Major stock averages at record highs as Dow closes above 20,000

Interestingly, we have beaten the market quite handsomely over this time frame, although beating the market has never been our objective. Rather, we have consistently tried not to lose money and, in doing so, have not only protected on the downside but also outperformed on the upside. – Seth Klarman

Good things come to those who wait. While it may have seemed like a long time, the Dow Jones Industrial Average went from 19,000 to 20,000 in only 42 days, making it the second-fastest 1,000 point advance in history. The Dow shattered the 20,000 barrier last week, closing at a new high, while the S&P 500 Index and the Nasdaq Composite Index also closed at all-time highs. All of these major stock averages posted gains of at least 1% last week as fourth quarter corporate earnings continued to impress on the upside. Following the strong profit results from the financials the week before last, a diverse group of companies such as Du Pont, 3M, Johnson & Johnson, McDonald’s, Verizon and Boeing all surpassed analysts’ earnings estimates last week. The new administration also showed that it intends to promote a business-friendly atmosphere in its attempt to bolster economic growth. President Donald Trump signed an executive order that would build the Keystone XL and Dakota Access pipelines and also withdrew the U.S. from the Trans-Pacific Partnership in order to negotiate a better trade deal. He even met with some business executives and representatives from the U.S. auto industry to tout his plan to cut taxes and unnecessary regulations. All of these actions were in keeping with his campaign promises to reduce corporate and individual taxes and reform the tax code and ease regulatory burdens on companies. Although there is still a lot of uncertainty over the outcome of Trump’s pro-growth initiatives, investors remain optimistic for now with the major stock averages at all-time highs and volatility at low levels. However, an unforeseen geopolitical event or unpredictable news item could bring volatility back into the market and lead to a pullback as many of Trump’s proposals have already been priced into the market.

Last Week

The market received no help from economic data last week as the reports generally came in below expectations. Sales of both new and existing homes fell more than expected in December as the supply of homes dropped to levels last seen in 1999. Weekly jobless claims also rose by 22,000 to 259,000, higher than expected, but claims have remained below 300,000 now for 99 straight weeks, a sign that the labor market remains strong. Durable goods orders for December declined and were below expectations, but core capital goods, a key measure of business investment, rose and provided a good omen for 2017.

U.S. fourth quarter gross domestic product (GDP) increased at a 1.9% annual rate compared to 3.5% in the third quarter. For all of 2016, GDP grew at only 1.6%, the weakest growth since 2011. Despite the weak quarter, the outlook for the year is still bright as the labor market is strong and rising wages should support consumer spending.

For the week, the Dow Jones Industrial Average rose 1.3% to close at 20,093 while the S&P 500 Index added 1% to close at 2,294. The Nasdaq Composite Index jumped 1.9% to close at 5,660.

This Week

The Federal Reserve ends its two-day meeting on Wednesday and the prevailing view is that there will be no change in interest rates. The Bank of Japan (BOJ) also meets this week and will announce its decision on interest rates. The most important piece of economic data will be released on Friday as the January employment report is expected to show that 175,000 jobs were created and that the unemployment rate remains at 4.7%. The January ISM Manufacturing Purchasing Managers Index (PMI) is expected to be solidly in expansion territory while December factory orders and construction spending are expected to increase modestly.

There will be a plethora of quarterly earnings reports again this week as Eli Lilly, Pfizer, Merck, Amgen, Exxon Mobil, Apple, Amazon.com, Facebook, UPS, Visa, Philip Morris International, Allstate, MetLife and Johnson Controls are just a few of the notable companies on the agenda.

Portfolio Strategy

One of the best investments for investors in this challenging environment for income has been real estate investment trusts or REITs. The typical yield on a REIT is about 4%, although many REITs have yields that are much higher than that. They also have been an excellent investment over the last five years on a total return basis, averaging almost 12% a year over this time frame. As interest rates have risen lately, REITs have underperformed and generally do poorly in a rising interest rate environment. But REITs also perform exceedingly well in a faster growing economy, something that could happen in 2017 if President Trump’s pro-growth policies on infrastructure spending and tax reform are enacted. On a longer-term basis, the positives for REITs of stronger economic growth generally outweigh the negatives from rising interest rates as there is a strong correlation between the strength of the economy and real estate fundamentals. One of the best ways for investors to play this sector is through the Vanguard REIT ETF (VNQ), which invests in stocks issued by REITs or companies that purchase office buildings, hotels, storage facilities, shopping centers and other real property. This ETF attempts to replicate the performance of the MSCI U.S. REIT Index, has a very low expense ratio and currently yields about 4.8%. In addition to its attractive yield, REITs also help diversify a portfolio and reduce the risk associated with both equities and fixed income investments.