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Stocks rebound strongly on stimulus optimism, vaccine rollout

Stock market corrections, although painful at the time, are actually a very healthy part of the whole mechanism, because there are always speculative excesses that develop, particularly during a long bull market. – Ron Chernow

After a volatile and losing week caused by a surge in prices of several stocks with significant levels of short interest, the stock market rebounded with a vengeance last week with the S&P 500 Index and the Nasdaq Composite Index closing at record highs. Concerns about the speculative retail trading mania eased tremendously as positions were unwound and investor confidence returned to the market. The 3% plus losses in the major stock averages from the prior week were erased and then some as the S&P 500 Index rose nearly 5% and the Nasdaq jumped 6%. The Russel 2000 Index of small cap stocks turned in the best performance with a gain of nearly 8%. It was another busy week for fourth quarter earnings reports and the results continue to be impressive. Of the 184 companies in the S&P 500 Index that have reported earnings, 84% of them have topped estimates. Two technology heavyweights, Amazon and Alphabet, led the charge last week as they both easily beat analysts’ revenue and earnings estimates. Alphabet reported revenue growth of 23% while Amazon announced its largest quarter for revenue of all time, $125.56 billion in sales. Economic data last week was also mostly positive and there was good news with regard to Covid-19 as the number of new cases was significantly lower than two weeks ago. There also will be two new vaccines soon as Johnson & Johnson filed for emergency-use authorization for its one dose vaccine and Novavax will do the same with its vaccine candidate. Additional fiscal stimulus seems to be on the way, too, either in the form of a huge $1.9 trillion economic relief package proposed by the Democrats or a scaled-down, more targeted bill preferred by the Republicans. Either way, the economy should benefit. With optimism over a vaccine rollout coupled with easy monetary policy and the strong possibility of more fiscal stimulus, companies should see stronger earnings growth, resulting in further gains in the market.

Last Week

The employment report in January was disappointing as only 49,000 new jobs were created, less than expected, and the unemployment rate fell to 6.3% from 6.7% in December, mainly due to a drop in labor force participation. ADP, on the other hand, reported that 174,000 private sector jobs were added in January, which was better than expected. Weekly jobless claims were 779,000, also better than the forecast of 830,000.   Although the ISM manufacturing index for January was less than expected and below the level in December, it was the 8th straight month of growth in the sector. The ISM services sector index for January topped expectations and pointed to continued growth going forward. Construction spending was also strong in December as strength in home building offset weakness in nonresidential construction.

For the week, the Dow Jones Industrial Average rose 3.9% to close at 31,148 while the S&P 500 Index gained 4.7% to close at 3,886. The Nasdaq Composite Index surged 6.0% to close at 13,856.

This Week

It will be a relatively quiet week for economic data as the January consumer price index (CPI) is expected to increase modestly and post a year-over-year rise of only 1.5%. The preliminary February University of Michigan consumer sentiment index is expected to be slightly better than the level in January.

The most prominent companies scheduled to report quarterly earnings this week include Hasbro, Mattel, Coca Cola, PepsiCo, Walt Disney, Kraft Heinz, Tyson Foods, Molson Coors, Kellogg, Du Pont, General Motors, Leggett & Platt, Simon Property Group, Cisco, Twitter, CME Group, Nissan, Honda, Dominion and Duke Energy.

Portfolio Strategy

In what could be viewed as a vote of confidence for the economy, interest rates have begun to rise and there are concerns that inflation could also begin to increase. In the past week, the prospect of additional fiscal stimulus, the rollout of vaccines and the declining number of new Covid-19 cases and improving economic data caused the 10-year Treasury yield to rise to 1.19%. The yield on the 10-year Treasury is important since it influences rates on mortgages and other consumer and business loans. The yield curve, or the difference between short-term interest rates and long-term interest rates, has also steepened with the yield on the 2-year Treasury declining to just 0.09% and the yield on the 30-year Treasury increasing to 1.97%. The spread between the 2-year Treasury and the 10-year Treasury has widened to 1.10%, the highest level since the second quarter of 2017. The steepening yield curve is a sign that the economy is improving with stronger growth expectations and increased inflation, which the Federal Reserve has been hoping before since inflation has been running below its 2% target for quite some time. The Fed has also said that the federal funds rate will likely remain at or near zero until 2023, suggesting that inflation could remain low as the yield curve continues to steepen. Recently the Fed has altered its policy and will let inflation run above its 2% target before it begins the tightening process of raising interest rates. With stronger economic growth forecast, cyclical stocks in sectors such as industrials, consumer discretionary, materials, energy and financials should begin to perform much better.