Stocks post gains on positive economic data

The investor’s chief problem – and his worst enemy – is likely to be himself. In the end, how your investments behave is much less important than how you behave – Benjamin Graham

Despite ongoing threats of increased tariffs on China, stocks rebounded last week with healthy gains as a plethora of economic data was mostly positive. All of the major stock averages were up at least 1% with the strong showing reflecting a vibrant economy with solid fundamentals. Inflation data dominated the economic calendar last week and all of the news was favorable. The producer price index (PPI) for August recorded its first drop since February 2017 while the core PPI, which excludes food and energy, edged up only slightly. Both readings were less than expected. The consumer price index (CPI) for August was also relatively benign as the headline and core numbers increased modestly and were both less than forecast. The core CPI has now risen only 2.2% in the 12 months through August. Perhaps the biggest surprise in the inflation data was import prices for August, which fell more than forecast and registered the biggest decline in more than one and a half years. A strong dollar was responsible for much of the decline as it reduced inflationary pressures on all imported goods, especially the cost of oil and other fuels. All of the soft inflation data sparked speculation that the Federal Reserve might forego a planned interest rate hike in December, although an increase at their September meeting is all but assured. But tariffs and trade war fears continued to hang like a cloud over the markets as President Trump reiterated his threat of an additional $267,000 in tariffs on top of the $200,000 in tariffs waiting to be imposed. Unless an agreement is reached between the U.S. and China that resolves their trade differences, the stock market is likely to consolidate its recent gains and trade sideways over the near-term.

Last Week

In addition to the inflation data, other economic data released last week was also favorable. Fueled by tax cuts and deregulation, the National Federation of Independent Business (NFIB) Small Business Optimism Index jumped to its highest level ever recorded. The preliminary University of Michigan consumer sentiment index for September was also much higher than expected. Industrial production in August was better than forecast and weekly jobless claims fell 1,000 to 204,000, a level not seen since December 1969. Although August retail sales were below forecasts, July was revised sharply higher.

The Federal Reserve’s Beige Book also lent credence to a strong economy as it said that the economy was expanding at a “moderate pace” with the Fed committed to gradually raising interest rates. Their biggest worries were trade war fears, tariffs and worker shortages.

For the week, the Dow Jones Industrial Average rose 0.9% to close at 26,154 and the S&P 500 Index gained 1.1% to close at 2,904. The Nasdaq Composite Index added 1.4% to close at 8,010.

This Week

There will be only a few economic reports released this week. Both August housing starts and existing home sales are expected to be above the numbers reported in July and August leading economic indicators are forecast to post a moderate increase slightly above what was reported in July.

The Bank of Japan announces its monetary policy and the central bank is expected to maintain its negative interest rate of -0.1%.

In a slow week for quarterly earnings reports, the most prominent companies on the agenda include Oracle, Micron Technology, FedEx, AutoZone, General Mills and Darden Restaurants.

Portfolio Strategy

Even though the inflation data last week was relatively soft, the Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) index, is currently at 2%, the Fed’s targeted rate. Due partly to the sharp upward revision in July retail sales on Friday, the yield on the 10-year Treasury climbed to 3.0% while the 2-year Treasury yield rose to 2.78%. Most economists also are forecasting at least 3% GDP growth in the third quarter and the labor market continues to be strong with only a 3.9% unemployment rate. In addition, the August employment report reported the highest wage growth since April 2009. Since consumer spending accounts for two-thirds of total U.S. economic output, all of these strong economic factors could cause the Fed to raise interest rates twice more this year – in September and December. The odds of a December rate hike increased last week as the European Central Bank (ECB) indicated that it would begin to wind down its asset purchase program. While the Bank of Japan is expected to leave monetary policy unchanged this week, the Federal Reserve has signaled in the past its desire to gradually normalize monetary policy. The yield on the 10-year Treasury has reached the 3% level four other times this year, but has failed to hold that level for very long each time. Global bond yields also rose last week as central banks seem to be following the U.S. lead in being less accommodative going forward. If this trend continues, investors would be wise to shorten the duration of their bond portfolios to minimize the risk of loss caused by rising interest rates.