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Stocks rebound strongly in a volatile week of trading

The message is clear – in the long run, stock returns depend almost entirely on the reality of the investment returns earned by our corporations. The perception of investors, reflected by the speculative returns, counts for little. It is economics that controls long-term equity returns; emotions, so dominant in the short-term, dissolve. – John Bogle

The roller coaster ride continued on Wall Street last week and when the closing bell rang on Friday, the major stock averages had posted solid gains. For the Dow Jones Industrial Average and the S&P 500 Index, it was the first weekly gain in December but the indices are still down about 10% for the month. Despite the positive week, the Dow is on track to record its worst performance in December since way back in 1931. The volatile week of trading began on Christmas Eve as the Dow plunged 653 points, the worst trading day ever on this date. Reports surfaced that President Trump was discussing how to remove Federal Reserve Chairman Jerome Powell, a move that could undermine investor confidence. To make matters worse, Treasury Secretary Steven Mnuchin called the heads of the six largest banks to reassure nervous investors about liquidity, something that raised more questions than answers. But the Dow snapped back on the day after Christmas with a gain of 1,086 points, which was the biggest one-day point gain ever for the Dow and the biggest one-day percentage rise for the major stock averages since March 2009. The market had been extremely oversold and there were reports that retailers were having their best holiday shopping season in six years. The wild ride resumed on Thursday as the Dow plummeted 611 points at its low of the day but rallied in the afternoon at the close to post a gain of 260 points, an increase of 1.1%. There was little in the way of economic data that would have caused such volatility, but sharp swings such as this can be caused by light trading volume and computer-driven trading, which tend to exacerbate any moves either up or down. Trading during the holiday season is normally very quiet as economic data is sparse and there are few if any quarterly corporate earnings reports. The trading last week was based primarily on emotions as there has been a huge gap between sentiment, which has been decidedly negative, and fundamentals, which continue to be positive and not supportive of a recession. The ongoing government shutdown is weighing on confidence and fears of a Fed monetary policy mistake, a prolonged trade war with China and a global economic slowdown are only adding to the uncertainty, which markets don’t like.

Last Week

The Conference Board’s consumer confidence index fell slightly in December but even with the drop, the index is likely to show solid economic growth in the short-term. Weekly jobless claims fell by 1,000 to 216,000, slightly better than expected, as claims remain just above their 49-year low, a positive sign for the labor market. Pending home sales in November declined to a 4-year low, a sign of weakness in the real estate market.

For the week, the Dow Jones Industrial Average gained 2.7% to close at 23,062 and the S&P 500 Index rose 2.9% to close at 2,485. The Nasdaq Composite Index jumped 4% to close at 6,584.

This Week

It will be a quiet week for economic data, but the important and potential market-moving December employment report will be released on Friday. It is expected to show that about 180,000 new jobs were added and that the unemployment rate remained at 3.7%. The December ISM Purchasing Manager’s Index (PMI) is expected to decline slightly from the previous month but still be comfortably in expansion territory.

Financial markets will be closed on Tuesday January 1st in observance of New Year’s Day.

There are very few quarterly corporate earnings reports scheduled this week and none from companies that are considered prominent.

Portfolio Strategy

Despite last week’s stock market gains, the three major stock averages are on pace to post their worst performance in December since the Great Depression. Much of the blame has been placed on the Federal Reserve, which raised interest rates as expected at its most recent meeting and signaled two additional rate hikes in 2019, down from its initial forecast of three rate hikes. Other factors contributing to the poor performance include the ongoing trade war with China with no resolution in sight, the partial government shutdown, political turmoil in Washington and fears of a global economic slowdown. Another reason for the weakness in December has been tax loss selling as investors sell stocks with unrealized losses to offset year-to-date realized capital gains in order to reduce their tax liability. Tax loss selling can make performance results worse than they otherwise might have been and causes mutual fund managers to sell their holdings to raise cash to meet redemption requests. But the forced selling in December gives way to January and the so-called January effect, when more normal trading returns to the market and there is typically a seasonal rally in stocks. Santa Claus failed to make an appearance in December, but hopefully the “January effect” can help lift stocks out of their doldrums in 2019.