Stocks edge higher on optimism over Deutsche Bank

In almost every walk of life, people buy more at lower prices; in the stock market they seem to buy more at higher prices. – James Grant

The stock market was taken on a roller coaster ride last week and when the ride stopped on Friday, the S&P 500 Index had managed to eke out a modest gain. Earlier in the week, concerns that Deutsche Bank, Germany’s largest bank, was experiencing financial difficulty as a result of a weak capital position caused jitters among investors. Shares of the bank plunged to an all-time low as hedge funds reduced their exposure in the name and uncertainty increased over whether or not Germany and Angela Merkel would have to bail them out. By Friday, however, reports surfaced that Deutsche Bank had settled a number of mortgage-securities cases with the U.S. Department of Justice for an amount that was far less than feared and the stock soared. Similarly, the stock market also staged a relief rally by gaining about 1% in Friday’s session. Among the best-performing sectors last week was energy as the price of oil rose to over $48 a barrel on news that OPEC had reached a deal to limit oil production in November. Even though optimism over an agreement faded by week’s end, energy stocks still had posted solid gains. A number of Federal Reserve officials also spoke last week but none more important than Fed Chair Janet Yellen, who once again said that the central bank has no fixed time table for raising interest rates. She also went as far to say that the Fed could help the U.S. economy in a future downturn if it could buy stocks and corporate bonds. Needless to say, these dovish remarks also helped the stock market close the week on a positive note. The economic data released last week was generally mixed, not good enough to send stocks noticeably higher nor bad enough to cause stocks to fall. The corporate earnings calendar was also light, but of the notable companies that did report, PepsiCo, ConAgra and Accenture all posted better than expected earnings. The sideways action of stocks recently seems to point to a market that is looking for direction and it could find it soon in the form of third quarter earnings season which is just around the corner.

Last Week

Data on the housing sector last week was weak as U.S. new home sales fell almost 8% in August and pending home sales also fell for the third straight month. The one bright spot was the Case-Shiller 20-City Composite Index, which rose 5% year over year. Orders for durable goods were flat in August, but core capital goods posted their third increase in a row, a positive sign for business investment. Second quarter gross domestic product (GDP) was also revised slightly higher from 1.1% to 1.4% while consumer spending was flat after posting solid gains in July and June. This slowdown should be temporary, though, as the consumer confidence index in September rose to 104.1, much higher than expected as consumers remain upbeat about the employment outlook and the economy.

For the week, the Dow Jones Industrial Average added 0.3% to close at 18,308 while the S&P 500 Index edged up 0.2% to close at 2,168. The Nasdaq Composite Index fell 0.5% to close at 5,312.

This Week

The September employment report is expected to show an increase of about 175,000 new jobs compared to 151,000 in August and the unemployment rate should remain at 4.9%. The September ISM manufacturing index is forecast to move back above the 50 threshold, a sign that the sector is expanding. August factory orders are expected to decline slightly while August construction spending should post a modest increase.

The first vice presidential debate between Democrat Tim Kaine and Republican Mike Pence will take place on Tuesday night.

In another quiet week on the earnings front, the most prominent companies scheduled to report include Micron Technology, Yum Brands, Darden Restaurants, Monsanto and Constellation Brands.

Portfolio Strategy

Since its inception in 1992, the Oakmark International Fund (OAKIX) has been an exceptional performer with an average annual return of 9.02%, compared to just 5.54% for the MSCI World ex-U.S. Index. This performance had earned the fund a 5-star rating from Morningstar until recently when the fund was downgraded to 4-stars. Over the last three years, the fund has fallen on hard times and has ranked in the bottom 10% of its peer group. It is not unusual for a fund with such a stellar long-term track record to underperform occasionally over the short term. David Herro, who has managed this fund since its inception, uses a contrarian approach in his stock selection process and typically buys stocks that are out of favor and cheap relative to their fundamentals. Right now he is significantly overweighted in European equities, particularly financial companies, which were beaten up after Britain’s Brexit vote in June. In Herro’s view, the banks are cheap and have begun to grow their earnings while, at the same time, their capital requirements have nearly doubled, making them stronger than ever. This strategy has already begun to work as the Oakmark International Fund (OAKIX) jumped 7.5% in the most recent month to place it among the top winners in the international space. Despite the recent disappointment of this fund, the long-term prospects remain excellent.