Post-election rally in stocks stalls as S&P 500 falls 1%

You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick ‘no’. – Warren Buffett

Both the S&P 500 Index and the Nasdaq Composite Index fell last week, snapping their three-week winning streak, as investors took profits after the strong post-election rally in stocks. The Dow Jones Industrial Average, however, managed to eke out a slight gain to keep its streak intact at four weeks. Most investment strategists were in agreement that the stock market had come too far, too fast and was due for a down week as stocks were overbought. Beneath the market’s surface, investors were rotating from one sector to another in an attempt to profit from the next winners. The Nasdaq, which primarily consists of technology stocks, tumbled 2.7% last week as financials, energy, materials and industrials continued to outperform. Consumer stables and utilities have also been weak recently. The market’s action, though, was not reflective of the economic data last week, which was mostly positive. The second gross domestic product (GDP) reading for the third quarter showed the economy expanded at a better-than-expected 3.2% annual pace. Consumer spending in the quarter grew at the fastest pace since 2002 and business investment was strong, growing at a 10% clip. The November employment report was also better than anticipated as 178,000 jobs were created and the unemployment rate dropped to 4.6%, a nine-year low. While this decline appears favorable at first glance, much of it was due to a jump in discouraged workers as 95 million people are currently not counted as part of the labor force. Another troubling sign in the employment report was a decline in wages, although a separate report on personal income registered its best reading since April. Consumers were also in a joyous mood as the U.S. consumer confidence index rose to 107 in November from 101 in October, a hopeful sign as the holiday shopping season gets into full swing.

Last Week

In other economic data last week, the Case-Shiller Index showed that U.S. home prices rose 5.5% in September and pending home sales edged slightly higher. Manufacturing data was also strong as the ISM manufacturing index and the Chicago purchasing managers index (PMI) were both comfortably in expansion territory in November. Construction spending rebounded strongly in October after a weak September.

OPEC agreed to reduce oil production by over a million barrels a day and, as a result, oil prices increased 9% and oil ended the week at over $51 a barrel. The Federal Reserve Beige Book showed that there is modest to moderate economic growth in most regions of the country. It noted that employment “continued to expand”, wage growth was “modest” and a strong dollar was a “headwind”.

For the week, the Dow Jones Industrial Average edged up 0.1% to close at 19,170 while the S&P 500 Index lost 1% to close at 2,191. The Nasdaq Composite Index dropped 2.7% to close at 5,255.

This Week

In a continuation of the strong manufacturing data reported last week, factory orders for October should be much higher than in September. Also on the calendar this week will be the ISM non-manufacturing or services sector index and the December Michigan Sentiment Index, which is expected to show that consumers remain confident about the economy and its prospects.

In overseas news, after voting on a referendum in Italy over the weekend that may determine whether or not Prime Minister Matteo Renzi remains in power, markets and particularly bank stocks could be volatile in the week ahead.

In another relatively slow week for quarterly earnings reports this week, the most familiar companies scheduled to report include AutoZone, Toll Brothers, H&R Block, Costco Wholesale, Broadcom and Bob Evans Farms.

Portfolio Strategy

For investors in municipal bonds and bond funds, the rise in interest rates since the election has resulted in falling municipal bond prices. While most municipal bond funds had been up about 2% through the end of October, those returns have evaporated and intermediate-term tax-exempt bond funds now show year-to-date losses of about 1%. Short-term municipal bond funds are also down about one half of a percent. The increase in rates has made high quality, 10-year municipal bonds very attractive with yields that approximate 3% in some cases. These yields are currently higher than yields on comparable Treasuries and high-quality corporate bonds with similar maturities even before taking into account the tax benefit. The reason for the weakness in municipal bond prices has been the anticipated pro-growth stimulus plans of president-elect Donald Trump, including higher spending and lower tax rates. Higher proposed infrastructure spending increases the supply of municipal bonds and lower tax rates reduce demand for these bonds. Both policies effectively result in lower prices for municipal bonds. Much of the sell-off in municipals, however, has been overdone as Trump has not even taken office yet and there is no guarantee that his policies will even be passed. Even if the policies are approved, they will take time to implement. Investors would be wise to stand pat and remember that the fixed income portion of their portfolio is designed to provide income and reduce the overall risk and volatility of the portfolio. Over time, rising interest rates can actually have a positive effect on returns as the yield of the portfolio rises and the investor receives more income.