Strong earnings propel Dow, S&P 500 to record highs

We need a mutual fund industry with both vision and values; a vision of fiduciary duty and shareholder service, and values rooted in the proven principles of long-term investing and of trusteeship that demands integrity in serving our clients. – John Bogle, founder of the Vanguard Group

Despite rising Covid-19 case numbers caused by the Delta variant in the U.S. and around the world, both the Dow Jones Industrial Average and the S&P 500 Index rose and closed at record highs. The technology-heavy Nasdaq Composite Index declined slightly as computer chip stocks suffered big losses. While it was a relatively quiet week for quarterly earnings reports, the results this earnings season have been nothing short of spectacular. So far about 90% of S&P 500 companies have reported their earnings and about 88% of them have exceeded expectations. Even more impressive is that about the same percentage of companies has also beaten revenue estimates during the same time frame. As expected during the dog days of summer with many people on vacation, trading last week was light as Friday produced the lowest volume of the year. As far as economic reports were concerned, the focus was on inflation data with the release of the producer price index (PPI) and the consumer price index (CPI). Excluding food and energy prices, the core PPI for July increased more than expected and on a year-over-year basis jumped 7.8%, the biggest increase since the measure was introduced more than a decade ago. On the other hand, the core CPI in July rose less than expected and on a year-over-year basis increased 4.3%, which was less than the prior month and a sign that inflation may have peaked and could be moderating. If this is true, it would confirm what Federal Reserve Chairman Jerome Powell has been saying, i.e. that the recent spike in inflation is likely to be temporary and transitory and that it should return to the Fed’s target of 2% by year-end.  After rising to 1.35% early in the week, the yield on the 10-year Treasury fell to 1.30% by Friday, indicating that investors seem to agree with the Fed’s assessment of inflation.

Last Week

Weekly jobless claims last week were 375,000, matching estimates and declining for the third straight month. The University of Michigan consumer sentiment index in August fell and was the weakest reading since December 2011, reflecting higher prices and an increase in the Delta variant case count. According to the Labor Department, job openings in June jumped to a record high of 10.1 million as hiring also increased.

The U.S. Senate passed a roughly $1 trillion infrastructure package that includes funding for projects such as roads and bridges, public transit, broadband, water and power. The bill now moves to the House of Representatives for their approval.

For the week, the Dow Jones Industrial Average rose 0.9% to close at 35,515 while the S&P 500 Index gained 0.7% to close at 4,468. The Nasdaq Composite Index fell 0.1% to close at 14,822. The Dow and the S&P 500 are at all-time highs.

This Week

Retail sales for July are expected to decline after posting a healthy increase in June and housing starts in July are forecast to fall slightly from levels in June. Leading economic indicators for July are expected to match the increase of 0.7% reported in June.

The Federal Open Market Committee (FOMC) releases the minutes from its monetary policy meeting in late July.

Retailers will dominate the second quarter earnings reports this week as Walmart, Target, Home Depot, Lowe’s, Kohl’s, Macy’s and TJX Companies are all scheduled to report earnings. Other notable companies on the agenda include Agilent Technologies, Cisco Systems, Analog Devices, Nvidia, Applied Materials, Brinker International and John Deere.

Portfolio Strategy

Although last week’s stock market gains were muted, they were a surprise in light of increasing concerns about the spread of the Covid-19 Delta variant. The best performing stocks last week were in cyclical sectors such as industrials, materials, financials and energy that perform best in an improving economy. One would think that a resurgence in the number of coronavirus cases would tend to slow economic growth and make technology stocks more attractive to investors, but the Nasdaq Composite Index closed slightly lower. This week will provide investors with a clearer picture of the economy with July retail sales data and earnings reports from the nation’s biggest retailers. Consumer spending accounts for about 70% of total economic activity so these reports will be important in assessing how strong the consumer has been. Minutes from the July Federal Open Market Committee (FOMC) monetary policy meeting could also shed light on the Fed’s plan to end its $120 billion a month bond-buying program that was designed to boost the economy and provide liquidity during the pandemic. Treasury yields moved higher last week after the release of the inflation data and the better than expected jobs data. Dallas Federal Reserve President Robert Kaplan also commented that the Fed should start tapering its bond-buying program as early as October. While the timing of this move is open to debate, it is important as it represents the first major move toward tighter monetary policy and higher interest rates. With continued improvement forecast for the economy, cyclical stocks should continue to perform well if for no other reason than they are cheaper than most technology stocks.