Trade deal optimism propels Dow over 28,000, a new all-time high

Other people’s fear is your friend, because it drives the price of stocks down. Your own fear is your enemy. – Warren Buffett

The Dow Jones Industrial Average closed above 28,000 for the first time ever last week and in doing so, established a new all-time high. Both the S&P 500 Index and the Nasdaq Composite Index followed suit and also ended the week at record highs. It was the sixth consecutive week that the S&P 500 has closed higher. Although there was no particular catalyst for the market’s historic move higher, investors continue to be optimistic that a partial trade agreement between the U.S. and China will be reached sooner rather than later. With the third quarter earnings season largely in the rear view mirror and no potentially market-moving economic data released last week, the focus has been squarely on trade talks. Early in the week, President Trump said in a speech at the Economic Club in New York that the first phase of a trade deal was close to being finalized but he offered few details. But the next day trade sentiment turned negative as negotiations hit a snag over expected agricultural purchases by China. The U.S. also said that it wanted stronger concessions from China in exchange for eliminating some tariffs. All of this back and forth about the trade talks has led to one simple conclusion: as news goes about the talks, so goes the market. Positive developments about the U.S.-China trade negotiations cause the stock market to rise while lack of progress and negative news sends the market lower. It was no surprise then last week that the biggest daily gain in stock prices came on Friday when White House economic adviser Larry Kudlow said that trade negotiations have been “very constructive” and that negotiators are getting close to an agreement. But with the continued rise of the major stock averages to all-time highs, much of the positive news regarding a Phase One trade deal is already priced into the market.

Last Week

Inflation continues to remain under control as the consumer price index (CPI) in October was slightly higher than expected but over the last 12 months, the core rate that excludes food and energy has risen only 2.3%. Much of the increase in the headline number was due to higher gasoline prices. The producer price index (PPI) in October was also slightly higher than forecast but the core rate over the last year has increased only 1.5%. U.S. import prices actually fell in October after rising slightly in September. Another positive sign for the economy was October retail sales, which were better than expected after a disappointing September, creating optimism that it will be a strong holiday shopping season.

In an address to the Congressional Joint Economic Committee, Federal Reserve Chairman Jerome Powell said that as long as the economy keeps growing, interest rates are likely to remain unchanged. He added that current monetary policy was appropriate if the outlook for moderate economic growth, a strong labor market and inflation near 2% remains intact.

For the week, the Dow Jones Industrial Average rose 1.2% to close at 27,004 while the S&P 500 Index added 0.9% to close at 3,120. The Nasdaq Composite Index gained 0.8% to close at 8,540.

This Week

The Leading Economic Index for October released by the Conference Board is expected to show a slowing but still expanding economy. Housing starts and existing home sales in October are forecast to be slightly higher than in September, suggesting continued strength in the housing sector due partly to low mortgage interest rates.

The Federal Open Market Committee (FOMC) releases minutes from its monetary policy meeting held at the end of October.

Retailers will dominate the third quarter earnings reports this week and the most notable of them include Kohl’s, Nordstrom, Home Depot, Lowes, Gap and Macy’s.

Portfolio Strategy

Although low current bond yields reflect the relatively benign inflation data reported last week, it wouldn’t take much for yields to rise from these historically low levels. The 10-year Treasury yield is currently at only 1.83% and the Barclays U.S. Aggregate Bond Index, which has a duration of 5.5 years, yields just 2.2%. Bond prices have soared this year, causing yields to decline and giving investors better than average returns on their fixed income investments. Duration measures a bond’s sensitivity to changes in the level of interest rates and is usually less than a bond’s average maturity due to the interest payments received prior to maturity. In the case of the Barclays U.S. Aggregate Bond Index, a one percent rise in interest rates would cause a 5.5% drop in the price of the index, more than offsetting the paltry yield of 2.2%. To protect against a possible rise in interest rates, investors should shorten the duration of their bond portfolios, especially with a flattish yield curve where short-term interest rates approximate longer-term rates. Two short-term bond funds that accomplish this objective are the Weitz Short Duration Income Fund (WEF1Z) and the JP Morgan Ultra-Short Income ETF (JPST). The Weitz Fund invests in Treasuries, Federal Agency issues, corporate bonds, mortgage-backed securities and asset-backed securities and has an average maturity of only 1.8 years and a current yield of 2.3%. About 90% of the securities in the Fund are rated BBB or better. The JP Morgan Fund invests only in investment grade securities rated BBB or higher and has an average maturity of only 1.1 years and a current yield of 2.4%. Both funds would lower the interest-rate sensitivity of a fixed income portfolio and provide investors with only a modest reduction in income from longer-term bond funds.