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Strong earnings, trade optimism lift S&P 500 close to its all-time high

What seems too high and risky to the majority generally goes higher and what seems low and cheap generally goes lower. – William O’Neil, American entrepreneur, stock broker and writer

The S&P 500 Index closed higher for the third consecutive week and came within three points of its record high close set back on July 26th. The Dow Jones Industrial Average and the Nasdaq Composite Index also ended the week higher as “Phase One” trade talks between the U.S. and China went well and third quarter earnings results continued to defy skeptics. China’s top negotiator said that substantial progress had been made on trade and that ending the trade war would benefit both countries as well as the global economy. Many sections of the initial trade deal are close to being finalized. It is likely that talks will be completed by the time President Trump and Chinese President Xi Jinping meet at a summit in Chile in November. It is there that an agreement will likely be signed. Investors also focused on quarterly earnings reports last week and the conclusion that can be drawn so far is that the earnings season is not as bad as feared. More than 30% of S&P 500 companies have reported and nearly 80% of them have beaten analysts’ estimates. Revenue is actually expected to increase by about 2.5% in the third quarter on a year-over-year basis. Of the eleven S&P 500 sectors, the best performer last week was energy, followed by technology, industrial and financials. Energy benefited by the recent rotation out of growth stocks into value stocks while Microsoft and Intel reported strong revenue and earnings growth that beat expectations, sending technology stocks higher. Both companies offered stronger than expected guidance for the current quarter as well. Although Amazon reported lower than expected earnings and its first profit decline in more than two years along with weaker than anticipated guidance, its stock managed to weather the storm remarkably well and closed only slightly lower. Even Caterpillar, a bellwether in the industrial sector, ended the week higher after missing revenue and earnings estimates and lowering its outlook. This may be a sign that investors are becoming more optimistic about global growth prospects and less fearful that a recession may occur anytime soon. The same signal may have been confirmed by the 10-year Treasury, which ended the week with a higher yield of 1.80%, a positive economic indicator for faster growth as the yield curve steepened. (Bond yields and prices move in opposite directions).

Last Week

Durable goods orders fell more than expected in September and a key measure of business investment, core capital goods orders, also fell for the second straight month, reflective of a global manufacturing slowdown likely caused by the U.S.-China trade war. Weekly jobless claims fell by a more than expected 6,000 to 212,000, another indication that corporate layoffs remain low and the labor market remains strong. The University of Michigan consumer sentiment index for October dipped slightly but was higher than in September.

In European Central Bank President Mario Draghi’s last monetary policy meeting as head of the ECB, the benchmark interest rate was left unchanged at negative 0.5%. Christine Lagarde, the former head of the International Monetary Fund (IMF), will be his successor.

For the week, the Dow Jones Industrial Average rose 0.7% to close at 26,958 while the S&P 500 Index increased 1.2% to close at 3,022. The Nasdaq Composite Index jumped 1.9% to close at 8,243.

This Week

The advance estimate for third quarter gross domestic product (GDP) is expected to be 1.7%, compared to a reading of 2.0% in the second quarter. The October employment report is expected to show that about 90,000 new jobs were created and that the unemployment rate edged higher to 3.6%. The ISM Manufacturing Purchasing Manager’s Index (PMI) is forecast to be below 50 for the third straight month, a sign that manufacturing continues to contract.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is widely expected to lower the federal funds rate by a quarter of one percent to a range between 1.50% and 1.75%.  The Bank of Japan (BOJ) also is expected to lower its benchmark interest rate to negative 0.2% from negative 0.1%.

Among the most notable companies scheduled to report earnings this week are AT&T, Alphabet (Google), Facebook, Apple, Walgreens Boots Alliance, Starbucks, Colgate-Palmolive, Merck, Pfizer, Celgene, Bristol Myers Squibb, General Motors, General Electric, MetLife, Chevron, Exxon Mobil and Berkshire Hathaway.

Portfolio Strategy

With earnings season in full swing, a Federal Reserve meeting on tap and key economic data due to be released, investors will have no shortage of information to sift through this week. Roughly 30% of S&P 500 companies are scheduled to report third quarter earnings and the index sits at just 0.1% below its all-time high. Technology bellwether Apple Computer announces its results on Wednesday and could set the tone for the technology sector and the overall market. The Federal Open Market Committee (FOMC) meets on Tuesday and Wednesday and there is a 94% probability of an interest rate cut, which would be the third such cut this year. However, the Fed could pause and reduce rates in December or leave rates unchanged for the balance of the year since trade talks with China seem to be progressing so well. The October employment on Friday is expected to show that only about 90,000 new jobs were created due to the direct impact of the strike at General Motors and the ripple effect on its suppliers. Without the strike, the total number of jobs would be in the 125,000 to 150,000 range. The preliminary estimate for third quarter GDP is only 1.7%, compared to 3.1% in the first quarter and 2% in the second quarter. The September personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, is also only forecast to rise slightly. Both slower expected growth and subdued inflation data should provide the Federal Reserve with solid reasons to further ease monetary policy.