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Strong momentum lifts Dow nearly 3% ahead of N. Korean summit meeting

The most dangerous thing is to buy something at the peak of its popularity. At that point, all favorable facts and opinions are already factored into its price and no new buyers are left to emerge. – Howard Marks

The stock market continued its momentum from the unexpectedly strong May employment report to post solid gains last week in all three major stock averages. The Dow Jones Industrial Average was the biggest winner with a gain of nearly 3% while the S&P 500 Index and the Nasdaq Composite Index were up over 1%. Despite ongoing trade tensions ahead of the G-7 summit meeting that was scheduled to begin on Friday, the market proved resilient as it brushed aside the uncertainty and marched higher. Although China offered to buy some $70 billion of U.S. goods to help ease tariff threats, President Trump was still not satisfied and lashed out at both China and Canada for unfair trade practices. These attacks came even as the U.S. trade deficit fell in April to its lowest level in seven months. However, the trade gap is expected to widen as the year progresses to the highest level in decades. Optimism about strong growth prospects in the U.S. after the encouraging jobs report may have been the deciding factor in the market’s strength. With quarterly earnings reports in the rear view mirror and an absence of significant economic data last week, investors focused on the outlook for growth, which by all estimates appears to be excellent. If the Atlanta Federal Reserve and most economists prove to be correct, second quarter GDP growth could be well above 4%, which would double the growth posted in the first quarter. This economic strength would lead to higher corporate sales and earnings results, a scenario that should ultimately not only support current stock prices but produce higher stock prices by year-end.

Last Week

There was not much in the way of potential market-moving economic data last week and the data that was reported was mostly mixed. U.S. factory orders in April fell more than expected due to much lower commercial aircraft orders, but the decline is likely to be temporary as overall manufacturing data has improved in May. The ISM non-manufacturing or services sector index was better than expected, though, and weekly jobless claims were also slightly lower than expected as layoffs remain very low and the labor market remains tight. The Job Openings and Labor Turnover Survey (JOLTS) in April showed that there were more jobs available than there were people looking for jobs. Employers will likely have to raise wages to fill these open positions. Finally, productivity in the first quarter rose less than forecast.

For the week, the Dow Jones Industrial Average surged 2.8% to close at 25,316 while the S&P 500 Index rose 1.6% to close at 2,779. The Nasdaq Composite Index climbed 1.2% to close at 7,645.

This Week

Both the May producer price index (PPI) and consumer price index (CPI) are expected to rise only 0.2%, the same increase as in April, as inflation remains relatively benign. Retail sales in May are expected to increase by twice the amount reported in April as consumer spending remains strong. The preliminary reading for the June University of Michigan consumer sentiment index should continue to be at a very high level. The Federal Open Market Committee (FOMC) meets and is widely expected to raise the federal funds rate by a quarter of one percent. Fed Chair Jerome Powell will give a press conference after the meeting.

President Trump will meet with North Korean leader Kim Jong-un on Tuesday to discuss denuclearization of North Korea in exchange for relief from U.S. economic sanctions.

In an extremely slow week for quarterly corporate earnings reports, H&R Block, Adobe Systems and Jabil Inc. are the most notable companies scheduled to report.

Portfolio Strategy

After turning in a strong performance last week, this could be a pivotal week for the stock market in light of the FOMC meeting, a European Central Bank (ECB) meeting and the North Korean summit meeting. The spotlight will definitely be on these meetings in the absence of any significant economic data and corporate earnings reports. While it is a near certainty that the Fed will increase the fed funds rate target to a range of between 1.75% and 2%, investors will also be interested in the Fed’s policy statement and its forecast of future rate hikes for the balance of the year. A shift to a total of four rate hikes this year from the current projection of only three could prompt fears that the Fed will tighten too fast, weakening the economy and possibly causing a recession. Continued tightening by the Fed could put upward pressure on the 10-year Treasury yield, although its yield fell below 2.95% last week after eclipsing 3% recently. As long as economic growth accelerates in line with current forecasts, rising rates should not be problematic for stocks provided the Fed maintains a gradual and deliberate approach to tightening. The ECB is also expected to reveal its plan for winding down its monthly bond buying program, which could take on added significance in light of the recent political turmoil in Italy and the selloff in its bond market. The Eurozone economy slowed in the first quarter and if the ECB delays the timetable for ending this program, there could be concern that the economic outlook has deteriorated, a negative for financial markets. Last but certainly not least, the much-anticipated North Korean summit meeting will receive tremendous media coverage and could have serious and long-lasting global implications. The outcome of each of these three meetings could have near-term implications for the stock market as well.