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Strong bank earnings propel stock market higher

If there is one common theme to the vast range of the world’s financial crises, it is that excessive debt accumulation, whether by the government, banks, corporations or consumers, often poses greater systemic risks than it seems during a boom. – Carmen Reinhart, American economist

For the second straight week, the stock market rallied into Friday’s close after posting losses on Monday and Tuesday as third quarter earnings season began with impressive results by the big money center banks. JP Morgan Chase started the earnings parade by beating estimates on both the top and bottom lines with solid growth despite the effects of the Delta variant and supply chain disruptions.  Their report was followed by better than forecast revenue and earnings by Bank of America, Citigroup and Wells Fargo as all of the banks reported better than expected loan losses. Morgan Stanley and Goldman Sachs also easily topped expectations with strong results in investment banking and asset management. It was these much better than anticipated quarterly earnings from the banks that turned the market around and enabled the S&P 500 Index to rise nearly 2% for the week. Adding to the positive sentiment was favorable economic data, too, as inflation data was not as bad as feared and retail sales and weekly jobless claims came in better than expected. A sobering assessment of the economy from the minutes of the Federal Reserve’s meeting in September wasn’t enough to slow the market’s momentum. They showed that Fed officials had agreed that they could begin to reduce their bond-buying program as early as mid-November and complete it by the middle of next year. This would be the first step in normalizing monetary policy. Most Fed officials were also concerned that supply disruptions and labor shortages might last longer than first expected and cause inflation to rise further. But earnings were the main catalyst for the market last week. While the reporting season is in the early stages and has been dominated primarily by the financials, the fact that 80% of S&P 500 companies that have reported have topped estimates bodes well for the rest of earnings season.

Last Week

It was a mixed bag for inflation data last week as the core consumer price index (CPI) in September was slightly higher than expected and has now risen 4% year-over-year while the core producer price index (PPI) edged up only slightly and was the smallest gain in nine months, a sign that producer prices may be peaking. The Federal Reserve expects supply shortages that are fueling price increases to subside in the months ahead. September retail sales were much better than forecast as consumers continued to spend despite expectations of a pullback due to pervasive supply chain problems, the end of enhanced government benefits and the spread of the Delta variant. Weekly jobless claims totaled 293,000, the first time that they have fallen below the 300,000 level during the pandemic.

For the week, the Dow Jones Industrial Average rose 1.6% to close at 35,294 while the S&P 500 Index gained 1.8% to close at 4,471. The Nasdaq Composite Index jumped 2.2% to close at 14,897.

This Week

Both September housing starts and existing home sales are expected to be fairly strong and exceed the numbers reported in August while September leading economic indicators are forecast to rise modestly and less than in August.

The Federal Reserve releases its Beige Book about the current economic conditions across the central bank’s 12 districts.

Among the most notable companies scheduled to report third quarter earnings are Johnson & Johnson, Abbott Labs, Netflix, IBM, Intel, Tesla, United Airlines, Southwest Airlines, Verizon, AT&T, American Express, Travelers, Honeywell, CSX, Dow, Whirlpool, Chipotle Mexican Grill, Procter & Gamble, Philip Morris International, Mattel, Schlumberger and Halliburton.

Portfolio Strategy

Although third quarter earnings season began on an auspicious note last week, the results are somewhat misleading as the reports were dominated by banks and other financial companies. Less than 10% of S&P 500 companies released their profit reports and the banks have not been affected by the supply chain disruptions that have plagued other companies. Investors will get a much better read on the strength of the economy and corporate profit growth this week as a diverse group of companies in the railroad, airline, telecommunications, technology, health care, consumer products and energy industries will report their earnings. Overall, third quarter earnings are expected to increase more than 20% from the third quarter a year ago but the rate of growth has been slowing. Throughout the pandemic, U.S. corporations have reported substantial earnings growth and have beaten analysts’ estimates by a wide margin. But instead of raising those earnings estimates, analysts now have been lowering estimates due to the effects of the Delta variant of Covid-19, supply chain disruptions and labor shortages. The supply chain issues have caused inflation to rise and costs to increase for corporations, which could reduce their profit margins if they aren’t able to raise prices. With the S&P 500 trading at about 21 times forward earnings, there is little margin for error as companies report their quarterly earnings and give guidance for the rest of the year.