In Wall Street, the only thing that’s hard to explain is next week. – Louis Rukeyser
The major stock averages consolidated recent gains last week and closed only modestly higher, with the Nasdaq Composite Index recording yet another all-time high and the S&P 500 and the Dow setting intra-day highs. Led by the financials. third quarter earnings season was in full swing and the money center banks and investment firms did not disappoint. JP Morgan Chase, Citigroup, Bank of America and Blackrock all beat earnings estimates and investors were optimistic that the trend would continue in subsequent weeks as companies in other sectors issue their profit reports. There also was other corporate news last week that set a positive tone for the market. Wal Mart Stores announced a $20 billion stock buyback and reaffirmed its earnings outlook for the year while Honeywell and Pfizer announced plans to spin off separate businesses. Investors also digested the minutes from the Federal Open Market Committee meeting in September and learned that Fed officials were in agreement that an interest rate hike in December was a near certainty. Despite divisions among its members over the direction and magnitude of inflation, most seemed to think that the factors keeping inflation low were temporary and that inflation would eventually hit their 2% target. The Fed’s preferred inflation gauge is currently showing a gain of only 1.4%. The minutes also confirmed that the Fed plans to begin its $4.5 trillion balance sheet reduction this month and Fed officials seemed confident that it would have little or no effect on the markets. They were sanguine about near-term economic growth and felt there would be no longer-term impact from Hurricanes Harvey and Irma as the affected areas would be rebuilt and economic activity would resume. The focus for the market over the next several weeks will be on third quarter earnings reports, but much of the expected good news is already reflected in stock prices.
The producer price index (PPI) for September rose more than in previous months but the core rate, which excludes food and energy, increased only slightly. Higher gasoline prices caused by Hurricane Harvey were the primary reason for the bigger increase in the headline number. The consumer price index (CPI) exhibited the same pattern and in the 12 months through September, the core CPI has risen only 1.7%. Retail sales in September were slightly less than expected but registered the largest monthly increase in over two years. Weekly jobless claims fell by 15,000 to 243,000 as more people went back to work in Texas and Florida, states affected most by the recent hurricanes. The preliminary University of Michigan consumer sentiment index in October reached its highest level since 2004.
For the week, the Dow Jones Industrial Average added 0.4% to close at 22,871 while the S&P 500 Index gained 0.2% to close at 2,553. The Nasdaq Composite Index also rose 0.2% to close at 6,605.
There will be more inflation data this week as import prices for September are expected to match the increase in August of 0.6%. September housing starts and existing home sales are forecast to be at levels consistent with those in the previous month and indicative of a healthy and vibrant housing market. Leading economic indicators for September are expected to show only a modest rise and be less than in August. China will release a number of economic reports, including consumer prices, third quarter GDP, industrial production and retail sales.
Financial companies will again highlight quarterly earnings reports this week as Charles Schwab, Morgan Stanley, Goldman Sachs, American Express and US Bancorp are all on the agenda. Other notable companies scheduled to report include IBM, CSX, General Electric, Johnson & Johnson, Abbott Labs, UnitedHealth, Verizon, Honeywell, Procter & Gamble and Philip Morris International.
Despite ongoing geopolitical risks and frequent warnings from noted investment gurus that the market is due for a correction, stocks continue to climb a wall of worry and grind higher. The simple explanation for this strength can be attributed to the fact that the U.S. economy and the global economy are both doing quite well. Corporate earnings have been excellent as first quarter earnings grew 14% and second quarter profits rose 10%. Earnings growth is expected to slow to 6% in the third quarter but most companies are expected to beat their earnings targets. Consumer spending accounts for about two-thirds of gross domestic product (GDP) and right now, the consumer is in great shape. The unemployment rate is at a 15-year low, consumer confidence is at record high levels and the housing market remains strong. Although Congress has struggled to pass any meaningful legislation, the Trump administration remains pro-business and anti-regulation, which should benefit corporations and their bottom lines. The possibility of tax reform and tax cuts only adds to the optimism for the economy and the stock market. Global growth prospects are also improving as the International Monetary Fund (IMF) recently raised its outlook for growth to 3.5% this year and 3.6% next year. In addition, there are few viable alternatives to equities as the 10-year Treasury yield ended last week at 2.28% and money market fund yields are miniscule. Investment grade corporate bonds with intermediate-term maturities only yield about 3% while junk bonds may have more attractive yields but they also come with a huge amount of risk. Finally, the stock market is entering the final three months of the year, which have historically been excellent from a total return perspective. Over the past 25 years, the S&P 500 Index has gained an average of nearly 5% during the fourth quarter. This statistic is all the more reason to think that this bull market still has some upside.