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S&P 500 Index at new all-time high on earnings, economic data

If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity, but a hell of a lot of patience. You stuck to your principles and when opportunities came along, you pounced on them with vigor. – Charlie Munger, American businessman and Vice Chairman of Berkshire Hathaway

The stock market continued its upward climb last week as the Dow Jones Industrial Average and the S&P 500 Index closed at new all-time highs on stronger than expected corporate earnings reports, favorable economic data and the possibility of further easing by the European Central Bank (ECB). Investors also applauded the results of the mid-term elections, which saw the Republicans gain control of the Senate and solidify their majority in the House. Worries about weak economies in the euro zone surfaced early in the week as the European Commission reduced the GDP growth forecast due to tensions between Russia and Ukraine and lack of business investment. It also expects inflation to remain below the 2% level targeted by the ECB until at least 2016. But later in the week, ECB President Mario Draghi announced that interest rates would remain unchanged and hinted that additional stimulus measures could be implemented to help bolster Europe’s sluggish economy. This wasn’t the first time that Draghi has proclaimed that he would do whatever it takes to turn the euro zone economies around and investors cheered the news. Meanwhile, U.S. economic data was positive as manufacturing continued to expand and the labor market added over 200,000 new jobs for the ninth straight month. Earnings for the third quarter also contributed to the optimism last week as companies not only beat analyst estimates but also offered positive earnings guidance going forward. The near 10% correction that occurred only several weeks ago seems like a distant memory now as bullish sentiment has returned to Wall Street.

Last Week

The ISM manufacturing index rose to the highest level in ten years as strong demand was evident across multiple sectors. Low oil prices have been a positive factor in the strength of the manufacturing sector. While the government employment report showed the creation of 214,000 new jobs in October and a drop in the unemployment rate to 5.8%, the ADP private sector payroll report showed equally strong job growth of 235,000 new jobs. Jobless claims also dropped to one of the lowest levels in 35 years and it was the eighth consecutive week that claims were below 300,000. However, wage growth is still almost nonexistent despite the economic recovery.

For the week, the Dow Jones Industrial Average added 1% to close at 17,573 while the S&P 500 Index rose 0.7% to close at 2,031. Both averages are at new all-time highs. The Nasdaq Composite Index ended virtually unchanged at 4,632.

This Week

Retail sales for October are expected to increase slightly, bolstered by the fact that oil prices are at 4-year lows and consumer confidence is at a 7-year high. Both factors bode well for consumer spending heading into the holiday shopping season.

In overseas news, China’s inflation rate is expected to fall to 1.5% while its industrial production in October should increase by 7.7%. Retail sales in the world’s second largest economy are expected to increase by over 11% in the month.

Retailers will dominate the corporate earnings calendar this week as Wal Mart Stores, Macy’s, J.C. Penney, Kohl’s and Nordstrom are scheduled to report. Other companies on the list include Dean Foods, D.R. Horton, Applied Materials and Cisco Systems.

Portfolio Strategy

With no shortage of positive news, it’s no wonder that the S&P 500 Index has rebounded strongly from its recent decline to post yet another all-time high, the 38th time that it has done so in 2014. The economy is back on track as third quarter GDP growth was 3.5% and expected to be at least 3% in the fourth quarter. Over 75% of the companies that have reported earnings have beaten estimates and over half of the companies have also surpassed revenue projections. Earnings guidance by those companies has also been favorable and profits for 2015 are expected to rise by 8%. The unemployment rate has dropped to 5.8%, layoffs have dropped to the lowest level in years and job growth has been running at better than 200,000 new jobs per month. Housing and manufacturing data have been steadily improving and oil prices and interest rates are low, which should benefit consumers. Even history is on the side of the bulls. In years where there is a mid-term election, the Dow has gained an average of 7% from the end of October to the end of April and stocks have risen 90% of the time during this period. Since 1900, stocks have also posted their best performance when there has been a Democratic President and a Republican-controlled Congress, the result of Tuesday’s election. The only problem with all of this good news is that investors are now more bullish about the prospects for the stock market than at any time this year. Emotion and fear of missing a rally can lead to still higher stock prices that are not justified unless fundamentals and earnings remain strong. When this happens, it’s time to be cautious and mindful of one’s tolerance for risk.