Dow erases losses for year as stocks continue their torrid rally

Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell. – Warren Buffett

The stock market continued its torrid rally last week as the S&P 500 Index and the Nasdaq Composite Index reached new all-time highs and the Dow Jones Industrial Average erased its losses for the year and is now in positive territory. The S&P 500 has risen over 7% so far in August, which is the biggest gain in the month since 1984. Since hitting an intraday low way back on March 23rd, the S&P 500 has gained about 60% and has posted a year-to-date total return of 10% through Friday’s close. There was a plethora of good news last week, beginning with a continued decline in the number of new coronavirus cases. The FDA also approved the use of convalescent plasma for hospitalized Covid-19 patients, a treatment that uses blood plasma donated by people that have recovered from the virus. There was growing optimism, too, about the possibility of a coronavirus vaccine as biotech manufacturer Moderna said its vaccine showed promising results in a small trial. The Federal Reserve also played a role in last week’s market gains as Fed Chairman Jerome Powell announced a major monetary policy shift. Instead of targeting inflation at 2%, it will use “average inflation targeting” in which the central bank will allow inflation to run higher than the 2% target before raising interest rates. In effect, this new policy will mean that interest rates will remain lower for longer as the Fed will not consider strong employment a sign of emerging inflation and immediately tighten monetary policy as a result. In their view, a strong job market can be sustained without leading to a rise in inflation. Despite rising tensions recently between the U.S. and China, progress was made as trade talks resumed with both sides taking steps to ensure the success of the phase one trade deal. For the most part, positive economic data and continued better than expected quarterly earnings supported the stock market’s surge to record highs, although valuations are obviously becoming stretched with each move higher.

Last Week

Sales of new single-family homes were strong in July, rising 14% from their level in June and registering their biggest increase since 2006. Durable goods orders in July were much higher than expected and core capital goods orders that exclude aircraft and are a good measure of business spending plans also increased. Consumer spending rose in July for the third straight month as the economy slowly recovers and weekly jobless claims were just over 1 million, down slightly from the previous week. Second quarter GDP was revised to a 31.7% annual decline from an initial reading of a 32.9% drop but it was still the largest quarterly plunge on record. Both the consumer confidence index and the University of Michigan consumer sentiment index remain well below their highs during the pandemic as unemployment continues to be elevated and could affect consumer spending.

Salesforce.com, Amgen and Honeywell will replace Exxon Mobil, Pfizer and Raytheon Technologies in the Dow Jones Industrial Average. The changes were caused by Apple’s 4-for-1 stock split, which will reduce the technology weighting in the price-weighted average.

For the week, the Dow Jones Industrial Average rose 2.6% to close at 28,653 while the S&P 500 Index jumped 3.3% to close at 3,508. The Nasdaq Composite Index surged 3.4% to close at 11,695.

This Week

The August employment report is expected to show that 1.5 million jobs were added to the economy and that the unemployment rate edged down slightly to 10% from 10.2% in July. The unemployment rate had been at a 50-year low of 3.5% back in February before the onset of the coronavirus pandemic. The ISM manufacturing index and non-manufacturing or services sector index for August are both expected to show readings in the mid-50s, a sign of solid expansion and in line with the previous two months.

This will be a quiet week for quarterly earnings as Zoom Video, Broadcom, H&R Block, Campbell Soup and Macy’s are the most notable companies on the agenda..

Portfolio Strategy

After posting a gain of over 7% in August for its best performance in the month in 36 years, the question becomes what can the market do for an encore as it enters September, which historically has been the worst performing month for stocks. Since World War II, the S&P 500 Index has lost an average of 0.5% in September while the Dow Jones Industrial Average has declined an average of 1% since the late 1800s. Many people have tried coming up with a plausible explanation as to why September has been a down month, but no one has succeeded in coming up with one that is credible. There is an exception to this statistical anomaly, though, and it occurs in years where there is a presidential election such as this one. In these years, the stock market has actually risen on average in the month of September. Certainly after five consecutive monthly gains for the S&P 500, one would expect the stock market to consolidate its gains and trade sideways or be the victim of profit-taking. But there is data that shows when the stock market rises more than 5% in August like it just has, the average gain in September has been over 1%. While Federal Reserve comments last week were dovish for the markets, efforts by Congress to pass a new economic relief package have reached a stalemate which could negatively impact stocks. Investors must balance this knowing also that September has been the worst-performing month for stocks except in presidential election years when the market has been positive. For these reasons, the best course of action for investors is to maintain one’s current asset allocation that coincides with their investment objective.