The stock market is a device for transferring money from the impatient to the patient. – Warren Buffett
Although the stock market limped to the finish line by posting modest losses last week, all three major averages ended in positive territory in December and recorded impressive gains for the year. December has historically been the best-performing month for stocks and the market lived up to these expectations again this year. Not only was the S&P 500 Index up in December, but for the first time ever, this benchmark managed to end each month of the year with gains on a total return basis. In one of the least volatile years on record, the Dow Jones Industrial Average, S&P 500 Index and Nasdaq Composite Index were up 25%, 19% and 28%, respectively. Not since 1995 has there been a year so quiet and free of heart-stopping declines as the biggest pullback for the S&P 500 was just 2.8%. Last week’s market action was also quiet for a number of reasons. Trading volume was very light because of the holiday-shortened week and there were no quarterly corporate earnings reports for investors to review and decipher. There also seemed to be a lack of sellers as investors opted to postpone realizing capital gains until 2018. There was very little in the way of economic data, too. Holiday shoppers have been in a spending mood as sales were up 5% from the beginning of November through Christmas Eve and online shopping was up nearly 20% from the prior year. As a result, retail stocks rebounded with strong gains after falling out of favor earlier due to the dominance of online retailer, Amazon. Reports that Apple will cut its sales forecast for the iPhone X by as much as 40% in the quarter rattled the technology sector. But the biggest surprise may have been the price of oil, which touched $60 a barrel for the first time in over 2 years. Production cuts and the prospect of stronger global economic growth that would increase demand were the reasons behind the increase. Even though stocks in the energy sector have been among the weakest performers in 2017, it was among the best-performing sectors in December.
Consumer confidence fell in December and was below forecasts by economists. Consumers were less confident about their outlook for jobs and business conditions but despite the decline, their expectations remain at historically high levels. The Chicago Purchasing Manager’s Index (PMI) rose to its highest level since March 2011 and was well-above 60, which is an exceptional number. Weekly jobless claims were unchanged from the prior week and slightly above estimates, once again confirming a strong labor market that remains near full employment.
For the week, the Dow Jones Industrial Average edged down 0.1% to close at 24,719 while the S&P 500 Index dropped 0.4% to close at 2,673. The Nasdaq Composite Index fell 0.8% to close at 6,903.
The most important piece of economic data this week will be the December employment report that is released on Friday. The expectation is for 190,000 new jobs to be created and for the unemployment rate to remain at 4.1%. November construction spending and factory orders are both expected to show modest increases.
The Federal Open Market Committee (FOMC) will release the minutes from its December policy meeting and the U.S. Senate will reconvene to craft a spending bill that will avert a possible government shutdown.
There are very few quarterly corporate earnings reports on tap this week and of these, the most notable are Walgreens Boots Alliance, Monsanto and Constellation Brands.
Perhaps the biggest risk to the financial markets as we begin 2018 is inflation, which has been mostly nonexistent for the last eight years as the economy has recovered from the financial crisis. To be sure, price pressures are largely absent now. Both the core consumer price index (CPI) and the core personal consumption expenditures (PCE) index, the Federal Reserve’s preferred measure of inflation, have been running slightly below the Fed’s targeted inflation rate of 2%. Economic growth has begun to accelerate with GDP topping 3% in the third quarter and the passage of tax reform and tax cuts will likely boost growth even more. A cut in the corporate tax rate from 35% to 21% could lead companies to increase business investment and capital spending, which might fuel more hiring. Plans by the Trump administration to increase infrastructure spending, though probably a longshot now after passage of tax reform, could mean even more investment. Wage growth has also been rising faster recently and the annual rate is now above 2.5%. Changes in minimum-wage laws in many cities across the country are partly responsible for higher wages, which is the single biggest contributor to rising inflation. With increased economic growth brings increased demand and commodities such as oil and metals could rise along with agricultural products and materials. The price of oil ended the year at nearly $60 a barrel, its highest level in over 2 years, and could go even higher with increased demand and coordinated production cuts by OPEC. The yield on the 10-year Treasury stood at 2.41% at year-end, close to its highest level in recent months and possibly a harbinger of things to come. The Federal Reserve sees higher inflation this year, too, and has indicated that it plans to raise interest rates three times in its effort to remain vigilant and normalize monetary policy. For stock investors, rising inflation along with rising interest rates typically hurts utilities, telecom stocks and consumer staples while fixed income investors are best served by keeping bond maturities in the short-to-intermediate term range.