers behind the rise in stock prices recently. But even if the stock market was not in an uptrend, it’s never a good idea to try to time the market. Not only does an investor have to be right on when to sell stocks, but he also has to be right on when to get back into the market. Such a strategy is a fool’s game that is rarely successful and can have disastrous consequences to a portfolio’s return. Since asset allocation accounts for over 90% of a portfolio’s return, the best course of action is to decide on a mix of stocks, bonds, alternative investments and cash that is appropriate for an investor’s age, time horizon and risk tolerance and to rebalance the portfolio periodically to make sure the allocation still makes sense.