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Dow closes at record high despite increased trade tensions

There are two kinds of investors, be they large or small: those who don’t know where the market is headed, and those who don’t know that they don’t know. Then again, there is a third type of investor, the investment professional, who indeed knows that he or she doesn’t know, but whose livelihood depends upon appearing to know. – William Bernstein, financial author, theorist and adviser

Investors brushed aside tariff announcements and trade tensions between the U.S. and China last week and propelled the Dow Jones Industrial Average to a record high close and the S&P 500 to a near-record close. The technology-laden Nasdaq Composite Index, however, fell victim to profit-taking and closed modestly lower as the so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google) sold off. Following through on his promise, President Trump imposed a 10% tariff on $200 billion of Chinese imports that could rise to 25% by year-end. He also threatened China with an additional $267 billion of tariffs unless a trade agreement is reached in the near future. China retaliated by slapping tariffs on $60 billion worth of U.S. products at 5% to 10% effective on September 24th. Although fears of a full-blown trade war are still a major concern for the markets, the tariffs announced by both sides last week were not as bad as feared. Investors took comfort in the fact that the U.S. economy is strong, corporate earnings are excellent and consumer confidence remains near all-time highs. But tariffs and trade concerns can be construed as inflationary, which can cause bond yields to rise. That is exactly what happened last week as the 10-year Treasury yield rose to 3.07% and the yield on the 2-year Treasury reached 2.81%. Rising interest rates usually are a headwind for stocks, but at the moment, investors view higher yields as an indicator that reflects a strong economy and faster growth, which should benefit corporate profits. Another positive sign for stocks last week was the fact that the Dow Jones Transportation Index hit a record high, which Dow Theory says should be a buy signal and lead to a higher stock market six to nine months from now. Time will tell whether or not this long-held belief has any merit.

Last Week

Leading economic indicators in August recorded a moderate increase and suggest that GDP growth in the last two quarters of the year will be at least 3%. Existing home sales in August were unchanged as the supply of homes for sale has been low, pushing up prices and discouraging prospective buyers. Housing inventory has also been affected by higher building material costs and land and labor shortages as well as rising mortgage rates, which has slowed demand. Weekly jobless claims fell by 3,000 to 201,000, less than forecast and the lowest level since November 1969.

For the week, the Dow Jones Industrial Average soared 2.3% to close at 26,743 and the S&P 500 Index gained 0.8% to close at 2,929. The Nasdaq Composite Index dropped 0.3% to close at 7,986.

This Week

There will be a plethora of economic reports this week and all of them are expected to be positive. The final September consumer confidence and University of Michigan consumer sentiment indexes should be at record highs. The final second quarter GDP reading should be 4.2% and August durable goods orders are expected to rebound strongly after falling in July. August new home sales are forecast to be slightly higher than in July and the September Chicago Purchasing Manager’s Index (PMI) is forecast to remain solidly in expansion territory.

The Federal Open Market Committee (FOMC) has a two-day meeting and is widely expected to raise the federal funds interest rate by a quarter percentage point to 2%-2.25%.

The most notable companies that are scheduled to report quarterly earnings this week include Nike, Conagra Brands, McCormick & Co., Carnival, CarMax, Accenture and KB Homes.

Portfolio Strategy

Dow Theory is a form of technical analysis that involves the relationship between the Dow Jones Industrial Average (DJIA) and the Dow Jones Transportation Average (DJTA). It was developed by Charles Dow, who founded the Wall Street Journal and created the Dow Jones Industrial Average. In short, it states that when one of these stock averages reaches an intermediate high, then the other is expected to follow suit within a reasonable amount of time. If this does not happen, then the averages are said to diverge and the stock market is likely to fall. At the time of its creation, the two stock averages consisted of the industrials and the rails and the rationale behind the theory was fairly simple: industrial companies manufactured the goods and the rails shipped them. If one average was at a new high, then it seemed logical that the other one would also be at a new high. If this was the case, then the two averages confirmed one another and the signal was considered valid. Last week, the Dow Jones Transportation Average hit a record high while the Dow Jones Industrial Average also rallied to its first new high since January. This confirmation is a positive sign for market technicians and suggests that the bull market in stocks still has legs and could continue to move higher. While there are negative factors that should also be considered, such as trade tensions and tariffs, rising interest rates, slowing global growth and divergence between the U.S. and overseas markets, this positive Dow Theory correlation bodes well for the stock market over the near term.