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Stocks close higher as oil prices rebound

You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. – Warren Buffett

If you like the thrill, excitement and terrifying ups and downs of a roller coaster ride, then the action in the stock market last week would probably appeal to you. After the ride finally stopped on Friday, the S&P 500 Index had closed up over 1% but that doesn’t fully explain the volatility that was experienced during the week. On Wednesday, the stock market took its cue from the price of oil, which plunged to a new low below $27 a barrel on renewed fears of an oil glut in world markets. As the price of oil plummeted to a new low, the S&P 500 Index followed suit, falling to a level about 15% below its all-time high set back in May. But after cascading lower by more than 3% on the day, the index staged a remarkable rally to close down only about 1% and finished the week with modest gains. Oil also rebounded strongly from its oversold position and ended the week at over $32 a barrel, an increase of over 20% from its low. From a technician’s point of view, the fact that the S&P 500 was able to claw its way back on Wednesday to close near the closing low set back in August of 1,867 was an encouraging sign on a near-term basis. There were also other positive news items last week that helped boost stock prices. China’s gross domestic product (GDP) for the fourth quarter was 6.8%, easing concerns that the world’s second largest economy was slowing dramatically. China’s annual growth of 6.9% in 2015 was the weakest in 25 years, but there was speculation that the country might take action to augment growth. Comments from central bank officials in both Europe and Japan also suggested that more stimulus measures could be implemented to help spur economic growth and lift inflation.  In the U.S., investors seem to be ignoring the fourth quarter earnings season, which, for the most part, has been better than expected. Banks and financial companies have dominated the reporting season so far and their earnings results have generally beat analyst estimates, although revenue growth continues to be a challenge. Economic data last week sent mixed signals, but the U.S. economy seems to be in better shape than what the stock market has reflected this year. Right now fear and speculation seem to have the upper hand over common sense and reality.

Last Week

Housing data was both positive and negative last week as building permits and housing starts fell modestly in December while existing home sales surged almost 15%, which was much better than expected. The December consumer price index (CPI) dropped slightly and in the last twelve months through December, the core CPI, which excludes food and energy, rose 2.1%. Jobless claims increased last week by 10,000 and December U.S. leading economic indicators declined slightly. The preliminary reading on the manufacturing purchasing manager’s index (PMI) for January was above 50, indicating continued expansion.

The International Monetary Fund (IMF) reduced its outlook for global economic growth to 3.4% from 3.6% and revised its forecast for U.S. growth to 2.6% from 2.8%.

For the week, the Dow Jones Industrial Average rose 0.7% to close at 16,093 while the S&P 500 Index jumped 1.4% to close at 1,906. The Nasdaq Composite Index gained 2.3% to close at 4,591.

This Week

Fourth quarter gross domestic product (GDP) is expected to show that the U.S. economy grew at only  1.0%, less than the 1.3% growth rate in the third quarter. Durable goods orders for December are forecast to decline slightly while new home sales should post a slight increase. The Chicago purchasing manager’s index (PMI) for January is expected to improve significantly over last month’s reading but still be below 50, the threshold for determining whether there is expansion or contraction.

The Federal Open Market Committee (FOMC) is expected to leave interest rates unchanged but its statement will be reviewed closely for its views on the outlook for the economy. In a speech in Germany, European Central Bank President Mario Draghi could shed more light on his stimulus remarks last week and the Bank of Japan will announce its decision on interest rates, with some expecting further easing measures.

The focus for investors this week should definitely be on earnings as there are a number of blue chip companies scheduled to report. Among the most prominent of these are Chevron, Apple, Microsoft,, Amgen, Abbott Labs, Johnson & Johnson, McDonald’s, Procter & Gamble, 3M Company, Boeing, Caterpillar and AT&T.

Portfolio Strategy

Last week’s stock market plunge that saw the S&P 500 Index fall 15% from its high in May seemed to indicate that investors were pricing in a recession, even though there currently is no recession and none forecast this year by economists. Fears that China’s slowing economy could send the U.S. into a recession are overblown as U.S. exports to China comprise less than 1% of our total gross domestic product (GDP). The Chinese economy seems to have stabilized, too, with news that its 4th quarter GDP grew a respectable 6.8% and 6.9% for all of 2015. Recessions usually are caused by excessive inventory build-ups, a financial crisis such as what occurred in 2008, overextended sectors such as technology in 2000 and housing in 2008 and aggressive tightening by the Federal Reserve. None of these conditions exist right now. Banks are well-capitalized and their balance sheets are as strong as they’ve ever been and the odds that the Federal Reserve will raise interest rates a second time have fallen considerably. While most people felt the Fed would hike rates again at their meeting in March, the probability now of that happening is only about one in four or 25%. With both Europe and Japan contemplating further stimulus measures, it seems highly unlikely that the Fed would continue down this tightening path, especially in light of the volatility and turmoil in the markets since the start of the year. If the Federal Reserve had it to do over again, it probably would not have raised the fed funds rate in December and not outlined a plan for an additional four rate hikes this year.