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Dow closes above 23,000 on strong quarterly earnings results

You need to have a passionate interest in why things are happening. That cast of mind, kept over long periods, gradually improves your ability to focus on reality. If you don’t have that cast of mind, you’re destined for failure even if you have a high I.Q. – Charlie Munger, Vice Chairman of Berkshire Hathaway and Warren Buffett’s partner

That sure didn’t take long. The Dow Jones Industrial Average closed above the 23,000 threshold on Friday for the first time ever after just eclipsing the 22,000 barrier back on August 2nd. Both the S&P 500 Index and the Nasdaq Composite Index also joined the party and closed at record highs. The week was special for another reason as Thursday marked the 30th anniversary of “Black Monday”, the worst day in U.S. stock market history. While the Dow was actually down by triple digits on that day, stocks erased all of the losses and wound up closing higher for the session. The biggest reason for the steady climb in stock prices has been third quarter corporate earnings, which have continued to beat analyst estimates. Over 70% of the companies that have reported have not only exceeded earnings estimates, they have also topped revenue expectations. The good news has broadened out to include companies in a wide range of  sectors. Netflix added 5.3 million subscribers during the third quarter and easily beat earnings and revenue targets. Other blue chip companies that surpassed profit forecasts included Morgan Stanley, Goldman Sachs, Johnson & Johnson, UnitedHealth and IBM, to name just a few. Positive earnings surprises weren’t the only catalyst to move the market higher, though. The Senate approved a budget resolution for fiscal 2018 that would allow a tax plan to be passed with a simple majority of votes, a move that essentially paves the way for tax reform. Optimism that a deal would be struck by year-end to reduce both individual and corporate taxes helped push the market higher. While failure to enact tax cuts and tax reform could derail the stock market and cause it to give back some of its gains, for now investors are viewing the glass as half full rather than half empty. With global economies improving and third quarter earnings beating estimates, the path of least resistance for the stock market appears to be higher.

Last Week

Industrial production, which includes manufacturing, mining and electric and gas utilities, increased modestly in September as the effects of the hurricanes waned. Import prices in September were higher than expected and recorded the biggest increase in more than a year. However, excluding the volatile food and energy components, underlying imported inflation remains modest. Weekly jobless claims fell 22,000 to 222,000, far less than expected and the lowest level in more than 44 years. Leading economic indicators in September fell slightly and were less than forecast.

The Federal Reserve’s Beige Book, a collection of economic anecdotes from the Fed’s regional districts, showed that economic growth has ranged from modest to moderate.

For the week, the Dow Jones Industrial Average surged 2% to close at 23,328 while the S&P 500 Index rose 0.9% to close at 2,575. The Nasdaq Composite Index gained 0.4% to close at 6,629.

This Week

The preliminary reading for gross domestic product (GDP) in the third quarter is expected to be 2.9% as consumer spending remains strong. Durable goods orders for September are forecast to increase by 1%, about half the increase in August. September new home sales should be on a par with the previous month while the final reading for the October Michigan sentiment index should exceed 100, a number that reflects a high degree of consumer confidence in the economy and the labor market.

This week promises to be the busiest one of the earnings season as AT&T, McDonald’s, Coca Cola, Visa, Eli Lilly, Merck, Amgen, 3M, UPS, Caterpillar, Boeing, General Motors, Ford, Alphabet (Google),, Intel, Microsoft, Exxon Mobil and Chevron are just a few of the prominent companies scheduled to report.

Portfolio Strategy

Just over 30 years ago on October 19, 1987, the Dow Jones Industrial Average plunged 508 points or 22.6%, making it the worst day in U.S. stock market history. From its high on August 25, 1987 to the low on Black Monday, the Dow actually lost 984 points or 36% in only 39 trading days. While there are some so-called investment gurus and pundits that have warned about another crash in the market, there are important differences between then and now. Probably the biggest cause of the 1987 crash was the increase in the discount rate by the Federal Reserve from 5.5% in August of that year to 6% in October.  The yield on the 10-year Treasury also soared from 7.23% at the beginning of the year to 10.15% on the day of the crash. Today the current yield on the same 10-year Treasury is only 2.38% and yields across the entire yield curve are much lower. If the long-term average total return for stocks has been in the neighborhood of 10%, why would you invest any money in risk assets such as stocks when a risk-free U.S. government bond is paying over 10%? Another possible cause that contributed to the crash was a new device called program trading that used computer algorithms to buy and sell stocks to make small profits. Two separate attacks by Iran on U.S.-owned ships in early October also caused jitters among investors. Investors who panicked and sold their equity positions on that day missed out on the recovery in stock prices as the Dow rallied 17% over the next two days. In fact, the Dow posted a total return of nearly 6% for the year despite the crash on October 19th. The best course of action for investors to weather this type of extreme volatility is to develop an asset allocation plan that fits their long-term investment objective and enables them to remain calm and to sleep at night, even under the most trying circumstances.