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S&P 500 closes modestly lower despite continued strong earnings

I have probably purchased fifty hot tips in my career, maybe even more. When I put them all together, I know I am a net loser. – Charles Schwab

Even though the Dow Jones Industrial Average and the S&P 500 Index posted their first two-week losing streak since August, the stock market showed its resiliency as the losses could have been much worse. Stocks fell hard on each of the first three trading days of the week only to stage furious rallies to close each session well off their lows. Throughout this long bull market, investors have learned to buy the dips and this past week was no exception. Early in the week, weaker than expected Chinese data on retail sales and industrial output raised concerns that the second-largest economy in the world was slowing. Worries continued when the International Energy Agency (IEA) slashed its oil demand forecast and predicted rising production outside OPEC, causing the price of oil to fall 2%. Doubts that tax reform would occur before year-end and key differences between the House and Senate plans also weighed on investors’ minds. Although the House passed its bill to cut the corporate tax rate to 20% from 35% and reduce the number of individual tax brackets, a vote on the Senate bill probably won’t happen until after Thanksgiving. The path to victory in the Senate is much narrower as the Republicans hold only a slim majority. Once again, though, it was strong quarterly earnings reports that came to the market’s rescue.  Technology bellwether Cisco Systems reported better than expected revenue and earnings and retail giant Wal Mart blew past estimates on both the top and bottom lines. Home Depot reported same-store sales that crushed estimates and its revenue and earnings also exceeded expectations. Third quarter earnings season is winding down, but results have been impressive, enabling the stock market to defy skeptics that claim its overvalued and long overdue for a correction. Over 75% of S&P 500 companies that have reported quarterly earnings have beaten analyst estimates and the stock market is heading into a historically favorable time of year. As long as the economy remains vibrant and corporate earnings continue to grow, there is no reason that the stock market can’t finish the year on an upbeat note.

Last Week

Inflation data for October continued to be relatively benign. The producer price index (PPI) was higher than expected but the core PPI, which excludes food and energy, rose modestly and has risen 2.3% in the past year. The consumer price index (CPI) edged up slightly, in line with expectations, and has risen at an annual rate of 2% through October. U.S. import prices also rose slightly. After posting a strong increase in September boosted by post-hurricane spending, October retail sales rose modestly but beat expectations. Sales should accelerate given the strong labor market and high consumer confidence. Industrial production in October was better than forecast but weekly jobless claims rose by 10,000 to 249,000, more than expected.

In corporate news, Comcast and Verizon joined Walt Disney in expressing interest in buying 21st Century Fox. General Electric cut its dividend in half and offered weaker than expected guidance for 2018, causing its stock price to trade at its lowest level in six years.

For the week, the Dow Jones Industrial Average dropped 0.3% to close at 23,358 while the S&P 500 Index slipped 0.1% to close at 2,578. The Nasdaq Composite Index bucked the trend and rose 0.5% to close at 6,782.

This Week

October leading economic indicators should rebound strongly after declining in the prior month. October existing home sales are expected to show a small gain over September’s number while durable goods are forecast to show a modest increase after strong gains last month. The final reading of the University of Michigan consumer sentiment index is expected to remain elevated. The Federal Open Market Committee (FOMC) releases minutes from its most recent meeting and markets will hope for clues about a possible interest rate hike in December.

Markets will be closed on Thursday in observance of Thanksgiving and will close early on Friday.

Among the most notable companies that will report quarterly earnings this week are HP, Analog Devices, Agilent Technologies, Campbell Soup, Hormel Foods, Lowe’s, Dollar Tree, Eaton Vance, Deere and Medtronic.

Portfolio Strategy

With the major stock averages trading near record highs and the third quarter earnings season winding down, the question arises as to what would cause stocks to continue their upward climb. After all, the S&P 500 Index currently trades at 20 times this year’s projected earnings and 18 times earnings estimates for 2018. These price earnings multiples are high by historical standards and suggest that the stock market is overbought and overvalued, even if interest rates remain at low levels. Provided Congress can agree on tax reform and tax cuts on a timely basis, such legislation could give stocks an added boost. Both third quarter sales and earnings for companies have comfortably exceeded estimates and the strength has occurred across almost all of the sectors that comprise the S&P 500 Index. Recent economic data has also been mostly positive, providing a favorable backdrop for continued profit growth. The months of November and December have proved in the past to be positive ones for stocks and there is no reason to suggest that this won’t happen again this year. Consumer sentiment is at all-time highs, inflation is under control and the job market remains strong with the unemployment rate at only 4.1%. Not only is economic growth accelerating in the U.S., but global growth is also improving and is forecast to be the best since the Great Recession. Economic growth is so prevalent throughout the world that the number of countries that are currently in a recession is at a historic low. While stock valuations do appear stretched, one could make a case that stocks could still add to their recent gains.