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Stocks post modest losses on new FBI probe

All intelligent investing is value investing – acquiring more that you are paying for. You must value the business in order to value the stock. – Charlie Munger

News on Friday that the Federal Bureau of Investigation had reopened its investigation of Hillary Clinton’s e-mails caused stocks to drop and left the major stock averages with modest losses for the week. The stock market had been pricing in a victory by the Democratic Party nominee but this surprising story rattled investors and prompted them to rethink the outcome of the upcoming presidential election. This new revelation detracted from the strong third quarter gross domestic product (GDP) that was also released on Friday. GDP grew at a 2.9% annualized rate in the quarter, which was the best growth turned in by the economy in two years. By contrast, GDP grew by only 1.1% during the entire first half of the year. Until the FBI’s surprise announcement, the market had been focused on third quarter corporate earnings, which continue to be mostly better than expected. In fact, of the approximately 50% of S&P 500 companies that have reported earnings so far, about 73% of them have beaten earnings estimates while 61% have also beaten sales estimates. Two of the most notable exceptions last week were Apple, which reported better than expected profits but issued disappointing forward guidance, and, which missed earnings estimates badly even as revenues were mostly in line. Sentiment was also helped by several mergers last week, including the announcement that TD Ameritrade was buying Scottrade and Rockwell Collins was acquiring B/E Aerospace. But rising bond yields were a headwind for stocks as the yield on the 10-year Treasury rose to 1.85% and served to undermine the performance of interest-rate sensitive sectors such as utilities, telecommunications, consumer staples and real estate investment trusts or REITs. All of these sectors were weak and have been under pressure for weeks now as bond yields have crept higher. Financial stocks, on the other hand, have been the beneficiaries of higher rates and their performance has been strong while interest rates have risen. With the election only about a week away, the uncertainty over the outcome will likely keep the S&P 500 in a narrow range, much like it has been over the last three months with a move of just over 1%.

Last Week

U.S. new home sales rose 3.1% in September, which was better than expected, and U.S. home prices jumped 5.1% year-over-year in August, according to the Case-Shiller 20-City Composite Index. The October services purchasing manager’s index (PMI) increased to 54.8, comfortably in expansion territory, but durable goods orders in September fell 1.2%, worse than what had been expected. Weekly jobless claims fell by 3,000 to 258,000 and suggested that the labor market remains strong with the possibility of better economic growth ahead. The University of Michigan consumer sentiment index fell to 87.2 in October, lower than expected, and could have been the result of uncertainty over the election.

In speeches last week, St. Louis Fed President James Bullard said that low interest rates are likely to be the norm over the next several years while Chicago Fed President Charles Evans predicted three interest rate hikes next year and said that the pace of the hikes should be tied to inflation.

For the week, the Dow Jones Industrial Average edged up 0.01% to close at 18,161 while the S&P 500 Index fell 0.7% to close at 2,126. The Nasdaq Composite Index declined 1.3% to close at 5,190.

This Week

The Federal Reserve meets on Wednesday and is expected to leave interest rates unchanged, but will probably hint that a rate hike is coming in December. The October employment report is forecast to show that about 195,000 new jobs were created and that the unemployment rate edged lower to 4.9%. The October Chicago PMI number is expected to be solidly in expansion territory while the ISM manufacturing PMI figure should also be expansionary. September construction spending should rebound after posting a weak reading in August while factory orders should increase modestly.

Among the most notable companies scheduled to report earnings this week are Southern Co., Dominion Resources, Duke Energy, American Electric Power, Pfizer, Archer Daniels Midland, Starbucks, Time Warner, MetLife, Automatic Data Processing, Facebook, Qualcomm, Berkshire Hathaway, Devon Energy and Occidental Petroleum.

Portfolio Strategy

One of the best performing investments this year has been gold but in recent months, the precious metal has fallen as interest rates have risen. Earlier in the year, investors sought a safe haven in gold amid all of the uncertainty surrounding the vote by the United Kingdom to leave the European Union as well as efforts by the European Central Bank (ECB) and the Bank of Japan (BOJ) to bolster their economies by adopting negative interest rate policies. Since early July, the yield on the 10-year Treasury has risen from a record low of 1.36% to 1.85% at the close of business last Friday. This increase, coupled with the fact that the Federal Reserve is likely to raise the federal funds rate at their meeting in December, has caused the price of gold to skid about 10% over this time period. Because gold doesn’t pay a dividend or any interest, it tends to underperform when yields rise on other presumably safe investments such as Treasury bonds and corporate bonds. The strong third quarter GDP report released last week along with continued strength in the labor market will only serve to keep a lid on the price of gold for the foreseeable future.