Stocks rebound on FOMC minutes, strong retail earnings

Value investing is at its core the marriage of a contrarian streak and a calculator. – Seth Klarman, American billionaire who founded one of the world’s largest hedge funds

The major stock averages rebounded strongly last week to recover most of what they had lost the previous week as investors embraced an all but certain interest rate hike in December. The language of the last Federal Open Market Committee (FOMC) minutes were viewed positively by investors as the Fed confirmed that the majority of its members were in favor of a rate increase next month. Their only concern was a possibility that the long-term growth potential of the U.S. economy may have permanently shifted into a lower gear. It was their contention, though, that an initial interest rate hike would send investors an important signal that the economy was strong enough to withstand an increase in rates. They all acknowledged that there appeared to be solid momentum in both business and consumer demand and that further delaying a rate hike could make financial markets more anxious about the significance attached to an initial hike. Certainty is one thing that investors crave and the belief that the Fed would be very slow and deliberate after the first move put their minds at ease. This has been the most over-analyzed and dissected federal funds rate increase of a mere 25 basis points in the history of Federal Reserve monetary policy. To finally have liftoff and end the never-ending debate over whether or not the timing is right could actually give investors confidence and lead to further stock market gains. Contributing to the bullishness in stocks last week were also better than expected third quarter earnings reports from some prominent retailers. Unlike the previous week, when U.S. October retail sales were weak and major department stores Macy’s and Nordstrom missed earnings estimates, retail giants such as Home Depot, Lowe’s, Wal-Mart and Target all reported strong sales and profits. These encouraging reports renewed hope that consumer spending would regain its momentum, especially heading into the all-important holiday shopping season.

Last Week

The consumer price index (CPI) rose 0.2% in October, the biggest increase in five months, as apartment rents and medical care were responsible for the largest increases. The core CPI, which excludes food and energy, has now risen 1.9% over the last 12 months. October U.S. industrial production fell modestly as the manufacturing sector continues to face difficult conditions from weak oil company investment, a strong dollar and slowing growth in Asia. Leading economic indicators in October were better than expected, suggesting that the outlook for the U.S. economy in 2016 is improving.

Dovish remarks from European Central Bank (ECB) President Mario Draghi that the ECB stands ready to implement additional stimulus measures if necessary helped boost European equities by 3.3% last week. Although third quarter gross domestic product (GDP) fell again in Japan following a decline in the second quarter, recent economic data there is improving and may indicate that the worst is over.

For the week, the Dow Jones Industrial Average soared 3.4% to close at 17,823 while the S&P 500 Index gained 3.3% to close at 2,089. The Nasdaq Composite Index jumped 3.6% to close at 5,104.

This Week

The markets are closed in the U.S. for the Thanksgiving holiday and both the stock and bond markets will close at noon on Black Friday, the unofficial start of the holiday shopping season. The second reading on third quarter GDP is expected to remain unchanged at 1.5%, although some economists believe it could be revised higher on stronger inventory investment. October existing home sales and new home sales should be in line with last month’s numbers as the housing market continues its steady recovery. In what could be a good omen for the holiday shopping season, the November consumer confidence index is expected to increase.

The third quarter earnings season is rapidly winding down as over 95% of S&P 500 companies have reported their earnings. On tap this week are Deere & Co., HP Inc., Analog Devices, Campbell Soup, Tyson Foods, Dollar Tree and Tiffany & Co.

Portfolio Strategy

After the horrific terrorist attacks in Paris on November 13^th, most investors probably presumed that the markets would open lower on Monday and have difficulty moving higher for the rest of the week. Instead, the S&P 500 was higher by midday last Monday and never looked back as it ended the week at 2,089, almost completely erasing the losses experienced in the previous week. The rebound in stock prices may have been due to the belief that the Fed would now stand pat on interest rates or that the stock market was oversold and cheap on a relative basis. Whatever the reason for the rally last week, history shows that any negative stock market reaction from terrorist attacks tends to be short-lived. The only exception to this was 9/11. Fundamentals drive stock prices and random terrorist attacks, as awful and tragic as they are, typically elicit only a temporary, muted response from stocks. With the third quarter earnings season almost behind us, any continued rise in stock prices will have to be driven by macroeconomic factors. But with only limited economic data to be reported between now and year-end, it may be difficult for stocks to tack on any additional gains.