Stocks post modest gains despite geopolitical concerns

As in roulette, same is true of the stock trader, who will find that the expense of trading weights the dice heavily against him. – Benjamin Graham

Geopolitical news dominated the headlines last week and when the markets finally closed on Friday, both the S&P 500 Index and the Dow Jones Industrial Average managed to post modest gains. The Nasdaq Composite Index bucked the trend and jumped over 1% while the Russell 2000 Index of small cap stocks briefly traded at a new all-time high. After hinting that the summit meeting with North Korea may not happen after all, President Trump officially canceled the meeting on Thursday, citing angry rhetoric from North Korea that was not conducive to reaching an agreement. This missed opportunity was offset by better news with regard to China as trade tensions eased with the U.S. and both countries agreed to suspend tariff threats and put a trade war on hold. Talks have been productive between the two countries but concrete measures must be implemented and enforced for the meetings to be considered a success. China said it lowered tariffs on automobiles and said it would purchase more U.S. farm and energy products. Despite these assurances, President Trump expressed dissatisfaction with the trade negotiations and efforts to close the $335 billion trade deficit with China. With little in the way of quarterly earnings reports and important economic data last week, the only other newsworthy event was the release of the Federal Open Market Committee (FOMC) minutes from the meeting in May. They showed that Fed officials were comfortable with letting inflation run above their 2% target as the economy continues to recover. They also telegraphed another interest rate hike at the June meeting but believed that economic growth should be allowed to accelerate before becoming too aggressive. All in all, investors seemed pleased with the Fed’s gradual approach to raising interest rates and believed that the economy would not be disrupted in any way.

Last Week

Existing home sales in April fell more than expected while new home sales fell less than expected although in both cases, a shortage of homes for sale at the lower end of the market and tight inventories were driving prices higher. Orders for durable goods dropped in April as demand for transportation equipment plunged. However, core capital goods orders which exclude aircraft were better than expected and are a good proxy for business spending plans.

In corporate news, General Electric announced that it is merging its transportation business with Wabtec, a rail equipment maker, in a deal valued at $20 billion while Fifth Third Bancorp agreed to buy MB Financial for $4.7 billion. Micron Technology, a computer chip manufacturer, raised its earnings guidance for the year and helped boost shares of companies in the semiconductor industry.

For the week, the Dow Jones Industrial Average added 0.2% to close at 24,753 while the S&P 500 Index gained 0.3% to close at 2,721. The Nasdaq Composite Index climbed 1.1% to close at 7,433.

This Week

The employment report for May is forecast to show that about 190,000 new jobs were created and that the unemployment rate remained at 3.9%. The May Chicago Purchasing Manager’s Index (PMI) is expected to be comfortably in expansion territory and April construction spending is expected to bounce back with a modest increase after declining in March. The final reading for first quarter gross domestic product (GDP) should be 2.3% and May consumer confidence should remain at very high levels.

Among the most notable companies on the earnings calendar this week are HP, Analog Devices, Dick’s Sporting Goods, Dollar Tree, Dollar General, Ulta Beauty, Abercrombie & Fitch and Costco Wholesale.

Portfolio Strategy

What was surprising in the minutes of the most recent Federal Reserve meeting was the fact that the Fed would allow inflation to run above its 2% target without necessarily raising interest rates right away. Fed officials have always viewed 2% inflation as the level that would sustain economic growth without causing inflation to spike. Their preferred inflation gauge, the core personal consumption expenditures (PCE) index, is currently at 1.9% with the headline rate that includes food and energy prices at 2%. The biggest and most worrisome component of inflation, wages, were described by the Fed as “moderate”, although recent data suggest that wage growth has been relatively modest. Most Fed officials seemed to agree that after years of below average economic growth and low inflation, it would be appropriate to let the economy build some momentum before applying the brakes. At the moment, two additional interest rate hikes are forecast by the Fed, but odds of a third increase have risen and will depend on the strength of the economy and levels of inflation. Expectations are for economic growth to accelerate after only modest growth of 2.3% in the first quarter and for wage growth and inflation to pick up as the labor market remains tight. While trade issues, fiscal policy and capital spending are concerns, the Fed’s outlook for the economy remains bright. Fed officials cited a number of positives, including above-average growth, a strong labor market, favorable federal tax and spending policies, strong overseas growth and high levels of consumer and business confidence. Above all else, the Fed seemed confident that it could raise interest rates gradually without hurting the economy, a course of action that should keep the current expansion intact.