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Strong earnings propel major stock averages to record highs

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists. – Benjamin Graham

It was the tale of two markets last week as all three major stock averages plunged on Monday on concerns over rising Covid-19 cases, but by the end of the week that was a distant memory as the S&P 500 and the Nasdaq Composite Index closed at new record highs. After falling 726 points on Monday, the Dow Jones Industrial Average recovered to gain 373 points for the week and closed above 35,000 for the first time ever.  The Delta variant was spreading among those people not vaccinated and the U.S. was averaging nearly 30,000 new cases a day during the previous week. There were worries that the rise in Covid cases would slow economic growth and the 10-year Treasury yield fell to a 5-month low of 1.19%. But investors have been trained to buy the dip when stock prices fall and that is exactly what happened as second quarter earnings reports were just what the doctor ordered for an ailing market. Blue chip companies such as Johnson & Johnson, Coca Cola, Verizon and American Express all beat revenue and earnings estimates and raised their outlook for full-year earnings. By Friday’s close, about one quarter of S&P 500 companies had reported earnings and 88% of them had exceeded expectations. The yield on the 10-year Treasury also rebounded to end the week at 1.3%, suggesting that growth and economic slowdown fears appeared to be premature and overblown. Investors received a vote of confidence from the JP Morgan equity strategist, too, as he raised his year-end target for the S&P 500 to 4,600 from 4,400, a gain of nearly 5%. But the week ahead promises to be the most important one of the second quarter earnings season as technology bellwethers Facebook, Apple, Amazon, Microsoft and Alphabet (Google) are all scheduled to report.

Last Week

Housing data released last week was encouraging as June existing home sales rose for the first time in five months as the number of homes on the market increased and June housing starts also rose more than expected. Leading economic indicators were up less than expected but the increase suggests that strong economic growth will continue in the near-term. Weekly jobless claims rose 419,000, higher than the 350,000 that economists were expecting, but there is strong potential for labor market gains in the months ahead as there are about 9.8 million job openings.

For the week, the Dow Jones Industrial Average rose 1.1% to close at 35,061 while the S&P 500 Index jumped 2.0% to close at 4,411. The Nasdaq Composite Index surged 2.8% to close at 14,836. All three averages are at all-time highs.

This Week

The preliminary estimate of second quarter gross domestic product (GDP) is expected to be 9.1% following an increase of 6.4% in the first quarter.  June new home sales are expected to exceed those in May and June durable goods orders should approximate the relatively strong orders last month. The July consumer confidence index is forecast to be slightly less than in June, which was the highest for the index since the start of the pandemic.

The Federal Open Market Committee (FOMC) meets to review its monetary policy and is expected to leave the federal funds rate unchanged near zero. The Fed may also lay out a timeline for reducing its monthly bond purchases, which are currently about $120 billion a month.

Among the most prominent companies scheduled to report quarterly earnings this week are Advanced Micro Devices, Automatic Data Processing, Qualcomm, Facebook, Amazon, Apple, Alphabet, Microsoft, Lockheed Martin, GE, Boeing, Ford Motor, Caterpillar, Tesla, 3M, UPS, Starbucks, Visa, McDonald’s, Procter & Gamble, Pfizer, Merck, Bristol Myers Squibb, Chevron and Exxon Mobil.

Portfolio Strategy

Not only is this the biggest week of the second quarter earnings season, but it also is important for investors because the Federal Reserve meets on Tuesday and Wednesday and there are key economic reports on the calendar. About 165 S&P 500 companies are scheduled to report earnings, including some of the most notable stocks with the biggest market capitalizations such as Apple, Amazon and Microsoft. So far nearly 90% of S&P 500 companies that have reported earnings have topped estimates and those earnings have risen significantly. Although no action is expected by the Federal Reserve this week, investors will be watching closely to see if the Fed gives any clues on the timing of the tapering of its monthly bond purchases. The Fed has emphasized that it will forewarn markets well in advance of such a move, but this would be the first step toward tightening and higher interest rates. There are also two economic reports due out this week that could potentially move the markets. The first one is second quarter gross domestic product (GDP), which is expected to be above 9% and the best quarter of the year for growth. The disturbing increase in the number of Covid-19 cases due to the Delta variant of the virus has caused some to question the strength of the U.S. economy. The yield on the 10-year Treasury plunged last week to below 1.2% only to recover slightly as investors feared that the spread of the virus could slow the economy. The second economic report, the personal consumption expenditure (PCE) index, will be released on Friday. It is the Federal Reserve’s preferred measure of inflation and will be released at a time when inflation has spiked in recent months due to supply disruptions caused by the pandemic and surging demand. The reading is expected to be higher than the Fed’s targeted rate of inflation of 2%, which could spark fears of tighter monetary policies sooner rather than later. Although the stock market came roaring back after last Monday’s sell-off, the market has not seen as much as a 5% pullback since October.

I will be out of the office on vacation for the next two weeks so the next weekly newsletter will not be sent until Monday August 16th.