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Stocks close lower on weak economic data, rising Covid-19 cases

The wisest rule in investments is: when others are selling, buy. When others are buying, sell. – Jonathan Sacks

Profit-taking hit the stock market last week as both the S&P 500 Index and the Nasdaq Composite Index fell 1.5% even though President-elect Joe Biden announced a $1.9 trillion stimulus package and the Federal Reserve reiterated its intention to maintain its easy monetary policies. It was the first weekly loss of greater than 1% for the S&P 500 in over two months and could be viewed as a “sell the news” reaction as the market had already priced in most of what was included in the new economic relief package. Termed the American Rescue Plan, the proposal calls for increasing federal unemployment payments, direct payments to many individuals of $1,400, extending federal moratoriums on evictions and foreclosures, $350 billion in aid to state and local governments and raising the federal minimum wage to $15 per hour. It remains to be seen whether or not Congress will approve the plan. Federal Reserve Chairman Jerome Powell also made some dovish comments last week that the Fed would not be raising interest rates soon and that it would continue its bond-buying program for the foreseeable future to help the economy recover. His remarks come at a time when Covid-19 cases are increasing at an alarming rate with nearly 250,000 new cases each day and the worst week for virus-related deaths since the pandemic began. The disturbing rise in cases across the country is prompting renewed lockdowns and further restrictions on businesses at a time when economic growth is slowing. Retail sales in December declined more than expected and weekly jobless claims were much higher than forecast. Fortunately, there was some good news last week with regard to vaccines as Johnson & Johnson reported that trial data for its one-dose coronavirus vaccine showed that it was about 80% safe and effective. Another bright spot last week was the start of fourth quarter earnings season, which was led by the big money center banks and financial companies. JP Morgan Chase reported much better than expected revenue, earnings and net interest income and Wells Fargo, Citigroup and Blackrock also beat earnings estimates. Much of the stock market’s recent strength has been built on the prospect of strong corporate earnings, massive fiscal and monetary stimulus and optimism over vaccines. The market may have gotten ahead of itself, though, and could see some consolidation of those gains over the near-term.

Last Week

As referred to above, weekly jobless claims surged to 965,000, much higher than the estimate of 800,000 new claims, and December retail sales were much worse than expected as the spread of Covid-19 affected spending in restaurants and reduced traffic to shopping malls. The producer price index (PPI) and the consumer price index (CPI) rose modestly in December with the increase in the CPI due mostly to higher gasoline prices. In the 12 months through December, the CPI has risen only 1.4%. The National Federation of Independent Business (NFIB) Small Business Optimism Index fell to its lowest level in seven months over uncertainty of the new economic policies of the incoming administration. Finally, industrial production in December had its best showing since July.

For the week, the Dow Jones Industrial Average dropped 0.9% to close at 30,814 while the S&P 500 Index  declined 1.5% to close at 3,768. The Nasdaq Composite Index also fell 1.5% to close at 12,998.

This Week

It will be a quiet week for economic data as December housing starts and existing home sales are expected to be in line with those reported in November and indicative of a strong and healthy housing market buoyed by historically low mortgage interest rates.

The European Central Bank (ECB) is expected to leave its benchmark interest rate at a record-low negative 0.5% while the Bank of Japan (BOJ) is also expected to keep its short-term rate the same at negative 0.1%.

The most notable companies scheduled to report fourth quarter earnings this week include Bank of America, Charles Schwab, Morgan Stanley, Goldman Sachs, U.S. Bancorp, Travelers, Northern Trust, Netflix, IBM, Intel, Procter & Gamble, UnitedHealth Group, CSX, Union Pacific, Schlumberger, Baker Hughes, Halliburton and United Airlines.

Portfolio Strategy

The official start of fourth quarter earnings season began last week and the early results from the big money center banks were encouraging. Banks and financial companies will dominate the earnings agenda again this week and the results should mostly be better than forecast. The yield curve has steepened with the 10-year Treasury yield above 1.10%, which should translate into improved net interest margins for the banks. While overall earnings in the quarter are expected to be down relative to the same period in 2019, the numbers will be better than those reported in the first and second quarters of 2020 when the coronavirus pandemic began and businesses were forced to shut down. But the earnings results are expected to be worse than they were in the third quarter as the number of Covid-19 cases spiked and lockdowns reoccurred. Fortunately for investors, the weak quarter will probably be ignored as what companies say about future earnings expectations will carry more weight. Past results are far less important to the market than earnings guidance for the balance of the year when the economy will likely recover as vaccines are widely distributed and administered and the pandemic has been put behind us. Fourth quarter earnings results are likely to be challenging, but comparisons will get much easier in the first and second quarters as companies should be able to beat dismal results reported in 2020. Earnings for companies in the S&P 500 are expected to be about $170 in 2021, with most of the gains coming in the second half of the year after vaccines have been rolled out. The price earnings ratio of the S&P 500 on those expected earnings is 22, which is considerably above the historical norm but still reasonable as long as interest rates remain at low levels.