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Stocks post strong gains as optimism over tax reform grows

As long as you enjoy investing, you’ll be willing to do the homework and stay in the game. That’s why I try to make the show entertaining, because if you aren’t interested, you’ll either miss the opportunity to make money in the market or not pay enough attention and end up losing your shirt. – Jim Cramer, former hedge fund manager and host of CNBC’s Mad Money

The stock market continued its relentless rise last week as optimism increased over the possibility of tax reform and tax cuts and economic data was mostly positive. All three major stock averages posted impressive gains of at least 1% with investors climbing aboard the rally for fear of missing out on any future gains. The slow and steady rise of the S&P 500 Index has also been remarkable for its lack of volatility. This widely-followed benchmark is poised to set a record this week for the longest period of time without a 5% correction, 334 days. Market expectations of continued low interest rates and passage of tax reform are a powerful combination that could keep this bull market in stocks alive for a while longer. One of the prerequisites for tax reform is passage of a budget resolution, which the House of Representatives accomplished last week, setting the stage for an overhaul of the tax code. Philadelphia Federal Reserve President Patrick Harker emphasized the benefits of tax reform when he said that the economy will remain mired in 2% growth until a tax plan is implemented. While there is much work to be done before any tax reform becomes law, investors appear willing to give Congress the benefit of the doubt, at least for now. The most important piece of economic data last week was the September employment report, which was a shock in that the economy actually lost 33,000 jobs, the first monthly decline in 7 years. Expectations were for an increase of 90,000 jobs but the effects of Hurricanes Harvey and Irma were far worse than thought as more people were unable to work. On a positive note, the unemployment rate fell to 4.2%, the lowest level in 16 years, and hourly wage growth was better than expected. The drop in payrolls should be temporary, too, as hiring should come back in October and more than erase the decline. The next major hurdle for stocks will come this week as the third quarter earnings season features financials and money center banks.

Last Week

The weak September jobs data was definitely a surprise, but the rest of the economic data released last week was positive. The ADP private sector jobs report for September was better than expected and the weekly jobless claims fell 12,000 to 260,000 as layoffs are expected to remain low. The ISM manufacturing index reached its highest level since May 2004 and the ISM non-manufacturing or services sector index also beat estimates and recorded its highest reading since August 2005. Factory orders rebounded in August and were better than forecast, a sign that business spending remains strong. General Motors, Ford and Fiat Chrysler all reported better than expected automobile sales for September, thanks in part to discounts and the need for people to replace vehicles damaged or destroyed by the hurricanes.

For the week, the Dow Jones Industrial Average jumped 1.6% to close at 22,773 while the S&P 500 Index rose 1.2% to close at 2,549. The Nasdaq Composite Index climbed 1.5% to close at 6,590.

This Week

Both the September producer price index (PPI) and the consumer price index (CPI) are expected to post bigger increases than the previous month but remain relatively benign and consistent with an economy that is growing modestly. September retail sales are forecast to rebound strongly after posting a slight decline in August. The preliminary University of Michigan consumer sentiment index for October should remain high as consumers remain optimistic about the economy and the job market.

Banks and financials will dominate this week’s third quarter earnings reports as JP Morgan Chase, Citigroup, Bank of America, Wells Fargo, PNC Financial Services and Blackrock are all on the agenda. Delta Airlines and Marriott are two other notable companies scheduled to release their profit reports.

Portfolio Strategy

One of the best-performing asset classes this year has been international developed markets as central banks in Europe and Japan remain very accommodative, helping to stimulate faster economic growth and resulting in stronger corporate earnings. Valuations have also been more compelling in overseas markets than in the U.S., where the S&P 500 Index currently trades at 19 times estimated earnings for 2017, higher than the historical average of 15. One of the best-performing mutual funds in the international space has been the Oakmark International Fund (OAKIX), which invests primarily in mid and large-cap non-U.S. companies that are priced below their estimate of intrinsic value. About 83% of the funds’ assets are currently invested in Europe and the United Kingdom with about 11% invested in Asia, primarily in Japan. The fund receives a 5-star rating from Morningstar, a mutual fund rating service, which is the highest rating assigned to a mutual fund for performance over a 3, 5 and 10-year time period. Since the fund’s inception in 1992, its average annual return has been 10.1%, easily beating the MSCI World ex-U.S. Index total return of 6.1%. The fund was up 27.1% on a year-to-date basis through the close of business on Friday and posted a total return of 9.1% in the 3rd quarter, compared to 5.6% for the benchmark. The Oakmark International Fund has long been recognized as one of the top-performing foreign funds and should be considered a core holding in the international space. Despite the fund’s strong year-to-date performance, it should continue to do well as there is still room for European multiples to expand as equity valuations remain attractive.