Although it’s easy to forget sometimes, a share is not a lottery ticket…it’s part-ownership of a business. – Peter Lynch
Strong earnings from several technology giants on Friday propelled the Nasdaq Composite Index to an all-time record high close and enabled the index to post a gain of over 2% for the day. The S&P 500 Index also closed at a record high as third quarter earnings for the broad market continue to beat analyst estimates. After marking time over the summer months, technology stocks sprang back to life on Friday after Amazon.com, Microsoft and Google parent, Alphabet, announced blowout earnings that easily surpassed expectations. The good news was not confined to the technology sector, either. In the busiest week of the earnings season, companies in a broad range of industry sectors managed to beat both on the top and bottom lines. Among the blue chips that reported strong earnings results were 3M, Ford, Visa, Caterpillar, United Technologies, Boeing, Coca Cola and technology bellwethers Intel and Texas Instruments. What is even more impressive is the fact that many of these companies are also reporting better than expected revenue growth. More than 70% of the S&P 500 companies that have announced their third quarter results have beaten earnings and revenue estimates. In addition to stellar earnings reports, the odds of tax reform and tax cuts increased last week. The House approved the Senate version of the 2018 federal budget, which should pave the way for the Senate to pass tax cuts later this year. Historically, the month of October has been the most volatile month of the year, but this October has been one of the quietest ones on record as stocks have continued to grind higher. Favorable economic data, positive corporate earnings reports, reduced geopolitical tensions and the real prospect of tax reform have all combined to provide strong underpinnings for the stock market.
Durable goods orders for September rose by more than double the expected increase and new orders for capital goods also were better than anticipated, indicating that business spending on equipment remains strong and supportive of manufacturing, which accounts for 12% of the U.S. economy. New home sales in September hit their highest level in nearly 10 years but pending home sales were flat due to high prices and low supply. The first reading for third quarter gross domestic product (GDP) was 3%, better than the estimate of 2.5%. Consumer sentiment in October remained high and in line with expectations.
The European Central Bank (ECB) announced that it would reduce its purchases of government and corporate bonds in January, but that the purchases would continue at least until September 2018.
For the week, the Dow Jones Industrial Average gained 0.5% to close at 23,434 while the S&P 500 Index added 0.2% to close at 2,581. The Nasdaq Composite Index rose 1.1% to close at 6,701.
After falling in September by 33,000 due to the effects of Hurricanes Harvey and Irma, nonfarm payrolls in October are expected to rebound with an increase of 310,000 jobs. The unemployment rate is expected to remain at 4.2%. The October Chicago Purchasing Manager’s Index (PMI) and September factory orders should both provide evidence that the manufacturing sector continues to expand. The Federal Reserve will hold a meeting and its statement on monetary policy should bring no major changes. The House Ways and Means Committee will also release details of its tax-reform package.
Among the most notable companies reporting earnings this week are Apple, Facebook, Qualcomm, Automatic Data Processing, Pfizer, Berkshire Hathaway, Archer Daniels Midland, Starbucks, Yum Brands, MasterCard, MetLife, Duke Energy, Devon Energy and Occidental Petroleum.
The most probable cause for the bull market in stocks to end would be the onset of a recession and the bond market can offer clues as to whether or not this might happen. Recently the yield curve has flattened as the difference between the yield on the 2-year Treasury and the 10-year Treasury is only 82 basis points. (A basis point is one hundredth of one percent). When yields on short-term rates such as 2-year Treasuries exceed those of longer-term rates such as 10-year Treasuries, the yield curve is considered inverted and that often signals a recession. One could make a case that the yield on the 10-year Treasury should approximate 3% based on current economic growth and inflation expectations. The current yield on the 10-year Treasury is 2.43%, having reached a low of 2.06% in early September but having traded in a fairly tight range between 2.2% and 2.6% for most of the year. Even though the Federal Reserve has begun the tightening process by reducing the securities on its balance sheet, other global central banks such as the European Central Bank, the Bank of Japan and the Bank of England continue to buy bonds, driving up prices and depressing yields. As a result, yields on U.S. securities remain attractive relative to those in other countries. Current yields on comparable 10-year Treasuries in Germany, Japan and the United Kingdom are 0.39%, 0.07% and 1.36%, respectively. This scenario bodes well for continued low interest rates in the U.S. despite stronger global growth and possible wage inflation. For this reason, the yield on the 10-year Treasury should not rise much higher than 2.50% by year-end. Only when global central banks begin the process of contracting their balance sheets like the U.S. will interest rates move appreciably higher.