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Stocks post modest losses as 10-year Treasury yield rises to 3.07%

If you’re in the luckiest 1% of humanity, you owe it to the rest of humanity to think about the other 99%. – Warren Buffett

In a relatively quiet and uneventful week, stocks gave back some of the solid gains from the previous week as all three of the major stock averages posted modest losses. With the first quarter earnings season largely behind us and a lack of potential market-moving economic data, there were no catalysts to continue the stock market momentum. The Dow Jones Industrial Average extended its winning streak to eight days on Monday but had its streak stopped on Tuesday as Home Depot beat earnings estimates but missed revenue expectations. The stock plunged on the news with management citing a slow start to spring sales due to inclement weather. On the same day, however, retail sales in April posted a moderate increase that was in line with estimates and sales in March were revised higher, suggesting that consumer spending still remains strong. Because the Dow had been on such a strong run, investors may have been just looking for an excuse to sell and take some profits. The biggest headwind for stocks last week was the rise in the 10-year Treasury yield to 3.12%, although it fell back and ended the week at 3.07%. This is the highest level for this benchmark yield since 2011 and a worrisome sign that inflation expectations may be rising. Gasoline prices have also been steadily climbing and a strong labor market with an unemployment rate of only 3.9% may eventually lead to higher wage growth and higher inflation. As long as interest rates do not rise too far or too fast, though, strong equity fundamentals should enable stocks to perform well as the year progresses. One beneficiary of higher gasoline and oil prices has been the energy sector, which was the best-performing sector last week and has been the second best-performing sector this year behind the technology sector. The focus again this week will likely be interest rates as the Federal Open Market Committee (FOMC) releases minutes from its May meeting and investors look for clues about future monetary policy and interest rate hikes.

Last Week

Industrial production in April was stronger than expected and was up for the third consecutive month while the New York Empire State Index, a regional measure of manufacturing, was also better than expected in May. Both pieces of data suggest that the outlook for manufacturing remains bright. The National Association of Home Builders sentiment index was very strong as demand remains healthy and supply remains tight. April leading economic indicators, which measure 10 key metrics of economic activity, rose for the sixth straight month and portend solid U.S. economic growth.

North Korea threatened to cancel the upcoming summit meeting with the U.S. over planned joint military exercises between the U.S. and South Korea. The U.S. promptly cancelled the exercises. President Trump also decided to assist ZTE, China’s second largest telecom equipment maker, after it had been slapped with trade sanctions by the U.S. This about-face to save jobs at the company was viewed by many as a way to ease tensions with China ahead of the meeting with North Korea.

For the week, the Dow Jones Industrial Average shed 0.5% to close at 24,715 while the S&P 500 Index also lost 0.5% to close at 2,712. The Nasdaq Composite Index declined 0.7% to close at 7,354.

This Week

April new and existing home sales are both expected to fall from levels reported in March but still be consistent with a strong housing market. April durable goods orders, which tend to be very volatile from one month to the next, are forecast to drop after posting a big gain in March.

Retailers will again dominate this week’s earnings agenda as TJX Companies, Kohl’s, Target, Tiffany, Lowe’s, Gap and Best Buy are scheduled to report. Other prominent companies on the list include Eaton Vance, Toll Brothers, Medtronic, McKesson and AutoDesk.

Portfolio Strategy

Rising crude oil prices and higher gasoline prices can be a double-edged sword. On the one hand, the rally in crude oil has enabled stocks in the energy sector to outperform and has helped boost returns in the S&P 500 Index this month. Higher oil prices also typically boost capital spending by oil producers and lead to more investment and more job creation, which helps increase economic growth. The rise in oil prices has  been accompanied by a concurrent rise in the yield of the 10-year Treasury, which settled at over 3.0% last week. Expectations for accelerating wage inflation due to the ongoing strength of the labor market have also contributed to the increase in Treasury yields. On the other hand, there is a downside to higher oil prices.  They result in higher gasoline prices for consumers at the pump, acting like a tax that effectively reduces their discretionary income and has an impact on consumer spending. Since consumer spending accounts for roughly two-thirds of all economic activity, less spending could have an adverse effect on growth and the overall health of the economy. However, the positive effect that higher oil prices have on energy companies is much more immediate while the negative effects on consumers are usually delayed and drawn out over time. While higher oil prices will reduce profit margins for companies that use energy, corporate earnings should nevertheless remain strong as U.S. economic growth accelerates and global central banks remain mostly accommodative.