The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs. – Warren Buffett
Despite headwinds from a stronger U.S. dollar and rising interest rates, stocks continued their upward climb as all three major stock averages added to solid election-week gains. The Russell 2000 Index of small cap stocks posted the best performance with a gain of 2.6% as it advanced for the 11th consecutive day. Conventional wisdom would suggest that a surging dollar would be a negative for profits of multi-national companies, causing these stocks to pull back from recent highs. Similarly, the yield on the 10-year Treasury jumped to 2.34% last week, a level not seen since a year ago and a situation that normally results in profit-taking among investors. Before the election, the 10-year Treasury yielded only about 1.80%. But neither rising interest rates nor a stronger dollar had any ill effects on stocks as economic data was positive last week and investors seem optimistic about president-elect Donald Trump’s pro-growth policy agenda. Retail sales in October rose 0.8% after posting a 1% gain in September, making the two-month gain the biggest since 2014. The data was better than expected as automobile sales continued to be strong. U.S. housing starts for October increased over 25% from the previous month and were at the highest level since 2007. Weekly jobless claims also fell again last week to 235,000, a 43-year low and further evidence that the labor market remains strong. Comments by Fed Chair Janet Yellen about the improving economy and the increased probability of an interest rate hike soon only seemed to confirm the prevailing view that the economic picture is becoming brighter. With inflation also picking up, the odds of a Federal Reserve rate hike in December have now increased to over 90%, an occurrence that is already priced into the bond market as bonds have sold off and yields have risen.
There was some evidence of higher inflation last week as import prices rose 0.5% and the consumer price index (CPI) rose 0.4%, both slightly higher than expected. However, the producer price index (PPI) was unchanged in October. In the 12 months through October, the PPI has increased 0.8% and the CPI has risen 1.6%, both measures still under the Federal Reserve’s target inflation rate of 2%. Industrial production was also unchanged in October, but should improve as oil demand increases due to increased infrastructure spending and tax cuts planned by the incoming Trump administration. Leading economic indicators edged slightly higher in November and suggest modest growth in the months ahead.
For the week, the Dow Jones Industrial Average inched up 0.1% to close at 18,867 while the S&P 500 Index gained 0.8% to close at 2,181. The Nasdaq Composite Index rose 1.6% to close at 5,321.
Durable goods orders are expected to rebound in October with a gain of 1.2% compared with a slight decline in September. Both October new home sales and existing home sales should be on a par with number reported in September and consistent with a steadily improving housing sector. The Federal Reserve also releases minutes from its meeting earlier this month.
U.S. markets will be closed on Thanksgiving Day and markets will close at 1:00PM eastern time on Black Friday, the unofficial kickoff day for the holiday shopping season.
The most prominent companies on the earnings calendar in this holiday-shortened week are Tyson Foods, Campbell Soup, Medtronic, Deere & Co., Valspar Corp., Barnes & Noble, Dollar Tree, Analog Devices and Eaton Vance Corp.
One of the unexpected results of the election has been the sharp and sudden rise of yields in fixed income investments, including Treasuries, municipal bonds, corporate bonds and preferred securities. In a matter of ten days, yields have spiked on all bonds and, in some cases, are at levels not seen in almost a year. In the Treasury market, the yield on the 2-year is now 1.06%; the yield on the 10-year is at 2.34% and the yield on the 30-year bond stands at 3.02%. The reason for the upward move in yields (bond prices move inversely to yields) is the expectation that inflation will begin to rise under the new administration. With Republicans in control of Congress, the thinking is that president-elect Donald Trump will be able to implement many of his pro-growth economic policies, including tax cuts, increased infrastructure spending and regulatory reform. All of these programs would likely be inflationary, including his much-talked about trade restrictions. But Trump has not even taken office yet and much of his agenda will take time and is by no means certain to be passed. In addition, quantitative easing and other stimulus measures adopted in Europe and Japan have resulted in much lower interest rates than in the U.S. and should serve to keep a lid on our interest rates. Weak global economic growth should also help restrain inflation. With the likelihood of a Federal Reserve interest rate hike in December, inflation expectations should be scaled back and be less of a concern, too. For these reasons, the rapid rise in interest rates may be overdone and yields could gradually come down. For fixed income investors, emphasis should be on investment grade bonds that have a yield advantage over comparable Treasuries with the same maturity. A simple ladder of maturities that is short-to-intermediate term in length would be well-positioned to take advantage of higher yields should interest rates continue to rise.