If you can follow only one bit of data, follow the earnings (assuming the company in question has earnings). I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow or next week is only a distraction. – Peter Lynch
Investors were treated to some great news on Monday when Pfizer and BioNTech announced that their coronavirus vaccine was more than 90% effective in preventing Covid-19 and the stock market soared. The Dow Jones Industrial Average ended the day more than 800 points higher and was up more than 4% for the week. The S&P 500 Index closed at an all-time high while the Nasdaq Composite Index was down slightly as investors rotated out of technology stocks into cyclical stocks that would benefit more from an improving economy. Small cap stocks also jumped as the Russell 2000 Index closed at a record high. Scientists had been hoping for a vaccine that was at least 75% effective so the news could be a game-changer in ending the global health crisis. The timing of the announcement was propitious, too, as infection rates continue to soar, hospitalizations are rising and economies are still struggling to reopen. The vaccine would be available for limited use as early as late December and widely available by the third quarter of 2021. The companies had reached a nearly $2 billion agreement in July to supply 100 million doses to the U.S. government as part of President Trump’s administration Operation Warp Speed. Pfizer and BioNTech will produce up to 50 million does in 2020 and up to 1.3 billion does in 2021. The announcement sparked a shift from so-called stay-at-home stocks in the technology sector to more economically sensitive sectors of the market such as consumer cyclicals, industrials, energy and financials. Travel, restaurant and hospitality companies saw the biggest rallies as investors bought into the idea that value stocks might finally be poised to outperform growth stocks. But even with the positive vaccine news, Federal Reserve Chairman Jerome Powell warned last week that the U.S. economic outlook remains highly uncertain as the virus continues to spread. Not since the onset of the virus back in March has the number of positive cases been this high, a stark reminder that we are not out of the woods yet.
Both the producer price index (PPI) and the consumer price index (CPI) in October were muted as the core PPI that excludes food and energy edged up slightly while the core CPI was unchanged. For the year through the month of October, the core CPI has risen only 1.6%, below the Federal Reserve’s target rate of inflation of 2%. The preliminary University of Michigan consumer sentiment index for November was less than expected and down from the October reading as coronavirus cases surged, weighing on the economic outlook.
For the week, the Dow Jones Industrial Average rose 4.1% to 29,479 while the S&P 500 Index added 2.2% to close at 3,585. The Nasdaq Composite Index dropped 0.6% to close at 11,829.
Retail sales for October are expected to increase modestly but less than the increase in September. Both October housing starts and existing home sales are forecast to approximate levels in September and confirm a housing market that remains strong. Leading economic indicators for October are expected to increase but less than in the previous month as the pace of growth has slowed.
Retailers will dominate third quarter earnings reports this week with the most notable companies scheduled to report being Home Depot, Lowe’s, Walmart, Target, Macy’s, Kohl’s and TJX Companies. Other prominent companies on the agenda include Palo Alto Networks, Nvidia and Tyson Foods.
The strong performance of the Dow Jones Industrial Average and the decline of the Nasdaq Composite Index last week was a clear signal that investors are rotating out of growth stocks in the technology sector into value stocks that will benefit from an economic recovery. Growth stocks, which typically have higher, more consistent revenue and earnings growth, pay little or no dividends, have demonstrated some competitive advantage and trade at much higher price earnings ratios, have significantly outperformed value stocks since the onset of the pandemic. The information technology and communication services sectors are two such growth sectors that have showed the highest returns. Value stocks, on the other hand, trade much more cheaply and have considerably lower price earnings and price to book value ratios while paying above average dividends. These type of companies usually perform best when the economy is coming out of a recession and economic growth is accelerating. Sectors that are considered value-oriented include the banks and financials, energy and industrials, all of which have lagged the overall market since March. In fact, growth has substantially outperformed value in recent years. With the announcement by Pfizer and BioNTech of an effective coronavirus vaccine last week, investors are counting on stronger global economic growth, which should favor more economically sensitive companies that are considered value plays. However, the wild card in this line of thinking is the virus as the number of Covid-19 cases in the U.S. and Western Europe is spiking at an alarming rate. While a vaccine is certainly positive news, the increased spread of the virus is not and could lead to a weaker than expected economic recovery, weighing again on value stocks.