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Strong momentum propels stocks to record highs

When people discover they are no good at baseball or hockey, they put away their bats and their skates and they take up amateur golf or stamp collecting or gardening. But when people discover they are no good at picking stocks, they are likely to continue to do it anyway. – Peter Lynch

What a difference a year makes. At this time last year, the stock market was having its worst December since 1931 and the Dow Jones Industrial Average lost 653 points on Christmas Eve, the worst day of trading ever on this date. In fact, from its high in late September to its low on Christmas Eve, the S&P 500 Index dropped 20% and wound up with a total return in 2018 of negative 4.4%. The primary reason for the plunge in stock prices was fear that the Federal Reserve’s forecast of two additional interest rate hikes in 2019 would throw the economy into a recession. While this obviously did not happen, the light trading volume around the holiday and computer-driven trading exacerbated the wild swings in the market and led to panic-selling. Last week all three of the major stock averages closed at record highs by posting solid gains, marking the fourth consecutive weekly gain for the indexes. The S&P 500 is on track for its best performance since 2013 with a year-to-date total return of 31% through the close of business on Friday. After agreeing to “phase one” of a trade agreement between the U.S. and China the previous week, stock market continued its momentum last week as investor sentiment remained positive. Treasury Secretary Steven Mnuchin confirmed that the “phase one” deal would definitely be signed in early January, giving investors confidence that increased trade could boost economic growth and lead to higher corporate profits. Not only was U.S. economic data mostly favorable last week, but China announced that industrial production and retail sales in November were both strong and better than expected. Although it was a light week for quarterly corporate earnings reports, the results were generally upbeat, too, as General Mills, Micron Technology and Nike all beat analyst estimates for both revenue and earnings.

Last Week

Housing data was particularly strong last week as the National Association of Home Builders/Wells Fargo Housing Market Index rose in December to its highest level in 20 years and building permits in November surged to a nearly 13-year high. U.S. housing starts also increased more than expected in November as low mortgage rates continued to boost the housing market and support the economy.  Consumer spending for the third quarter was revised higher and the University of Michigan consumer sentiment index in December was higher than expected as the impeachment hearings had virtually no effect on economic expectations. Weekly jobless claims fell by 18,000 to 234,000 from 252,000 the previous week as the labor market also remains strong.

For the week, the Dow Jones Industrial Average rose 1.1% to close at 28,455 while the S&P 500 Index gained 1.7% to close at 3,221. The Nasdaq Composite Index jumped 2.2% to close at 8,924.

This Week

It will be a slow week for economic data as November new home sales are forecast to be in line with numbers reported in October while November durable goods orders are expected to post a solid gain that should exceed the increase in October.

The stock market and the bond market will close early on Christmas Eve and will remain closed on Christmas Day.

There are no quarterly corporate earnings reports scheduled to be released this week.

Portfolio Strategy

The stock market is poised to post its best performance in December in nine years and if history is a guide, the odds of it happening are excellent. The market has historically been strong during the final five trading days of the year and the first two trading days of the new year. For this reason, this period of time has been referred to as the “Santa Claus rally” as the average gain has been 1.3% since 1950 over these seven business days. Over the last ten years, there have been only two years when this rally failed to materialize. Unlike last year when there was a lot of selling pressure by investors to realize losses to offset gains, this year there are very few unrealized losses since all of the asset classes have performed well and have positive returns. The only asset classes that had positive returns in 2018 were short-term bond funds and money market funds as the fear of higher interest rates, slowing global growth and trade tensions with China took their toll on both stocks and bonds. This year has been the exact opposite as investors are optimistic over recent trade deals, improved economic data in the U.S. and overseas and the expectation of stronger global growth as central banks around the world remain accommodative. Much of this good news has been priced into the market, though, and it would not be a surprise for stocks to pause at these levels and consolidate recent gains. But this low interest rate environment with the Federal Reserve on hold should serve as a strong underpinning for the stock market as we begin a new year.