Rally in stocks stalls despite strong earnings, positive economic data

We don’t get paid for activity, just for being right. As to how long we’ll wait, we’ll wait indefinitely. – Warren Buffett

The major stock averages were mixed last week as both the Dow Jones Industrial Average and S&P 500 Index edged lower while the Nasdaq Composite Index bucked the trend and rose 1%, closing at a record high. Since the election, the Dow has jumped 9% and the S&P 500 has risen 6% and both indices now appear tired and in need of a breather. Much of the strength in stock prices has been predicated on optimism over President-elect Donald Trump’s pro-growth policy agenda but hope can only take the markets so far. Although fourth quarter corporate earnings and economic data were generally better-than-expected last week, they did not provide the catalyst needed to propel stocks higher and continue the post-election rally. The banks and financials began the earnings parade last week and the news was favorable as JP Morgan Chase, Bank of America, PNC Financial and Blackrock all beat earnings estimates. The pre-announcement season for earnings has been quiet, which usually portends a positive earnings season. Last weeks’ results were no exception and expectations are for fourth quarter earnings per share of companies in the S&P 500 to rise over 4% year-over-year. What may have caused stocks to stall last week were comments from Donald Trump at his first press conference. He provided no details on his policies of cutting corporate taxes, deregulation and fiscal stimulus and, instead, blasted the pharmaceutical industry for its high drug prices. Comments by St. Louis Federal Reserve President James Bullard may also have put a damper on stocks. He said that the new administrations’ fiscal policy proposals were more a story for 2018 and 2019 and that the economy will likely remain in a low interest rate and slow growth environment throughout this year. It still remains to be seen whether or not these pro-growth policies will be implemented and, if they are, how much time will elapse before they have an effect on the economy. Until this becomes clearer, stocks are likely to trade sideways and consolidate recent gains.

Last Week

As expected, retail sales in December were strong, rising 0.6%, as automobile sales recorded their biggest increase since April. The National Retail Federation (NRF) also reported that holiday retail sales rose 4% and beat expectations. The producer price index (PPI) for December was in line with estimates and rose 1.6% for all of 2016. Import prices in December also rose modestly due to higher oil prices but were less than expected. The strong dollar has helped keep inflation under control. Weekly jobless claims rose by 10,000 last week to 247,000, below expectation of 255,000, as the labor market remains at or near full employment. The tightening labor market has caused a welcome increase in wage growth. Job openings remained at 5.5 million and the number of people quitting their jobs hit a record high, a sign that workers are confident about the economy.

The preliminary Michigan consumer sentiment index for January remained near record high levels and the National Federation of Independent Business (NFIB) small business survey for December showed sentiment rising to a 12-year high.

For the week, the Dow Jones Industrial Average fell 0.4% to close at 19,885 while the S&P 500 Index slipped 0.1% to close at 2,274. The Nasdaq Composite Index added 1% to close at 5,574.

This Week

The December consumer price index (CPI) is expected to rise modestly as inflation remains benign while December industrial production is expected to be stronger than it was in November. Housing starts in December should rise to 1.18 million units and confirm continued strength in the housing sector. A number of Federal Reserve bank presidents are scheduled to speak this week and the European Central Bank (ECB) meets to decide whether or not to leave interest rates unchanged.

Financials will again dominate the fourth quarter earnings releases this week as Morgan Stanley, Citigroup, U.S. Bancorp, Goldman Sachs, American Express, Northern Trust, SunTrust Banks and Charles Schwab are all scheduled to report. Other notable companies on the agenda include IBM, General Electric, United Health, Union Pacific and Schlumberger.

Portfolio Strategy

The S&P 500 Index posted a total return of 12.0% last year but most investors received a return less than that for a number of reasons. It’s true that an all-equity, domestic portfolio that was overweighted in value stocks over growth stocks and with an overweight in small and mid-cap stocks over large cap stocks probably beat the benchmark. But overseas markets lagged the U.S. market and the average developed market international fund gained only about 2%. Emerging markets performed better but most portfolios have only a modest allocation to this asset class. Another reason that investors’ returns lagged those of the S&P 500 was the performance of real estate investment trusts or REITs, which are considered an alternative investment. Although REITs had a good year, they generally underperformed equities as the MSCI U.S. REIT Index was up just 8.60%. The biggest reason that investors trailed the S&P 500 Index was the fixed income allocation of their portfolio, which can vary significantly depending on the investor’s age, time horizon and risk tolerance. After starting the year at 2.3% and falling to an all-time low of 1.4% in July 2016, the yield on the 10-year Treasury rose to 2.5% by year-end and, as a result, investors were fortunate to collect their interest payments as the rise in yields caused principal values to decline (bond prices move inversely to yields). The average total return on intermediate bonds was about 3% while short-term bonds returned only about 1.5%. While all three of these investments underperformed the S&P 500 in 2016, they provide diversification to a portfolio by reducing the overall risk and volatility and help to minimize losses in the event that U.S. stocks decline sharply.