There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know. – John Kenneth Galbraith
The Nasdaq Composite Index snapped its two-week losing streak as Apple topped earnings and revenue expectations while the S&P 500 Index closed higher for the fifth consecutive week on continued strong corporate earnings growth. Apple’s excellent results caused the stock of this technology bellwether to soar and it became the first publicly traded company in history to reach $1 trillion in market value. But it wasn’t just Apple that led the charge. Other notable companies such as Caterpillar, Procter & Gamble, Pfizer and Archer Daniels Midland also beat analysts’ earnings estimates. With more than 70% of S&P 500 companies having reported second quarter earnings, nearly 80% of them have exceeded forecasts. The market seemed to ignore any news on tariffs, which was generally mixed. Early in the week, there were reports that the U.S. and China were attempting to restart talks to avoid a possible trade war. Some companies were planning for the worst. After raising its full-year earnings guidance, Caterpillar announced that it would raise prices to offset a second-half profit hit from tariffs. Optimism over an anticipated trade agreement quickly turned sour two days later as the Trump administration said that it was considering increasing tariffs up to 25% on $200 billion worth of Chinese goods. China threatened to retaliate by imposing tariffs on $60 billion of U.S. goods, primarily agricultural-related products ranging from 5% to 25%. The market has heard these threats from both sides before but, instead, chose to focus on the fundamentals, which have been solid. In addition to the stellar earnings season, economic data last week was also favorable as evidenced by the July employment report. Although the number of new jobs created was only 157,000, compared to estimates of 190,000, both the May and June payroll numbers were revised higher by a total of 59,000. The unemployment rate fell from 4.0% to 3.9% and the average hourly earnings were in line with expectations and not too high as to cause worries about inflation. At the moment, the tariffs that have been implemented are not having an appreciable effect on earnings or the economy. Unless these new threats become a reality, the fundamentals should dictate the direction of the market.
Both the ISM manufacturing and non-manufacturing or services sector indices fell in July and were less than expected due to escalating trade tensions. However, both remain comfortably in expansion territory despite the weakness. The core personal consumption expenditures (PCE) index that excludes food and energy rose slightly in June and has risen only 1.9% for the year. This is the Federal Reserve’s preferred measure of inflation. Consumer spending was also strong in June and consumer confidence was better than expected as consumers remain upbeat about economic conditions and prospects for the next six months. This bodes well for the economy as consumer spending accounts for about 70% of U.S. economic activity.
The Federal Reserve left interest rates unchanged at their meeting last week but suggested that another rate hike is likely soon based on recent job gains, strong economic activity and inflation near its 2% target. The markets are figuring a 90% chance of a rate hike in September and a 70% chance in December.
For the week, the Dow Jones Industrial Average was virtually flat and closed at 25,462 and the S&P 500 Index rose 0.8% to close at 2,840. The Nasdaq Composite Index gained 1% to close at 7,812.
The only economic data of significance this week is the inflation data. Both the July producer price index (PPI) and the consumer price index (CPI) are expected to increase only modestly, suggesting that inflation remains under control.
The first phase of restored U.S. sanctions against Iran are set to be implemented and China will release its trade-balance numbers for July.
The most prominent companies scheduled to report earnings this week are Walt Disney, Viacom, Marriott International, Emerson Electric, CVS Health, Cardinal Health, Tyson Foods, Occidental Petroleum and Murphy Oil.
Barring a meltdown of historic proportions, the S&P 500 Index will set a record in less than three weeks for the longest bull market in history. Based on second quarter earnings results so far and extrapolating those results for the remainder of earnings season, this milestone seems nearly certain. Companies that have announced their profit reports have had average sales growth of 10% and earnings growth of 24% and these strong numbers are expected to continue for the next two quarters. Nearly 80% of these companies have also topped expectations, which is unheard of this late in the cycle. The economy seems to be firing on all cylinders, too, with 4.1% GDP growth in the second quarter. At its meeting this past week, the Federal Reserve upgraded its view of the economy from “solid” to “strong” and signaled that there would be future interest rate hikes as a result. While stocks are not cheap and valuations are stretched, the S&P 500 trades at 21 times trailing earnings compared to 24 times when this benchmark index hit an all-time high back in January. The only negative appears to be geopolitical risks involving trade war fears with China. A full-blown trade war with China would have harmful consequences and would definitely hamper economic growth and detract from the above-average growth achieved during the first half of the year.