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Stocks fall victim to profit-taking as Covid-19 cases spike

The point is that market returns are determined by both investment factors – the fundamentals of the initial dividend yield on stocks plus the rate at which their earnings grow – and speculative factors – the change in the price that investors will pay for each $1 of corporate earnings. – John Bogle

After closing higher the previous two weeks, the stock market took a breather last week and finished modestly lower as the number of coronavirus cases continued to spike across the country and state and local governments imposed more restrictions on businesses. The S&P 500 fell 1% but has rebounded from its low in March to post a year-to-date gain of 15.4%. More than 200,000 people on average are testing positive for the virus every day, hospitalizations are at record levels and the virus has claimed nearly 300,000 lives. At the same time that the country seems to be going in the wrong direction, Congress continues to drag its feet on passing another economic relief bill. Fortunately, the House averted a government shutdown by passing a 1-week federal spending extension that will allow more time to reach an agreement. The extra time may not be enough, however, as disagreements remain between Democrats and Republicans over state and local stimulus, unemployment assistance and stimulus checks to individuals. Without passage of a new stimulus bill, millions of Americans could lose their unemployment benefits by year-end. Amidst the grim news on the sky-high coronavirus infection rate and the ongoing stalemate in Washington, there was a glimmer of hope last week as the Food and Drug Administration (FDA) approved Pfizer and BioNTech’s coronavirus vaccine for emergency use on Friday. Within 24 hours, 2.9 million doses will be given and an additional 2.9 million doses will be given in 21 days for patients to get their second shot. While the approval of the vaccine is certainly good news, widespread distribution to the general public will probably not be completed until the spring. In the meantime, stock market valuations are stretched as 90% of the stocks on the New York Stock Exchange are trading above their 200-day moving average. For this reason, the market could trade sideways over the near-term and consolidate its recent gains until there is less uncertainty with regard to the spread of the virus and the political situation in Washington.

Last Week

Weekly jobless claims rose to 853,000 last week, much higher than estimated and higher than a week ago, as Covid-19 cases have spiked and local and state governments have clamped down on businesses to slow the spread of the virus.  The producer price index (PPI) in November edged slightly higher and was in line with estimates as inflation remains benign. Businesses have little pricing power as the pandemic continues to weigh on the economy. The consumer price index (CPI) also increased modestly and has risen only 1.2% during the last 12 months. The preliminary University of Michigan consumer sentiment index was much better than expected and reflects the optimism around distribution of a vaccine.

For the week, the Dow Jones Industrial Average fell 0.6% to close at 30,046 while the S&P 500 Index dropped 1% to close at 3,663. The Nasdaq Composite Index declined 0.7% to close at 12,377.

This Week

Retail sales in November are expected to increase modestly but less than in October while leading economic indicators for November are also forecast to rise slightly but not as much as in October. November housing starts are expected to remain flat but with numbers that confirm continued strength in the housing market.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is expected to keep the federal funds rate unchanged near zero and possibly make changes to its bond-buying program. The Bank of Japan (BOJ) also will meet and is expected to leave its benchmark interest rate at negative 0.1%.

Among the most prominent companies scheduled to report third quarter earnings this week are Nike, General Mills, FedEx, Accenture, Lennar and Darden Restaurants.

Portfolio Strategy

Whether or not there is a Santa Claus rally in stocks heading into year-end could depend on events that transpire this week. On the one hand, the disturbing increase in the number of coronavirus cases across the country and the rise in hospitalizations to record levels mean more restrictions for businesses, which could hamper the economic recovery. On the other hand, the approval of the Pfizer and BioNTech vaccine for emergency use means there is a light at the end of the tunnel, which should allow for the economy to eventually return to normal next year. The deciding factor between these two opposing forces could be the ability of Congress to compromise their differences and pass another economic relief bill, which is sorely needed since federal unemployment benefits and an eviction moratorium expire at the end of the month. The clock is ticking with the budget deadline being pushed back to December 18th and five days left to negotiate an agreement. The recent spike in the number of coronavirus cases could slow the economy and further weaken the labor market, especially in light of the surge in weekly jobless claims last week. The Federal Reserve has its final meeting of the year this week and it is unlikely that it will announce any significant monetary policy changes, although it could purchase additional longer-dated bonds to help suppress longer-term interest rates. The Fed has been saying all along that what the economy needs now is more fiscal stimulus from the government. The ball is in their court. We will find out this week if they are up to the challenge.