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Stocks gain on optimism over Covid-19 vaccine

When you start to confuse Freddie Mac, Sallie Mae and Fannie Mae with members of your family, and you remember 2,000 stock symbols but forget the children’s birthdays, there’s a good chance you’ve become too wrapped up in your work. – Peter Lynch

Promising phase one trial results reported from biotechnology company Moderna on Monday caused the stock market to surge over 3% and stocks were able to maintain those gains as the week ended. All three major stock averages increased at least 3% even though economic data continued to be horrible and tensions between the U.S. and China escalated. Although the results from Moderna’s Covid-19 vaccine trial were encouraging, the sample size was limited and lacked sufficient data. Nevertheless, after two doses, all 45 trial participants had developed coronavirus antibodies. Federal Reserve Chairman Jerome Powell also made some reassuring comments that the Fed is not out of ammunition and would be able to do a lot more to help the economy if necessary. He emphasized that people should not bet against the American economy and was confident that the economy would rebound in the second half of the year. While Powell was optimistic about an economic resurgence, minutes from the Fed’s April meeting were much more guarded. They showed that there was deep concern about the state of the economy and what lies ahead. Fed officials were also worried about a second wave of coronavirus infections, which could weigh heavily on business capital investment and create a reluctance to rehire workers. Last week the number of people that filed jobless claims continued to be high. The total was 2.44 million, which brought the total filings during the pandemic to 38.6 million. If there was one bright spot in the data, it was that the pace of new filings had declined from previous weeks. The market was also able to overcome growing tensions between the U.S. and China. Not only did the U.S. criticize the Chinese for taking steps to eliminate Hong Kong’s independence, the Senate passed a bill that would potentially delist Chinese stocks from U.S. exchanges. But optimism about the U.S. economy reopening and a potential vaccine for the coronavirus outweighed the negative jobs data and the increased acrimony with China.

Last Week

April housing starts fell to their lowest level since 2015, falling 30% from their level in March and much lower than forecast. Historic unemployment levels and a huge decline in consumer confidence affected sales and builders decided to cut back on construction activity. Existing home sales dropped nearly 18% in April, the largest one-month decline since July 2010 and much lower than a year ago.

The Congressional Budget Office (CBO) forecast that gross domestic product (GDP) could decline 38% in the second quarter, which is in line with current Wall Street forecasts.

For the week, the Dow Jones Industrial Average gained 3.3% to close at 24,465 while the S&P 500 Index rose 3.2% to close at 2,955. The Nasdaq Composite Index jumped 3.4% to close at 9,324.

This Week

The second estimate of first quarter GDP is expected to show a decline of 4.8% while April durable goods orders are expected to drop about 18%, worse than in March. New home sales for the month of April are forecast to drop significantly from levels in March and May consumer confidence is forecast to be roughly even with the level in April, which was 87.

Among the most prominent companies scheduled to report quarterly earnings this week are AutoZone, Dollar General, Dollar Tree, Nordstrom, Autodesk, HP Inc., Dell Technologies, Toll Brothers, Costco Wholesale, Bank of Montreal and Royal Bank of Canada.

Portfolio Strategy

One of the concerns of the recent strength in the stock market has been the lack of market breadth and the fact that just a few number of stocks are responsible for the strong performance. For the year, the S&P 500 Index is down only about 8% while the Nasdaq Composite Index has actually gained about 8%. Market breadth measures the number of stocks advancing relative to those that are declining in a given index. Positive market breadth happens when more stocks are advancing than are declining and suggests a bullish trend is in place. It refers to how many stocks are participating in a given move higher or lower in an index. In the recent rebound from the stock market lows established on March 23rd, a small number of stocks have produced such large gains that they have pulled the entire index higher. Beneath the surface, though, more than half of the stocks in the index are performing poorly with negative returns. Both the S&P 500 Index and the Nasdaq Composite Index are market-capitalization-weighted indexes where the largest companies are driving the bulk of the gains. The five largest companies in the S&P 500 are Microsoft, Apple, Amazon, Alphabet (Google) and Facebook while the ten largest companies in the Nasdaq are these same five companies and five other technology companies. Of these ten companies in the Nasdaq, only one, Cisco Systems, is down on a year-to-date basis. The vast majority of stocks in these indexes are down approximately 20% or more and tend to be in sectors that are mostly value-oriented. Growth sectors such as technology (up 5%), health care (flat) and consumer discretionary (down 2%) have been leading the market while value sectors that include energy (down 37%), financials (down 29%), industrials (down 21%), materials (down 15%) and utilities (down 13%) have been trailing the overall market. The problem for investors is that valuations of the top holdings in both the S&P 500 and Nasdaq are very expensive relative to valuations of the typical stock in these benchmarks. As the economy begins to recover, the risk for investors is in the largest market-cap-weighted companies while the cheaper, value-type stocks that have not participated in the rally should begin to outperform.