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S&P 500 falls nearly 4% as investor sentiment turns negative

Investors must keep in mind that there’s a difference between a good company and a good stock. After all, you can buy a good car but pay too much for it. – Richard Thaler, American economist

In the worst Thanksgiving week decline since 2011, all of the major stock averages were down more than 3%, with the Nasdaq Composite Index and the Dow Jones Industrial Average posting the worst losses. Leading the decline were the so-called FAANG stocks (Facebook, Amazon, Apple, Netflix and Google), which have all dropped more than 20% from their 52-week highs. Apple fell sharply last week on a report that the company has cut production orders for the new iPhones unveiled earlier this year. The broad stock market has also been hit hard as investor sentiment has turned decidedly negative on global trade concerns and fears of slowing economic growth. The S&P 500 Index has now given back all of its gains for the year and has a year-to-date total return of just 0.2%. Oil prices also continued to slide last week with a barrel of West Texas Intermediate falling to about $50, the lowest price of the year. While there was no definitive data on supply and demand, the plunge in oil prices from $76 a barrel in October is more a function of too much supply rather than weak demand. OPEC is scheduled to meet on December 6th and there is speculation that they will agree to cut production in order to lift oil prices. Ongoing trade tensions between the U.S. and China are also causing worries among investors as they fear that a deal will not be reached soon. It is hoped that a planned meeting between President Donald Trump and Chinese President Xi Jinping at the G-20 summit meeting at the end of the week will lay the groundwork for a trade agreement. The market also has concerns about Federal Reserve monetary policy and the possibility of a policy mistake by the Fed. While the Fed is widely expected to raise the federal funds rate by a quarter of one percent in December, it is less clear what their intentions are next year. The expectation has been for an additional three rate hikes in 2019, but the federal funds futures market is now forecasting only one rate hike due to the anticipated slowdown in global growth. The market does not like uncertainty and right now, there are a number of issues whose outcome remains unclear.

Last Week

Durable goods orders in October fell more than expected but excluding transportation orders, orders were basically flat. Business investment was also flat, causing concern about slowing economic growth and rising trade tensions with China. October housing starts rose due to a rebound in multi-family housing projects but single-family homes fell as higher mortgage rates caused weakness. The National Association of Home Builders (NAHB) home builder confidence survey dropped to its lowest level in over two years but was still considered favorable with a reading of 60. Anything above 50 is positive. The final University of Michigan consumer sentiment index fell slightly but was still high while weekly jobless claims rose 3,000 to 224,000, more than expected.

For the week, the Dow Jones Industrial Average lost 4.4% to close at 24,285 and the S&P 500 Index dropped 3.8% to close at 2,632. The Nasdaq Composite Index declined 4.3% to close at 6,939.

This Week

The preliminary third quarter gross domestic product (GDP) is expected to be 3.5% compared to 4.2% in the second quarter. October new home sales are forecast to be higher than those in September while the November Chicago Purchasing Manager’s Index (PMI) is expected to be comfortably in expansion territory, a sign of strength in the manufacturing sector.

Federal Reserve Chairman Jerome Powell is scheduled to speak at the Economic Club of New York and the Federal Open Market Committee (FOMC) releases the minutes from its meeting earlier in the month.

Among the most notable companies scheduled to report quarterly earnings are Dick’s Sporting Goods, Dollar Tree, Abercrombie & Fitch, Tiffany, Eaton Vance, HP, Rockwell Collins and JM Smucker.

Portfolio Strategy

Third quarter earnings have been strong and recent economic data has been mostly positive, but the stock market is forward-looking and not backward-looking and it is now more concerned with the future and potential pitfalls. The market is currently in a correction, defined as a loss of 10% or more from recent highs. A bear market is a loss of 20% or more and is usually caused by a recession, which is highly unlikely given our current economic growth and projections of modest growth next year. Since 1980, there have been 11 market corrections and those related to geopolitical events, such as current tensions between the U.S. and China over trade, tend to be short-lived. There also is a widely-held belief that rising interest rates lead to poor stock market returns. The theory holds that higher rates make bonds relatively more attractive versus stocks and help slow economic growth, which in turn reduces corporate profits. But history shows that in times of rising interest rates, stock market returns have mostly been positive. While stock market valuations have also been a concern, the S&P 500 Index now trades at its lowest valuation in nearly two years. This benchmark now is valued at 16 times estimated operating earnings for 2018 and less than 15 times earnings estimates for 2019. The market seems to have discounted a possible slowdown in global economic growth with the recent sell-off. In times like these, it may be tempting for investors to sell their equity holdings and move to the sidelines. However, studies have shown that market-timing is next to impossible to execute successfully and usually results in selling low and buying high, exactly the opposite of what one should be doing.