The following is a weekly investment commentary for the week of Nov. 1 from Jeffrey Kleintop, chief market strategist at LPL Financial.
The long-awaited events of last week included the mid-term elections and Federal Reserve (Fed) announcing the details of another stimulus program. Stock market momentum had stalled out in the two weeks leading up to last week as investors held their breath awaiting the outcome. The events unfolded just as the markets had anticipated and mostly priced in during the double-digit gain in the S&P 500 that took place during September and October. As investors breathed a sigh of relief last week, the stock market posted a solid 3.5% gain resulting in a new two-year high in the S&P 500 as pent-up demand for stocks was invested.
While the major headlines are out of the way, what happens in Washington during the remainder of the year will still hold influence over the markets. Some of the lame duck agenda items with potential market-moving impact include the expiration of unemployment benefits, government funding, and the Bush tax cuts.
Extended unemployment benefits will expire at the end of November if Congress fails to renew them in the coming weeks. People who exhaust their 26 weeks of regular state unemployment benefits can then receive up to 73 weeks of federally funded benefits, for a total of 99 weeks in high-unemployment states. This summer, when the emergency benefits were last renewed, Republicans temporarily allowed extensions to expire for nearly two months. They objected to the extension because the cost to do so was not offset by other spending cuts and therefore added to the federal deficit, in violation of the pay-as-you-go rules. Since Republicans gained seats in the Senate last week, it could be even tougher to pass a renewal of the program potentially leaving millions without benefits during the peak consumer spending holiday season, posing risks to retailers and overall economic growth.
Before the mid-term elections, Congress passed a resolution funding the government until December 3, setting up a showdown over spending in the lame duck session. Also, the fiscal commission established by President Obama is due to report on December 1. There are indications that leading Democrats on the panel are seeking to present major changes to Social Security intended to ensure the program is solvent for the long run.
The most important item facing Congress is the looming expiration of the Bush tax cuts. Congress is likely to address the tax cuts in some way. Both parties risk a huge backlash if no action is taken and all tax rates revert to higher levels, which puts pressure on the 70% of the economy that is driven by consumer spending. This is a concern given that current economic growth is already sluggish. We continue to believe it is likely that Congress will pass a one or two-year extension of all the Bush tax cuts during the lame duck session, but admit it is a close call.
The potential for extending the dividend tax rate at 15% (as opposed to reverting up to 39.6% for the top bracket) and the ability of the companies in the Financials sector to boost dividend payouts made the sector the best performer last week. Financial companies that received TARP money must get regulatory approval to boost their dividend which may soon be forthcoming. The first quarter of the year has traditionally been when companies announce increases to their dividend payments. Last week, the Energy, Materials, and Industrials sectors benefitted from the Fed's actions on Wednesday that weakened the dollar.
Investors' appetite for yield has prompted strong inflows into the high-yield bond market this year. Perhaps last week's performance is a sign that investors may migrate from high-yield bonds toward high dividend-paying stocks, possibly ending the U.S. equity buyers' strike that has resulted in outflows from U.S. equity mutual funds every week during the second half of 2010. We will be watching money flows closely to see how they react to the changes in Washington.
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