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S&P 500 closes at record high on post-election optimism

The index fund is a sensible, serviceable method for obtaining the market’s rate of return with absolutely no effort and minimal expense. Index funds eliminate the risks of individual stocks, market sectors and manager selection, leaving only stock market risk. – John Bogle

For the third consecutive week, all three of the major stock averages rose and ended the week at record high levels as optimism over Donald Trump’s pro-growth policies sent investors on a buying spree. The Russell 2000 Index of small cap stocks also continued its winning streak, closing at a record high after posting its 15th straight positive session on Friday and returning almost 16% during that time. The market has become convinced that GDP growth will accelerate under the new administration, leading to increased corporate profits and higher stock prices. Never mind that inauguration day is some eight weeks away and that passage and implementation of Trump’s agenda are far from certain and will take time. Investors have chosen to look at the glass as being half full rather than half empty and are assuming only a best case scenario for the new president while giving him the benefit of the doubt. Time will only tell whether or not this is a valid assumption. In the meantime, economic data was mostly positive last week, at least providing some rationale for higher stock prices. U.S. durable goods orders rose 4.8% in October, much better than expected, and optimism spread that business spending would rebound in the fourth quarter. Existing home sales also rose in October by a better-than-expected 2% and September sales were also revised higher. The October sales number was at the highest annual rate since February 2007, but could fall in subsequent months as mortgage rates have begun to rise. Although U.S. new home sales were lower than expected in October, they can be volatile from month to month and the setback is likely to be temporary as the labor market remains strong, which should be a positive catalyst for future sales. The fact that the University of Michigan Index of Consumer Sentiment was better than expected probably summed up best the current euphoria on Wall Street as investors remain optimistic over prospects for the economy and glad and relieved that the election is finally over.

Last Week

Even though weekly jobless claims rose last week by 18,000 to 251,000, they remained below 300,000 for the 90th straight week and are evidence of a strong labor market and an economy that is at or near full employment. Oil prices closed higher last week on renewed optimism that OPEC would reach an agreement to cut production at their meeting this week. Russian President Vladimir Putin said that his country was ready to freeze production and was also optimistic that a deal would be reached.

Minutes from the most recent Federal Reserve meeting showed that officials thought it would be appropriate to raise interest rates soon in light of an improving labor market and slightly higher inflation trends. The Atlanta Fed forecast that GDP would increase at a 3.6% annual rate in the fourth quarter.

For the week, the Dow Jones Industrial Average gained 1.5% to close at 19,152 while the S&P 500 Index added 1.4% to close at 2,213. The Nasdaq Composite Index rose 1.5% to close at 5,398.

This Week

The most important piece of economic data this week will be the November employment report, which is expected to show that about 170,000 new jobs were created and that the unemployment rate remains unchanged at 4.9%. The preliminary gross domestic product (GDP) for the third quarter is forecast to be 2.9% and the November ISM Manufacturing Purchasing Managers Index (PMI) is expected to be slightly above 50, a level that denotes continued expansion. Construction spending in October is also forecast to rebound strongly after falling slightly in September.

In other news, OPEC meets on Wednesday to decide whether or not to cut oil production and the Federal Reserve releases its beige book of regional financial conditions.

In a relatively light week of key earnings releases, the most notable companies on the agenda include Autodesk, Tiffany, Dollar General, Kroger and American Eagle Outfitters.

Portfolio Strategy

Over the last three weeks, small cap stocks as measured by the Russell 2000 Index have risen 15.8% and have posted a gain in each of the last 15 trading sessions. Much of the remarkable move in small cap stocks can be directly attributable to the election of Donald Trump as president. One of the policies that Trump called for during his campaign was more protectionism and more restrictive trade agreements. Such a policy would tend to favor small companies as they usually generate less than 20% of their sales overseas, compared to larger companies that garner over 30%. Trump’s promise to lower the corporate tax rate to 15% would also be a boon to smaller companies, which don’t have the wherewithal or geographic capability to reduce their tax rate below the 35% federal rate. Small companies would also be helped if Trump is successful in reducing government regulation as they are less able to afford the high costs of compliance than larger companies. The Russell 2000 Index has underperformed the S&P 500 Index from the beginning of 2014 through election day and, as a result, valuation measures for small cap stocks have become more favorable. Although the current winning streak for small caps is unlikely to continue, Trump’s policy agenda, if implemented, could enable small cap stocks to outperform large caps in 2017.