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Stocks post solid gains on optimism over U.S.-China trade talks

The stock market goes up or down, and you can’t adjust your portfolio based on the whims of the market, so you have to have a strategy in a position and stay true to that strategy and not pay attention to noise that would surround any particular investment. – John Paulson

The stock market continued its winning ways last week as all three major averages closed higher for the third consecutive week. Although stocks closed slightly lower on Friday, it was the first time since September that the stock market posted a 5-session winning streak. Trade officials from the U.S. and China concluded their meetings this past week and there was renewed optimism that the trade talks went well and that both sides moved closer to an agreement. While there was nothing definitive, reports indicated that negotiations were positive as President Trump tweeted that the two sides made significant progress. With both countries seeing a slowdown in economic growth, it would be in their best interest to end the trade war as soon as possible. The same urgency seems lost on the federal government as it set a record over the weekend for the longest government shutdown in U.S. history, 22 days and counting. So far the stalemate between President Trump and the Democrat-controlled House has had no effect on the stock market, but a prolonged shutdown could begin to show up in economic data. Investors chose to ignore potential negative effects from a shutdown crisis and, instead, focused on minutes from the most recent Federal Reserve meeting, which were mostly dovish in their tone. They showed that Fed officials were divided on whether to raise the federal funds rate by a quarter of one percent in December since inflation was below their 2% target. The minutes clearly showed that the Fed could afford to be patient about any further rate hikes due to the lack of any inflationary pressures. Their forecast was cut from four interest rate hikes to only two in 2019 due to other concerns as well, including escalating trade tensions, slowing global growth prospects, weakening corporate profits and volatility in financial markets. The minutes also emphasized that there was no preset path for interest rate hikes and that future economic and market data would determine any change in policy. With a lot of bad news already priced into stocks, these comments were welcome news to investors.

Last Week

The ISM non-manufacturing or services sector index was lower than expected in December and at the slowest pace since July, but still comfortably in expansion territory. The consumer price index (CPI) in December posted its first decline in nine months due to the plunge in gasoline prices. Over the past 12 months, the CPI increased 1.9%, the first time it has fallen below the 2% level since August 2017.

For the week, the Dow Jones Industrial Average rose 2.4%% to close at 23,995 and the S&P 500 Index added 2.5% to close at 2,596. The Nasdaq Composite Index jumped 3.5% to close at 6,971.

This Week

The December producer price index (PPI) is also expected to decline slightly after edging higher in November. The preliminary University of Michigan consumer sentiment index for January is expected to fall slightly from its reading in December but still be indicative of strong consumer confidence and optimism about future economic and job prospects.

Financial companies will dominate the first week of fourth quarter corporate earnings season and the most prominent of these include Citigroup, Bank of America, JP Morgan Chase, US Bancorp, Wells Fargo, PNC Financial Services, Charles Schwab, Goldman Sachs, Morgan Stanley and American Express. Other notable companies scheduled to report include UnitedHealth, Netflix, CSX, Schlumberger and Delta Airlines.

Portfolio Strategy

The primary focus this week will be on fourth quarter earnings, which are expected to be strong with nearly 15% profit growth. The real test for the stock market, though, will be company earnings guidance for both the first quarter and the full year. Several companies such as Apple and Samsung have already warned investors that their revenue and earnings would fall short of analysts’ estimates and their stocks have reacted negatively. After a dismal December that saw the stock market post its worst performance in the month since the Great Depression, stocks have rebounded about 10% from their lows on Christmas Eve with the S&P 500 Index trading just below 2,600. While most of the bad news on fourth quarter earnings has already been announced, any results or guidance about future earnings that are worse than expected could send the stock market lower. On the other hand, if earnings are better than expected and companies make positive comments about their future business prospects, stocks could add to their recent gains. Expectations are for earnings growth to be about 4% in the first quarter and approximately 7% for the full year compared to nearly 24% profit growth in 2018. The recent strength of the S&P 500 has raised the price earnings multiple on estimated earnings for 2019 to 15 from 14, but this is still less than the average price earnings ratio of 16 over the last 25 years. Although the worst of the stock market decline is probably over, there are still a number of geopolitical risks that could negatively impact stocks. For this reason, volatility is expected to remain high throughout the earnings season.