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S&P 500 gains 1% as U.S.-China trade tensions ease

The only true test of whether a stock is “cheap” or “high” is not its current price in relation to some former price, no matter how accustomed we may have become to that former price, but whether the company’s fundamentals are significantly more or less favorable than the current financial-community appraisal of that stock. – Philip Fisher

Improving trade relations between the U.S. and China coupled with favorable economic data contributed to another positive week for stocks as the Dow Jones Industrial Average closed higher for the eighth straight session on Friday. Although there is still no trade agreement between the two countries with the largest economies in the world, tensions appear to be easing as both sides have been making concessions. Treasury Secretary Steven Mnuchin said on Monday that the U.S. and China have a “conceptual agreement” on how to enforce intellectual property theft. China then offered to buy more U.S. agricultural products and announced a tariff exemptions list for products from the U.S. President Trump returned the favor by delaying an additional increase in tariffs from 25% to 30% on Chinese goods by two weeks until October 15th “as a gesture of goodwill”. While formal negotiations are not scheduled to resume until October, the harsh rhetoric of the past has been replaced with efforts by both sides to be conciliatory and eager to compromise. That bodes well for upcoming trade talks as investor sentiment has turned decidedly positive for the time being. The stock market also received a boost from encouraging economic data and further easing by the European Central Bank (ECB). U.S. retail sales were much better than expected in August due to increased auto sales and strong online sales, a positive sign that consumer spending will remain strong. In Mario Draghi’s last major decision as president of the ECB, he announced that the deposit rate would be cut further into negative territory and that a new bond buying program would be implemented to help revive Europe’s slowing economy. All of this positive news was music to investors’ ears as stocks moved closer to their all-time highs set back in late July.

Last Week

Inflation data released last week confirmed once again that prices remain under control. The producer price index (PPI) and the consumer price index (CPI) for August edged up slightly and were in line with expectations. The PPI has now risen only 1.8% over the past year while the CPI has risen 2.4% during the same time period. The University of Michigan consumer sentiment index in August was better than expected as consumers felt more confident about the economy and their job prospects. Weekly jobless claims also fell by 15,000 to 204,000 as there continue to be very few layoffs.

At Apple’s fall launch event, the company unveiled three new iPhones along with a new Apple Watch and a television subscription service.

For the week, the Dow Jones Industrial Average rose 1.6% to close at 27,219 and the S&P 500 Index gained 1.0% to close at 3,007. The Nasdaq Composite Index added 0.9% to close at 8,176.

This Week

Both August housing starts and existing home sales are expected to be healthy and approximate the numbers for last month while August industrial production is forecast to increase slightly. Leading economic indicators for August are expected to be flat after posting a sizable increase in July.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is widely expected to cut the federal funds rate by a quarter of a percentage point to a range of between 1.75% and 2.0%.

The only prominent companies scheduled to report quarterly earnings this week are Adobe, FedEx, General Mills and Darden Restaurants.

Portfolio Strategy

One notable change in the market that occurred last week was the rotation by investors out of growth stocks and into value stocks. Growth stocks, which are typically characterized by their higher price earnings ratios, lower dividend yields, strong momentum and consistent earnings growth, have handily outperformed so-called value stocks over the past several years. Most of this outperformance was attributed to stocks in the technology sector and was helped by the fact that interest rates have been near historic lows. Value stocks, on the other hand, trade at lower valuations, generally have higher dividend yields and are considered cheap or undervalued relative to the market. With the increase in the yield of the 10-year Treasury to 1.90% last week from its recent low of 1.50%, financials and bank stocks, which are considered value stocks, have rallied while momentum plays such as technology stocks have faltered. There has been an extreme divergence between the performance of value stocks and growth stocks and the rotation that began last week could continue in the weeks and months ahead. While the trade negotiations in October between the U.S. and China still hold the key for the overall market, even if the trade talks fail, value stocks should provide better downside protection given their lower valuations and above-average dividend yields.