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Despite strong earnings, S&P 500 posts slight decline on trade worries

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists. – Benjamin Graham

The S&P 500 Index saw its four-week winning streak halted last week as it closed modestly lower but the Dow Jones Industrial Average and Nasdaq Composite Index bucked the trend to post modest gains. News on Friday that the longest partial government shutdown in U.S. history finally ended after 36 days had little effect on the stock market, which had risen 10% since the shutdown began. Political differences rarely have much effect on stocks and this time was no different as the market ignored the shutdown and focused on the economy and earnings, which remain mostly positive. Although the fourth quarter earnings season is still early, over 70% of S&P 500 companies that have reported have beaten analysts’ estimates. Blue chips such as IBM, United Technologies, Procter & Gamble and Starbucks were just a few of the companies that announced strong earnings last week. But uncertainties remain over global economic growth and trade relations with China as well as another government shutdown as the deal to reopen and fund the government is temporary and only lasts three weeks. Data from China showed that their economy grew only 6.6% last year, which was the slowest growth in 28 years. The International Monetary Fund (IMF) also trimmed its global growth forecast to 3.5% from 3.7%. Adding to the uncertainty were conflicting reports on trade talks between the U.S. and China. Earlier in the week, Commerce Secretary Wilbur Ross said that the U.S. and China were not close to reaching a trade deal and that a number of issues still had not been resolved. The next day, however, Treasury Secretary Steven Mnuchin said that both sides were “making a lot of progress” in reaching a possible trade agreement. The S&P 500 has risen over 13% from its low on Christmas Eve, but further gains may be limited over the near-term unless uncertainty over trade with China and global growth is eliminated.

Last Week

U.S. existing home sales fell to their lowest level in three years in December and home price increases slowed sharply. Leading economic indicators in December declined slightly, matching expectations, and suggested that U.S. economic growth will probably slow this year to about 2% by year-end. Weekly jobless claims fell to 199,000, their lowest level in 49 years.

For the week, the Dow Jones Industrial Average edged up 0.1% to close at 24,737 and the S&P 500 Index slipped 0.2% to close at 2,664. The Nasdaq Composite Index ticked up 0.1% to close at 7,164.

This Week

The January employment report is expected to show that about 171,000 new jobs were created and that the unemployment rate fell to 3.8% from 3.9%. Fourth quarter gross domestic product (GDP) is expected to show growth of 2.7% and the January ISM Chicago Purchasing Manager’s Index (PMI) is expected to drop from the December reading but still be comfortably in expansion territory. Both the January consumer confidence index and the Michigan consumer sentiment index should approximate last month’s readings and show that consumers remain optimistic about their jobs and economic prospects.

The Federal Open Market Committee (FOMC) meets this week and is expected to keep the federal funds rate unchanged between 2.25% and 2.50% after raising the rate four times last year by a quarter of one percent each time.

Among the most prominent companies scheduled to report earnings this week are Caterpillar, 3M, Boeing, GE, Honeywell, Verizon, AT&T, Pfizer, Merck, Amgen, Apple, Facebook, Microsoft, Amazon, McDonald’s, Visa, Exxon Mobil and Chevron.

Portfolio Strategy

While it is widely expected that the Federal Open Market Committee (FOMC) will leave interest rates unchanged this week, what’s more important will be the policy statement issued by the Fed and the press conference held by Federal Reserve Chairman Jerome Powell. After the quarter of one percent interest rate hike in December, Chairman Powell has become dovish in his tone and has said that the Fed would be “patient” in tightening monetary policy. Even though the Fed has forecast two interest rate hikes for 2019, Powell said that he would keep an open mind with regard to future increases and stressed that there would be no pre-determined path for rate hikes. Instead, the Fed would rely on economic data as it’s presented to formulate its monetary policy. With inflation running below the Fed’s target of 2% and economic growth expected to slow, the Fed has also considered ending the runoff of its portfolio of U.S. Treasury and Federal Agency mortgage securities on its balance sheet. Such a move would provide more liquidity in the financial system. The partial government shutdown also could influence the Fed’s policy. With several key pieces of economic data not released because of the shutdown, Fed officials are left with less information with which to make an informed decision and are more apt to error on the side of easier monetary policy. One of the market’s biggest fears, an aggressive Federal Reserve and higher interest rates, seems to have been eliminated. Many economists are now predicting that the Fed will only raise rates once this year and the odds of just one rate hike have shrunk dramatically.