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S&P 500 climbs 3% as optimism increases over reopening economy

So please don’t forget that considering the probabilities of future returns only begins the decision-making process. Decisions have consequences. If the consequences of being badly wrong about future returns would imperil your financial future, be conservative. – John Bogle

The stock market continued its march higher last week as there was widespread optimism over reopening the economy and the potential for a vaccine sooner rather than later. All three major stock averages participated in the rally, with the Dow Jones Industrial Average up nearly 4% and the S&P 500 Index up 3%. The Nasdaq Composite Index, which is positive for the year due to the strong performance of the technology sector, posted a gain of less than 2%. Stocks that had been the most beaten up due to the steep downturn in the economy, such as cyclicals, retailers and travel and tourism-related companies, were the best performers last week. All 50 states have now reopened to some extent and the stock market seems to be pricing in a V-shaped recovery as the S&P 500 Index closed above 3,000 for the first time since March and now trades above its 200-day moving average. There also was good news in the quest to find a vaccine for the coronavirus as there are currently 10 vaccines in clinical evaluation and 114 in pre-clinical evaluation. The Federal Reserve’s Beige Book, a survey of economic conditions across the country released last week, acknowledged that the economic downturn caused by the pandemic was severe with steep job losses but felt the economy was at or near the bottom and that there would be a rebound in the second half of the year. The market’s strength last week was a surprise to many as the economic data continues to be dismal and tensions with China seem to be rising. Moves by China to exercise greater control over Hong Kong by eliminating its autonomy could result in the U.S. imposing sanctions on that country, which could further strain relations and jeopardize the trade agreement. If the tensions continue to escalate and the situation deteriorates, the stock market could relinquish some of its recent gains.

Last Week

First quarter gross domestic product (GDP) was revised to a decline of 5% from the initial estimate of a 4.8% drop. Durable goods orders in April fell less than expected but still registered the second largest decline that the government has ever recorded. Core capital goods orders, a key measure of business investment, also fell but the decline was much less than expected. New home sales in April actually rose slightly versus forecasts of a huge drop as there is considerable pent-up demand for housing and low mortgage rates give potential buyers more incentive. Weekly jobless claims totaled 2.1 million, bringing the grand total of claims to nearly 41 million since the coronavirus was declared a pandemic. If there is a silver lining in this grim data, it’s that the pace of filings has declined and continuing claims have fallen.

For the week, the Dow Jones Industrial Average gained 3.75% to close at 25,383 while the S&P 500 Index rose 3.0% to close at 3,044. The Nasdaq Composite Index added 1.8% to close at 9,489.

This Week

The employment report for May is expected to show that nonfarm payrolls fell by 7 million and that the unemployment rate rose from 14.7% in April to 19%. ADP also releases its National Employment Report and it’s expected to show a decline of 9.5 million private-sector jobs in May. Both the ISM Manufacturing and Non-Manufacturing Purchasing Manager’s Indices (PMI) for May are forecast to be slightly better than in April but still well below 50, the threshold for expansion. April construction spending and factory orders are also expected to be weak and worse than in the previous month.

This will be a light week for quarterly earnings reports and the most notable companies scheduled to report include Campbell Soup, J.M. Smucker, Tiffany, Gap, Tribune Publishing, Broadcom and Zoom Video.

Portfolio Strategy

While investors have become more optimistic about the economy reopening and the prospects for coronavirus treatments and vaccines, the market has probably gotten ahead of itself as any recovery is likely to be slow, especially after the protests over the weekend that turned violent and damaged many businesses. It’s encouraging that there are so many vaccines in clinical trials, but a successful one probably won’t be available until next year and there are no proven treatments against the virus, although there are a few that have showed promise. On a more positive note, there has been massive monetary and fiscal stimulus that has helped prop up the economy and the Federal Reserve will likely remain accommodative as it still has additional tools in its toolbox to provide needed support. There also is a good chance that the federal government will pass another stimulus package that includes more tax cuts, unemployment benefits and aid to state and local governments. However, any additional stimulus money may be limited as the budget deficit has ballooned and all of this spending must eventually be paid for, most likely through higher taxes. With the unemployment rate expected to rise to nearly 20% in May and tensions expected to escalate between the U.S. and China, the economy could face significant headwinds over the near-term and struggle to get back on track. For these reasons, the stock market will likely consolidate its recent gains and volatility could remain elevated over the next few months, especially after the strong rebound in stock prices.

Since I will be out of the office next week, the next weekly newsletter will be sent on Monday June 15th.