The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer. – Warren Buffett
The calendar may have changed last week from 2018 to 2019 but the volatility that characterized the month of December stayed the same. In another wild week of ups and downs, all three major stock averages posted solid gains for the second consecutive week. The gyrations began on Wednesday after the market closed when Apple announced that its first quarter revenue would be only $84 billion, well short of guidance that was in the range of between $89 billion and $93 billion. The company blamed the shortfall on China’s slowing economy and the news hit Apple’s stock hard along with the share prices of other companies that do business in China. Economic data also showed that manufacturing activity in China had contracted for the first time in 19 months and manufacturing data in Europe was also soft. The Dow Jones Industrial Average plunged 660 points or nearly 3% as investors feared that the trade war with China was sparking a global economic slowdown that could negatively impact corporate profits. A better than expected private payrolls report by ADP in December that showed the biggest gain in jobs since February 2017 did little to appease investors. On Friday morning, though, investors were greeted with the government’s December employment report, which showed that 312,000 new jobs were created and that the unemployment rate rose to 3.9% as more people looked for work. Wages rose faster than expected and the labor participation increased as more workers joined the labor force. The number of new jobs was almost double the number that was expected and both October and November job numbers were revised higher. Uncertainty over the strength of the economy seemed to be lifted. Not only was the jobs report strong, but Federal Reserve Chairman Jerome Powell said that the central bank would be “patient” with regard to the economy and would keep an open mind with regard to interest rate hikes. He stressed that the Fed has no pre-determined path for raising interest rates and that it would be flexible and data-dependent when making its decisions. His dovish remarks were icing on the cake and all three major stock averages ended the day over 3% higher.
The U.S. manufacturing Purchasing Manager’s Index (PMI) in December fell to a 15-month low but was still comfortably above 50, the threshold for expansion. Manufacturers reported higher costs due to price increases from tariffs and their optimism about the future fell.
For the week, the Dow Jones Industrial Average added 1.6% to close at 23,433 and the S&P 500 Index gained 1.9% to close at 2,531. The Nasdaq Composite Index rose 2.3% to close at 6,738.
The only piece of economic data due to be released this week is the December consumer price index (CPI), which is expected to decline slightly after a flat reading in November.
U.S. trade officials will meet with their Chinese counterparts this week to try to resolve their differences and reach an agreement. It will be the first meeting between the two countries since a 90-day truce was agreed upon on December 1.
The only prominent companies scheduled to report quarterly earnings this week are Delta Airlines, Bed Bath & Beyond, Acuity Brands and Constellation Brands.
Although bonds outperformed stocks in 2018, it was still a difficult year for fixed income investments on a total return basis and bond yields remained low, providing investors with few opportunities for income. In its effort to normalize monetary policy, the Federal Reserve raised interest rates four times last year, which put pressure on bond prices (bond yields and prices move in opposite directions). As a result of these increases, short-term bond yields rose and the yield on the 10-year Treasury climbed from 2.41% at the start of the year to 3.25% in October before falling and ending the year at 2.68%. For fixed income investors, this meant that only money market funds and short-term bond funds had positive total returns last year. Money market funds were generally up about 2% while short-term bond funds were up anywhere from 1% to 2% depending on their average maturity and duration. Rising interest rates did benefit investors with individual bonds as the proceeds from maturing bonds could be reinvested at higher rates. Long-term bond funds suffered the worst losses while those funds with intermediate-term maturity structures posted modest losses that were generally less than 2.50%. Although spreads between high yield bonds and Treasuries widened in the fourth quarter and provided investors with attractive yields, high yield bond returns were also negative in 2018. For investors in higher tax brackets, municipal bond funds actually bucked the trend and were up slightly as light issuance helped boost their prices. Other sources of high income, such as real estate investment trusts or REITs (yields of 4% or higher) and high dividend-paying stock funds (yields of about 3.5%) also performed poorly last year as both asset classes were down more than the S&P 500 Index.