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Further Gains on Solid Data

| November 28, 2016
MPCA Weekly Market Update

Stocks gained for yet another post-election week, bringing all of the major indexes to a series of new highs. Several news organizations reported that on Monday stock markets achieved a “superfecta” for the first time in 17 years with the Dow Jones Industrial Average, Standard & Poor’s 500 Index, Nasdaq Composite Index, and small-cap Russell 2000 Index all setting records. Exchanges were closed on Thursday for the Thanksgiving holiday, and trading ended at 1 p.m. EST on Friday, but trading volumes were solid early in the week.

Concerns that the U.S. economy is not strong enough to withstand a Federal Reserve rate hike and higher borrowing costs appear overblown, at least for now (more on this below). Overall, the week’s economic data were generally favorable. The University of Michigan’s gauge of consumer sentiment rose more than expected in November, Markit’s flash reading of November manufacturing activity showed an increase, and October durable goods orders recorded a solid gain. Housing market data were more mixed. Sales of existing homes in October reached their highest level since early 2007, but new home sales unexpectedly declined. The recent spike in mortgage rates caused some concern about whether the homebuilding cycle in the U.S. has peaked.

Earnings drive markets, and the recent turnaround in corporate earnings has also buoyed investor spirits. FactSet reports that corporate earnings for the S&P 500 rose by 3% in the third quarter on a year-over-year basis, reversing a streak of five quarterly losses. Investors have been expecting earnings to rebound sharply in 2017, although many wonder if such lofty expectations will be realized.

U.S. President-elect Donald Trump met with Japanese Prime Minister Shinzo Abe last week, which raised some hopes for a softening stand on trade relations with Japan on the part of the new administration. In a brief YouTube video statement this week, however, the future president announced that he would issue an executive order to withdraw the U.S. from the Trans-Pacific Partnership (TPP), which was a signature policy of current President Barack Obama. Trump said he would replace it with a “fair and bilateral” trade deal that brings jobs home. Japanese Prime Minister Shinzo said that without the U.S. the TPP agreement would be meaningless, and Trumps' critics have argued that abandoning the agreement will allow China to increase its influence in Asia.

A December rate hike from the Fed continues to look like a done deal. On Wednesday, investors took comments from the Federal Reserve’s policy meeting early in the month as an assurance that a rate hike was coming in December. Treasury prices fell in response, and the U.S. dollar rose against a basket of other currencies to its highest level in over a decade.

The corollary to a rising dollar these days is a weaker euro, as the sustainability of the Eurozone project continues to come under scrutiny.  The Brexit vote in June was a major driver in the process, and a series of upcoming elections, beginning with the Italian referendum and the Austrian presidential election in early December, have the potential to further weaken the European Union.  France is also electing a new president in April 2017, and German federal elections are expected in the fall.

Investors continue to expect Europe to underperform the U.S. in the near term, although valuations are of interest to those with longer time horizons.  Structural change is needed to support the bullish growth case for a unified Europe, however, including labor market reform and effective fiscal policies.