S&P 500 closes at record high, fueled by post-election optimism

The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. – John Bogle

After seeing its winning streak snapped in the prior week, the stock market came roaring back last week to post gains in excess of 3% as the Dow Jones Industrial Average, S&P 500 Index and Nasdaq Composite Index all hit record highs. The Russell 2000 Index of small cap stocks also closed at an all-time high. A rising tide lifts all boats and that certainly seems to be the case right now as all sectors of the market participated in the rally. The Dow currently sits at 19,756, a mere 244 points from 20,000. What propelled the market to such lofty heights is difficult to answer as there was no significant economic data released last week and no earnings reports of any consequence. The most likely explanation is continued optimism on the part of investors for the pro-growth economic agenda of president-elect Donald Trump. The prospect of fiscal stimulus in the form of increased infrastructure spending, corporate and individual tax reform and tax cuts and fewer government regulations have all been responsible for fueling the rally in stocks ever since election day. No indicator reflected the current mood of the public better than the December University of Michigan consumer sentiment index, which hit 98 last week, the highest reading since January 2015 and within a tenth of a percent of the highest level since 2004. Confidence in the outlook for the economy can go a long way toward increasing consumer spending and business investment and boosting manufacturing and housing activity. The stock market is a forward-looking mechanism and right now it likes what it sees.

Last Week

It was a quiet week in terms of economic data but reports that were released were generally positive. The November ISM non-manufacturing or services sector index was 57, compared to 54 in October, and confirmed that the sector continues to show healthy expansion. Factory orders were slightly better than expected in October and third quarter productivity rose 3.1%, the fastest pace in two years. Weekly jobless claims were 258,000, matching estimates, and at a level that denotes a strong labor market with very few layoffs.

In overseas news, President Mario Draghi and the European Central Bank (ECB) decided to keep interest rates unchanged and extended their quantitative easing program until December 2017, but with a reduced amount of bond purchases each month. A referendum in Italy regarding a plan to change the Italian constitution was defeated as voters rejected legislative reform measures. As a result of the vote, Prime Minister Matteo Renzi resigned.

For the week, the Dow Jones Industrial Average soared 3.1% to close at 19,756 while the S&P 500 Index also rose 3.1% to close at 2,259. The Nasdaq Composite Index jumped 3.6% to close at 5,444.

This Week

The most anticipated event this week will be the Federal Reserve meeting on Wednesday and it is widely expected that they will raise the federal funds rate by a quarter of a point, the first increase in interest rates since last December.  Inflation data should also be relatively benign, with November import prices falling modestly and the producer price index (PPI) and the consumer price index (CPI) for November edging up slightly. November retail sales are also forecast to increase, but by less than in October, and November housing starts are expected to be less than the previous month as well but still consistent with a healthy housing market.

It promises to be another quiet week for earnings reports, with the most notable companies on the agenda being Verifone Systems, Oracle, Adobe Systems, Joy Global, Apogee Enterprises and Carnival.

Portfolio Strategy

While many investment strategists believe that the stock market is overbought given its strong rally since early November, the bond market, on the other hand, appears oversold. Since election day, the yield on the 10-year Treasury has climbed from 1.80% to 2.46%, with short-term and long-term interest rates also moving appreciably higher. At the European Central Bank (ECB) meeting last week, President Mario Draghi acknowledged that deflation was no longer a risk but did not significantly alter the ECB’s stimulus program. While the amount of monthly bond purchases was reduced by 25%, the length of time that these purchases will be made was extended to the end of 2017. Even though the Federal Reserve is widely expected to raise interest rates this week, the forecast for next year is only for two or three additional quarter point hikes depending on the strength of forthcoming economic data. In other words, the Fed will take a wait-and-see approach and will make its decision solely based on the economic data as it presents itself. Most economists expect a very gradual rise in rates. The Bank of Japan meets one week after the Federal Reserve and is also likely to maintain its stimulus programs, thereby keeping its interest rates very low. With Treasury yields so much higher than government bond yields in Europe and Japan, interest rates aren’t likely to move much higher here since the relative attractiveness of our securities will bring in buyers, driving up the price and lowering the yield. This disparity between yields in the U.S. and yields abroad should help keep a lid on interest rates.