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Stocks fall victim to profit-taking after posting all-time highs

When navigating the financial markets, the long-term investor must keep in mind the four basic dimensions of long-term return – reward, risk, cost and time – and must apply them to every asset class. Never forget that these four dimensions are remarkably interdependent. – John Bogle

After reaching all-time highs the previous week, investors decided to take some profits last week and stocks closed modestly lower. It was the first weekly decline in over a month for the major stock averages as the market has benefited from mostly favorable economic data, better than expected third quarter corporate earnings and continued optimism over U.S.-China trade negotiations. The rally has been driven partly from investors’ fear of missing out on the current rally. With all of the major indexes posting total returns in excess of 20% so far this year, who could blame investors for reaping some of the rewards by booking some profits. Last week it was the retailers that dominated the earnings releases and the results were decidedly mixed. Although Home Depot beat earnings estimates, its sales fell short of expectations and the company reduced its sales forecast for the year. Department store chains Macy’s and Kohl’s also reported disappointing sales and earnings and Kohl’s slashed its profit outlook for the year as it expects heavy discounting by competitors to continue. On the bright side, though, both Target and Lowe’s exceeded analysts’ estimates for revenue and earnings and both companies raised their profit outlook. But as is usually the case lately, trade talks with China overshadowed both earnings and economic data and were in the spotlight once again last week. There was concern that a “phase one” trade agreement would not be completed this year and China also condemned a U.S. resolution that supports human rights in Hong Kong. New tariffs are scheduled to go into effect on December 15th and China wants more extensive tariff rollbacks as part of the deal. Pessimism over trade turned to optimism on Friday, though, when President Trump said that both sides were “very close” to reaching a trade agreement. These positive comments allowed stocks to rebound slightly on Friday, erasing losses from the previous two sessions caused by negative trade remarks.

Last Week

For the most part, housing data last week was upbeat as housing starts and existing home sales both rebounded in October and building permits for new-home construction hit a post-recession high. The home-builder confidence index also hit a 20-month high in October due partly to low mortgage rates.  Leading economic indicators in October fell slightly due largely to concerns over trade with China but November consumer sentiment came in better than expected as consumers remain confident about the economy and their job prospects.

Minutes from the Federal Reserve meeting in October suggested that interest rates are likely to remain the same for a while as Fed officials were in agreement that they won’t cut rates unless U.S. economic conditions deteriorate significantly.

For the week, the Dow Jones Industrial Average dropped 0.5% to close at 27,875 while the S&P 500 Index fell 0.3% to close at 3,110. The Nasdaq Composite Index slipped 0.2% to close at 8,519.

This Week

The preliminary third quarter gross domestic product (GDP) is expected to be 1.9% while durable goods orders in October are expected to decline slightly. October new home sales are forecast to improve over those reported last month and be consistent with other recent strong housing data.

The U.S. markets will be closed on Thursday in observance of Thanksgiving and will close early on Friday.

The most notable companies scheduled to report earnings this week include Analog Devices, Agilent, Hewlett Packard Enterprise, Palo Alto Networks, HP, Best Buy, Dick’s Sporting Goods and Deere & Co.

Portfolio Strategy

The stock market may have taken a breather last week from its lofty perch at all-time highs but Thanksgiving week is often a positive one for stocks. In fact, the market is moving into a seasonally strong time of year as the month of December has been the best month of the year for stocks. The holiday shopping season kicks off on Black Friday and the National Retail Federation forecasts sales will increase about 4%, much better than last year when sales increased about half that amount. Last December the Federal Reserve was poised to begin tightening monetary policy and raising interest rates, which was part of the reason the stock market plunged and the S&P 500 Index ended the year with a loss of about 4%. This year the Fed has been very accommodative and interest rates have moved steadily lower. The 10-year Treasury yield was only 1.75% on Friday, down from 1.95% just ten days ago. Benign inflation is partly responsible for the decline in yields, but doubts have also surfaced about the U.S. and China reaching a trade deal by December 15th when a new round of tariffs goes into effect. Since retail sales drive more than two-thirds of the economy, a strong holiday shopping season could bolster prospects for higher growth. While the S&P 500 currently trades at about 18 times forward earnings, above its historical average, stronger economic growth could translate into better earnings growth and justify the higher stock market valuation.