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S&P 500 gains nearly 2% for the week, bodes well for 2021

Over the short-term, however, the fundamentals are often overwhelmed by the deafening noises of speculation – the price at which the stock market values each dollar of earnings. – John Bogle

Despite several events last week that under normal circumstances would have caused the stock market to trade lower, just the opposite happened as all three major stock averages closed at record highs and the Russell 2000 index of small cap stocks turned in its best performance to start the year since 1987. There is an old adage that says “so goes January, so goes the year” and if this past week’s market action is any indication, this year could be another positive one for stocks. History shows that the S&P 500 has been up 82% of the time for the full year if the market is higher in the first five days. These are not normal times in which we live and if there is anything we’ve learned is that we should expect the unexpected. In the Georgia runoff elections for the Senate, the two Democratic candidates were declared the winners, giving the Democrats control of the Senate along with the House and the White House. Markets generally prefer divided government so it was a surprise that stocks rallied on the news. The expectation now is for more government spending and a bigger stimulus package, which apparently the market likes. On Wednesday, President Trump supporters in Washington D.C. that were there to protest the legitimacy of Joe Biden’s victory stormed the Capitol building as Vice President Mike Pence was certifying the presidential results. But the markets shrugged off the event as it had no effect whatsoever on the direction of the economy, earnings or interest rates. It also will not affect the peaceful and orderly transition of power that will occur next week on January 20th. Finally, on Friday, the December employment report showed that nonfarm payrolls dropped by 140,000 compared to forecasts of an increase of over 100,000 new jobs. It was the first monthly decline in jobs since April, but most of the job losses were in the hospitality and leisure industries, which will return once the coronavirus pandemic goes away. The weak report will also likely guarantee that additional stimulus will be approved, which will not only help the economy but the stock market as well.

Last Week

ADP reported that private payrolls declined by 123,000 in December versus an estimate of a gain of 60,000 and followed an increase of 304,000 in November. Weekly jobless claims, though, were better than expected as they totaled 787,000 compared to forecasts of 815,000. The ISM index for manufacturing in December rose to its highest level since August 2018 and was much better than expected while the ISM index for non-manufacturing or the services sector also exceeded expectations. Factory orders in November were also better that forecast as manufacturing continues its recovery.

Covid-19 cases continued to spike and a more contagious variant of the virus emerged and could complicate matters as the rollout of the vaccines has been slower than anticipated, although the vaccines should be effective against this new strain of the virus.

For the week, the Dow Jones Industrial Average rose 1.6% to close at 31,097 while the S&P 500 Index  gained 1.8% to close at 3,824. The Nasdaq Composite Index surged 2.4% to close at 13,201.

This Week

Both the December producer price index (PPI) and the consumer price index (CPI) are expected to increase slightly, with the year-over-year increase in the CPI forecast to be only 1.2%. Retail sales in December are expected to be up modestly after falling more than 1% in November.

Fourth quarter earnings season begins this week and will be headlined by the banks and financials, including JP Morgan Chase, Citigroup, Wells Fargo, PNC Financial and Blackrock. Other notable companies scheduled to report include KB Home and Delta Air Lines.

Portfolio Strategy

With the expectation of more stimulus and government spending now that Democrats have control of the Senate, bonds sold off last week (bond prices move inversely to yields) and the yield on the 10-year Treasury rose to 1.13%. It was the first time since March that the 10-year Treasury yield topped 1%. The 30-year Treasury yield also rose but is still under 2% while the yield on the 2-year Treasury is just 0.14%, reflecting the Federal Reserve’s position to hold short-term interest rates near zero for the next few years. With fixed income yields at historic lows, investors have to look elsewhere to find other investments that generate more income. Corporate bond spreads to Treasuries are fairly tight and yields on high yield or junk bonds are less than 5% and involve taking more risk as their credit quality is below investment grade and subject to greater default risk. The iBoxx High Yield Corporate ETF (HYG) has a current yield that is less than 4%. Stocks that pay above-average dividend yields are one alternative as their performance also languished in 2020 as investors favored growth stocks. Two exchange traded funds (ETFs) that invest in high-dividend paying stocks are the Vanguard High Dividend Yield ETF (3.2% yield) and the iShares Core High Dividend ETF (4.0% yield). For investors that prefer higher dividend growth over pure yield, there is the ProShares S&P 500 Dividend Aristocrats ETF (about a 2% yield) which invests in companies that have increased their dividend consistently over the years. Real estate investment trusts or REITs also offer above-average yields and should perform well in a low interest environment, especially with the economy expected to improve in 2021. The Vanguard REIT ETF (4% yield) invests in companies that purchase real property such as office buildings, hotels, shopping centers, apartment buildings and storage facilities. REITs also help diversify the risks of owning stocks and bonds in a portfolio.