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Dow closes above 29,000 as Phase One trade deal with China signed

The hardest thing over the years has been having the courage to go against the dominant wisdom of the time, to have a view that is at variance with the present consensus and bet that view. Courage and the ability to withstand pain are required. – Michael Steinhardt, American investor and hedge fund manager

For the first time ever, the Dow Jones Industrial Average ended the week above 29,000 and wound up just 2.2% shy of the 30,000 threshold. The S&P 500 Index and the Nasdaq Composite Index also logged strong gains for the week as there was a plethora of good news for investors to digest. It was the start of fourth quarter earnings season and the first companies to report were the financials, which did not disappoint. JP Morgan Chase, Citigroup, Bank of America, Goldman Sachs and Morgan Stanley all beat analysts’ earnings estimates, which were were aided by a strong consumer and stabilization in global economic growth. Expectations heading into earnings season were for a 2% decline in profits in the fourth quarter but early results suggest that earnings could surprise on the upside. In addition, the Phase One trade agreement between the U.S. and China was signed last week, a positive first step that should boost economic growth and lead to higher corporate profits. While some U.S. tariffs on Chinese goods will remain in place through the 2020 election, the agreement increases Chinese purchases of U.S. agricultural, manufacturing and energy products by more than $200 billion over the next two years. It is expected that U.S. exports to China should increase to $263 billion in 2020 and $309 billion in 2021. China was also removed from a list of countries that manipulate their currency. Not only was a deal reached with China, but the U.S.-Mexico-Canada Agreement (USMCA) was approved by the Senate as a replacement for the North American Free Trade Agreement (NAFTA). Both deals are expected to bolster global growth at a time when there are visible signs that growth has been slowing. The release of the Fed’s Beige Book, a survey of business conditions in various Federal Reserve districts, also painted a rosy picture of the economy. It indicated that economic activity had picked up recently and that the labor market remained tight. The near-term outlook was also favorable due to the prospect of continued strong consumer spending and low inflation. Since interest rates are likely to remain near historic lows, the relative attractiveness of stocks to bonds will continue, especially if the Federal Reserve remains on hold.

Last Week

Inflation data released last week was benign as the producer price index (PPI) rose just slightly and has risen only 1.3% year-over-year while the consumer price index (CPI) was less than expected as the core rate that excludes food and energy edged up 0.1%. Retail sales in December increased moderately and were in line with expectations while December housing starts showed that home construction rose at the fastest pace since 2006. Weekly jobless claims fell by 10,000 to 204,000, a bigger decline than was expected, as the labor market remains strong. The University of Michigan consumer sentiment index in January slipped from its December level but still remains very high.

China’s economic growth accelerated in December as the world’s second largest economy posted its fastest monthly expansion since last March.

For the week, the Dow Jones Industrial Average added 1.8% to close at 29,348 while the S&P 500 Index gained 2.0% to close at 3,329. The Nasdaq Composite Index jumped 2.3% to close at 9,388.

This Week

It will be a light week for economic data with December existing home sales expected to be better than those reported in November and December leading economic indicators expected to be up just slightly but better than last month’s flat reading.

The most prominent companies scheduled to report fourth quarter earnings this week include IBM, Intel, Texas Instruments, Abbott Labs, Johnson & Johnson, American Express, Travelers, Union Pacific, Southwest Airlines, Procter & Gamble, Comcast, Kimberly Clark, Northern Trust and Halliburton.

Portfolio Strategy

With Phase One of the trade deal between the U.S. and China in the rear view mirror and a lack of potential market-moving economic data on the calendar this week, the focus will be squarely on earnings. Phase Two talks for the trade deal are scheduled to begin almost immediately but they will be much more difficult as they ultimately will involve removal of all tariffs. Although banks and other financial companies reported exceptional earnings last week, the first week of earnings season was mostly confined to the financials and not much else. So far about 70% of S&P 500 companies have surpassed earnings estimates but we have a long way to go. This week should be more revealing even though only a few dozen companies are due to report. A broad range of companies in the technology, consumer, energy, health care and industrial sectors are on tap, which should provide a much better read on the overall strength of corporate earnings. In 2019, earnings were basically flat and expectations are much higher for 2020 with estimates that range from 5% to 10% profit growth. The question now becomes whether or not quarterly earnings will be good enough to justify the fact that the major stock averages are at record highs and that the S&P 500 currently trades at 19 times projected earnings for this year, well-above its historical average. Not only will actual quarterly corporate profit results be important, but what those companies say about earnings going forward may hold the key for whether or not stocks add to their gains or the market suffers a long-awaited pullback.