Be always at war with your vices, at peace with your neighbors, and let each New Year find you a better person. – Benjamin Franklin
In a relatively quiet, holiday-shortened week, Santa Claus made his appointed rounds on Christmas Eve and also paid a visit to Wall Street as stocks rebounded with strong gains. After plunging in the wake of the Federal Reserve announcement to raise interest rates, the S&P 500 Index recovered those losses to get back to even for the year. Investors took advantage of an oversold stock market by buying many beaten-down names, particularly in the commodities and materials sector. The price of oil stabilized and climbed to $38.10 by week’s end as stocks in the energy sector rose 5%. The rally in oil prices was partly due to a report from the Energy Information Administration (EIA) that showed a decline in U.S. crude inventories. Market breadth was also improved last week as the gains in stock prices were more broad-based and included many stocks that had fallen out of favor. Much of the strength in the S&P 500 Index this year had been concentrated in a few technology names. In fact, an acronym termed FANG has been used to refer to four of the most popular and best-performing technology stocks. These stocks include Facebook, Amazon.com, Netflix and Google (now Alphabet Inc., a holding company for Google) and they have produced tremendous returns for investors, doubling and even tripling in value. Without their strong performance, the major stock averages would be at lower levels than where they are now. The stock market did not receive any help from economic reports last week, either, as the data was decidedly mixed. Earnings reports were also few and far between and will remain this way until the fourth-quarter earnings season begins in about three weeks.
November existing home sales recorded their sharpest drop in five years but the decline was most likely due to new regulations designed to make paperwork easier to process. Rising home prices and fewer homes for sale could also be reducing home purchases. Although November new home sales rose 4.3%, the increase was less than expected. Orders for durable goods were flat in November as the strong dollar and weak global economies have hurt exporters and cheap oil has forced spending cuts by energy producers. Third quarter gross domestic product (GDP) was revised lower to 2.0% from 2.1% as consumer spending was strong but business investment remained weak. On a positive note, consumer sentiment in December was better than expected as lower inflation helped increase real incomes.
For the week, the Dow Jones Industrial Average gained 2.5% to close at 17,552 while the S&P 500 Index jumped 2.8% to close at 2,060. The S&P 500 Index began the year at 2,058. The Nasdaq Composite Index rose 2.5% to close at 5,048.
This week promises to be a very quiet week in terms of economic data. The Conference Board issues its consumer confidence index and it’s expected to increase from the November reading. Pending home sales for November are also expected to post a healthy increase while the Chicago Purchasing Managers’ Index (PMI) for December is forecast to be up slightly to 50, indicating continued expansion but just barely.
U.S. stock markets are open on New Year’s Eve and closed on New Year’s Day. There are no earnings reports scheduled for this week but there are two college football bowl games worth noting on New Year’s Eve that will determine the eventual national champion. In the Orange Bowl, No. 4-ranked Oklahoma plays No. 1-ranked Clemson and in the Cotton Bowl, No. 3 Michigan State faces No. 2 Alabama.
Since 2000, the S&P 500 Index has posted an average gain of over 1% in the week between Christmas Eve and New Year’s Eve. With tax-loss selling abating and portfolio managers looking to boost returns relative to their benchmarks, this trend could happen again this week as there may be additional upside in many of these beaten-down value stocks. Many of the biggest winners in last week’s rally were in the energy and materials sectors, which are still down 22% and 9%, respectively, for the year. Value stocks typically trade with above-average dividend yields and lower price-to-book value ratios and price-earnings ratios while growth stocks are priced to perfection because of their consistent earnings growth year after year. Growth stocks usually come with high expectations, too, and a quarterly earnings miss can have a huge negative effect on the company’s share price. These stocks generally pay little or no dividends and have higher than average price-earnings ratios, which can make them risky and vulnerable. Value stocks also usually perform better during periods of rising interest rates and the Federal Reserve is poised to do just that over the next year. Bank stocks, which are considered value stocks as they usually trade at below market multiples, should perform better in an environment where interest rates are rising gradually. Cyclical stocks in the capital goods and industrial sectors should also rebound as the economy improves and the Fed begins to hike rates. If the Fed raises interest rates gradually, global economies expand modestly and oil stabilizes and rises slightly, then value stocks have a good chance of outperforming growth stocks in the year ahead.