Trifecta Stocks Portfolio: Rate Hike, A Fed Story

 | Dec 18, 2016 | 12:00 PM EST
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The following commentary is an excerpt from the Weekly Roundup to Trifecta Stocks subscribers originally sent on Dec. 16. Click here to learn more about this dynamic portfolio and market information service.

This week was largely a mixed one for the stock market as the Dow Jones Industrial Average continued to tick higher while both the S&P 500 and Nasdaq Composite Index finished relatively unchanged. We'd also point out the small-cap heavy Russell 2000 finished the week down more than 1%. Even after factoring in these moves, all four indices were still well into the green on a quarter-to-date basis with the strongest performer being the Russell (up more than 9%) and the Nasdaq (up more than 2%) the laggard.

As for the Trifecta Stocks portfolio, we saw our positions in Facebook  (FB) , Alphabet (GOOG) L and AT&T T outperform the market over the last five days. Underperforming was International Flavors & Fragrances (IFF) , which we attribute to the continued strengthening of the dollar (more on that below). During the week, we downgraded our rating on CVS Health  (CVS) to Three from Two and, following a downgrade in its Street Quant Rating, we shed our active position in Costco Wholesale  (COST) . But given our favorable fundamental and technical view on COST shares, we have placed them in Trifecta Bullpen.

We also received a mixed bag of economic data this week that serves to remind investors that just because there is a new president-elect it doesn't mean economic woes have all been erased. But there are reasons to be optimistic, as evidenced by the Markit Flash reading for December that saw manufacturing activity hit a 21-month high with robust increases in new orders and job creation. That was tempered by weaker-than-expected November readings for industrial production, retail sales and housing starts.

Also weighing on the market this week was the revelation the Federal Reserve sees up to three interest rate moves higher in 2017 compared to the September view for two. Understandably, that news overshadowed the widely telegraphed and expected 25 basis point rate hike that was made a reality coming out of the December FOMC meeting this past Wednesday.

With that bumped-up outlook, the Fed's dovish bent remained intact and it once again trotted out the much-used, if not often-abused, "data dependent" phrasing when it comes to those follow-on rate increases. Let's remember, though, that over the last few years the Fed has often targeted raising rates, but did far less than it telegraphed for a variety of reasons. The message here is just because the Fed thinks it might raise rates, does not mean it eventually will.

Even so, the U.S. dollar continued to climb, and we expect to hear more companies follow Adobe's  (ADBE) lead and discuss the headwind the current dollar strength poses to 2017 forecasts. We will watch the dollar's impact on Trifecta positions, such as McCormick  (MKC) and International Flavors & Fragrances, that have meaningful exposure to markets and currencies outside the U.S.

Getting back to the FOMC meeting, what was most interesting to us were the modest changes to the central bank's 2016 and 2017 economic projections, issued alongside the Fed's statement. That forecast showed a modest bump higher in both 2016 and 2017 GDP expectations to 1.9% and 2.1%, respectively, from the 1.8% and 2% forecast in September. Alongside those revisions, the Fed's unemployment forecast also ticked lower compared to September expectations. For 2018, the Fed still sees GDP at 2%, which suggests it isn't quite ready to forecast any increase in growth rates from the potential stimulus policies to be enacted by President-elect Trump just yet, even though the stock market has risen over the last six weeks.

While we expect market activity to slow as next week progresses with just five trading days before the Christmas holiday and just nine until the end of 2016, we'll still get a hefty dose of data, including the third look at 3Q 2016 GDP. So far, expectations call for no real change from the last print of 3.2%. Granted, that's looking in the rear view mirror, and next week's data -- the November reports on durable orders, existing home sales, personal income & spending, leading indicators and new home sales -- should provide a better gauge of GDP for the current quarter vs. the prior one. The Atlanta Fed's GDP Now forecasts GDP of 2.6% for the current quarter.

As we said in last week's Roundup, "past a certain point the stock market's valuation and expectations will have to contend with economic reality." While enthusiasm is running high for what's to come in 2017, companies still have to contend with the current quarter ahead of potential tax cuts, regulatory reform, infrastructure spending and other Trump stimulus plans. Rest assured, we'll be looking for opportunities in the coming days and weeks.

Enjoy your weekend and be sure to get some of that holiday shopping done before it's too late. We'll see you back here next week to discuss the weekend box office following the debut of Rogue One: A Star Wars Story and help you navigate the pending market-related slowness ahead of the holidays.

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