Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it. – Albert Einstein
The stock market turned in another wild week of ups and downs but when the closing bell finally sounded on Friday, it had little to show for it. The Dow Jones Industrial Average and the S&P 500 Index each slipped modestly while the Nasdaq Composite Index bucked the trend and increased over 1%. The technology sector was particularly strong after Apple reported better than expected revenue and earnings even though it sold fewer iPhones than had been forecast. The company issued strong earnings guidance for the balance of the year and announced a $100 billion share repurchase program along with a dividend increase. That news, plus word that Warren Buffett had purchased 75 million shares of Apple during the first quarter, sent the stock to an all-time high. If the stock market was only focused on earnings, the path of least resistance would certainly be higher as about 80% of S&P 500 companies that have issued their first quarter profit reports have beaten analysts’ estimates. Last week was no exception as companies such as Merck, Pfizer, CVS Health, Archer Daniels Midland and McDonald’s all topped expectations. Profit growth for the first quarter has been exceptional and profits are expected to rise through the end of the year. But investors have been distracted by other events that could cause trouble down the road, including talks between U.S. administration officials and Chinese officials on trade, a possible renegotiation of the Iran nuclear deal and a subpoena of President Trump by special counsel Robert Mueller. All of these news events are creating a lot of uncertainty and angst among investors and are undermining strong quarterly corporate earnings results. Although the Federal Open Market Committee (FOMC) left interest rates unchanged last week, it, too, was partly responsible for the increased volatility as its statement confirmed further interest rate hikes as inflation moved closer to its 2% target. If this bull market in stocks is going to continue, it will have to climb a wall of worry in order to do so.
The most important piece of economic data released last week was the April employment report, which showed that 164,000 new jobs had been created and that the unemployment rate had fallen to 3.9%, an 18-year low. The number of jobs was less than expected and the average hourly earnings or wage growth was also less than expected. The core personal consumption expenditures (PCE) index, the Fed’s preferred inflation measure, rose 1.9% through March and matched expectations. Consumer spending, which accounts for more than two-thirds of U.S. economic activity, grew at the slowest pace in the first quarter in nearly five years. Factory orders were stronger than expected in March but the ISM manufacturing and non-manufacturing indexes were less than expected, though both remained comfortably in expansion territory.
The Atlanta Federal Reserve forecast that gross domestic product (GDP) will grow by 4.1% in the second quarter.
For the week, the Dow Jones Industrial Average fell 0.2% to close at 24,262 while the S&P 500 Index also slipped 0.2% to close at 2,663. The Nasdaq Composite Index jumped 1.3% to close at 7,209.
Both the April producer price index (PPI) and consumer price index (CPI) are forecast to rise modestly with predictions of a 1.8% year-over-year increase in the CPI. April import prices are expected to post a moderate increase after being flat in March. The preliminary University of Michigan sentiment index for May should remain at a high level.
Among the most prominent companies on the quarterly earnings agenda this week are Sysco, Tyson Foods, Dean Foods, Anheuser-Busch InBev, Walt Disney, Gannett, Dun & Bradstreet, Marriott International, Toyota Motor, Occidental Petroleum and Duke Energy.
After experiencing a 10% correction back in February, both the Dow Jones Industrial Average and the S&P 500 Index remain in correction territory as year-to-date returns have been basically flat. Not since the financial crisis and Great Recession have stocks been in this position for so long. The bull market in stocks, which began in March 2009, has now stretched over nine years but appears to be on relative solid footing as the economy continues to grow. A bear market is usually defined as a 20% decline from a peak in the market, twice as much as a typical correction. While it may be tempting to try to time the market to avoid a possible bear market, history has shown that it is almost impossible to do for any investor. History has also shown that the last year of a bull market can be one of the best of the economic cycle in terms of stock appreciation. Data indicate that in the 12 months that precede the start of a bear market, large cap U.S. stocks have posted returns of nearly 25%. Recently there have been concerns that future equity returns might be weak as expectations have been lowered for a number of reasons. Trade policies with China, geopolitical tensions with North Korea and Iran, the ongoing investigation into possible Russian collusion in the 2016 election, changing monetary policies by the Federal Reserve and the risk of higher interest rates are among the headwinds that face the stock market. These uncertainties have overshadowed a strong first quarter earnings season and the fact that equity valuations remain reasonable. The best course of action for investors is to remain patient and take a long-term view with an asset allocation that fits their risk tolerance and time horizon. By doing this, investors can avoid making short-term trading decisions and reap the benefits of compound interest and proper asset allocation.