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Stocks strong as Dow shatters 25,000 level, Nasdaq closes above 7,000

The boom and the bust were normal – just two more swings in stock returns over the past century. Reversion to the mean is the iron rule of the financial markets. – John Bogle

The stock market picked up this past week where it left off last year as all three major stock averages closed at all-time highs. Not since 2006 have stocks begun a year this strong as the market was up every day last week. The Dow Jones Industrial Average broke through the 25,000 level for the first time ever and, in doing so, recorded the fastest 1,000 point move in the history of the index. It took just 23 days for the Dow to go from 24,000 to 25,000. The technology-heavy Nasdaq Composite Index also recorded a milestone by closing above 7,000 for the first time ever. Not to be outdone, the broad-based S&P 500 Index gained 70 points and was up 2.6% in the holiday-shortened week. Over the past 20 years, statistics show that if the S&P 500 ends the first trading day of the year higher, it averages a 14% return for the full year; if it is down, the full year return is basically flat. It was a remarkable start to the year and reflected optimism that better economic growth will translate into strong earnings growth. Although economic data last week was mostly positive, it hardly justified such huge gains in stock prices. The December employment report showed that only 148,000 new jobs were created, fewer than the 190,000 jobs that were expected, and that the unemployment rate remained at 4.1%. However, the November jobs number was revised higher by 24,000 and the ADP report showed that 250,000 private sector jobs were created, far more than expected. Wage growth continued to be modest, though, suggesting that inflation may remain mild and cause the Federal Reserve to be less aggressive in hiking interest rates this year. The market even brushed aside some geopolitical concerns. Protests erupted in Iran over rising inflation and corruption and North Korea completed its nuclear weapons program and claimed a missile could reach any point in the U.S. The rising stock market tide lifted other boats as well with gold and oil ending the week higher and the yield on the 10-year Treasury rising to 2.48%.

Last Week

The ISM manufacturing index in December was strong and recorded its second best reading of the year while the ISM services sector index was also strong and in line with estimates. Factory orders rose more than expected in November but U. S. automobile sales fell slightly for the year, the first annual decline since the financial crisis. The Atlanta Federal Reserve raised its GDP forecast for the fourth quarter to 3.2% from 2.8%.

Minutes from the December Federal Reserve meeting showed that Fed officials raised their expectations for 2018 GDP growth due to tax reform as cuts will boost consumer and business spending. They were concerned, however, that savings from the corporate tax cuts would be spent on dividends and stock buybacks and not capital spending and more hiring.

For the week, the Dow Jones Industrial Average jumped 2.3% to close at 25,295 while the S&P 500 Index climbed 2.6% to close at 2,743. The Nasdaq Composite Index surged 3.4% to close at 7,136.

This Week

Investors will get a good look at inflation this week as import prices for December are forecast to be lower than in November while the December producer price index (PPI) and the consumer price index (CPI) are expected to increase only modestly. Retail sales for December are expected to be about half the increase reported last month but should still be considered fairly strong.

This week marks the first week of the fourth quarter earnings season and financials will dominate as Bank of America, Blackrock, Wells Fargo, PNC Financial Services and JP Morgan Chase are scheduled to report.

Portfolio Strategy

It was a banner year for financial assets in 2017 as all of the major asset classes posted positive returns. Emerging market stocks in countries such as China, Taiwan, India, Brazil and South Africa were at the top of the list with an average return of 31.4%. Closely behind developing market stocks were foreign stocks that comprise the EAFE Index, which stands for Europe, Australasia and the Far East. This benchmark had a total return of 25.0% as companies in Europe and Japan benefited from continued easy central bank monetary policies and improved economic growth. The S&P 500 Index posted a total return of 21.8% and was led by the technology sector, which was the best-performing sector with a return of 37.1%. The only two sectors with negative returns were energy, with a loss of 2.4%, and telecom, with a loss of 5.4%. Within the large cap stock space, there was a wide discrepancy between the performance of growth and value stocks. Growth stocks, such as those in the technology, health care and biotechnology sectors, typically trade at higher price earnings ratios, have lower dividend yields and more consistent earnings growth. They were the big winners last year as the average large cap growth fund returned about 28%. Value stocks, on the other hand, include sectors such as financials, energy, industrials, materials and utilities and trade at lower multiples with higher dividend yields. They usually benefit from a stronger economy. The average return from value stocks last year was about 17%. Small cap stocks trailed large caps as the Russell 2000 Index gained 14.7%. As far as alternative investments were concerned, real estate investment trusts or REITs were up 4.9% and gold returned 11.4%. As expected, fixed income investments were the worst performing major asset class as interest rates remained low throughout the year. The Barclays U.S. Aggregate Bond Index posted a total return of 3.5% in 2017.