Stocks rebound strongly but market faces many uncertainties

In reality, no one knows what the market will do; trying to predict it is a waste of time, and investing based upon that prediction is a speculative undertaking. – Seth Klarman, American hedge fund manager

The uncertainty surrounding the outcome of the mid-term elections was lifted on Tuesday and the stock market rebounded with strong gains for the week. Both the S&P 500 Index and the Dow Jones Industrial Average were up more than 2% for the week while the technology-laden Nasdaq Composite Index was up modestly. Stocks recorded their biggest post mid-term election gains since 1982 on Wednesday as the Democrats took control of the House while the Republicans retained the majority in the Senate. A split Congress is probably the best outcome for the U. S. market as stocks have historically posted strong returns when Congress is divided. The gains for the week might have been even greater had it not been for disappointing economic data out of China on Friday and worries about a slowdown in the global economy. Weakness in the price of oil, which fell below $60 a barrel and is now trading more than 20% below its 52-week high, also contributed to anxiety over slowing global growth in Europe and Japan. If that wasn’t enough, the Federal Open Market Committee (FOMC) meeting took place last week and although the Fed left interest rates unchanged, it all but assured another rate hike in December. While Fed officials noted that business investment has slowed from the fast pace earlier in the year, it also emphasized that the unemployment rate has declined to the lowest level (3.7%) since December 1969. With GDP expected to be 3% in the fourth quarter after averaging 3.3% in the first three quarters, the Fed is expected to gradually raise interest rates an additional three times in 2019. The other wild card continues to be trade and the lack of an agreement between the U.S. and China, which is causing uncertainty among investors and volatility in the stock market. The best hope for a deal might be at the G-20 meeting later this month. Whether or not an agreement is reached could determine the near-term direction of stock prices.

Last Week

The producer price index (PPI) in October increased much more than expected but the core PPI, which excludes food and energy, was up just modestly. The PPI has risen 2.9% in the 12 months ended in October. The ISM non-manufacturing or services sector index fell slightly in October but was better than expected. The University of Michigan consumer sentiment index topped expectations in November and the weekly jobless claims fell slightly as the number of people receiving benefits remains at a 45-year low.

In corporate news, Walt Disney and Berkshire Hathaway reported better than expected third quarter earnings and Berkshire also bought back nearly $1 billion of its own shares. Apple lowered its iPhone sales for the fourth quarter and the Trump administration said it was looking into possible anti-trust violations against Amazon.

For the week, the Dow Jones Industrial Average rose 2.8% to close at 25,989 and the S&P 500 Index also gained 2.1% to close at 2,781. The Nasdaq Composite Index added 0.7% to close at 7,406.

This Week

The consumer price index (CPI) for October is expected to post a moderate increase while import prices are expected to be flat. October retail sales are forecast to record a healthy increase, thanks to continued high consumer confidence levels and a strong labor market. Industrial production in October is expected to rise modestly.

Retailers will dominate this week’s quarterly earnings reports as Home Depot, WalMart, Macy’s, Nordstrom, Williams-Sonoma and the Gap are scheduled to report. Other notable companies on the agenda include Cisco Systems, Applied Materials, Tyson Foods, Rockwell Collins and Viacom.

Portfolio Strategy

A divided Congress with Democrats taking control of the House and Republicans retaining control of the Senate might be the best possible outcome for the financial markets over the remaining two years of President Trump’s term. Such a scenario means that lawmakers and the president will not be able to pass any harmful legislation or reverse any legislation that has helped boost the economy. In other words, gridlock may actually be good for the stock market. The corporate tax cuts enacted last year were a major positive for the economy and should remain in place. It is also less likely that there will be further tax cuts which could add to the already massive federal budget deficit. This scenario would probably prevent government bond yields from rising too fast, providing a near-term positive for stocks. Without additional fiscal stimulus that might accelerate economic growth, the Federal Reserve may be less inclined to hike interest rates further. This could also be beneficial for stocks going forward. While Democrats and Republicans have both expressed interest in increasing infrastructure spending, any legislation that is passed would almost certainly be fiscally neutral so as not to increase the ballooning federal deficit. It’s true that the stock market has performed well in years with a mid-term election, but it may be premature to draw any strong conclusions this time, especially given the unresolved trade issues with China.