Stocks edge higher on earnings, Fed policy

I don’t look to jump over seven-foot bars: I look around for one-foot bars that I can step over. – Warren Buffet

For the third consecutive week, the S&P 500 Index closed higher on mostly positive third quarter earnings reports and the belief among investors that the Federal Reserve won’t hike interest rates until next year. As recently as last month, the stock market sold off when the Fed decided to maintain their near-zero interest rate policy as investors concluded that no action meant that the U.S. economy was not strong enough to warrant such a move. Now investors have once again adopted the view that bad news is good news if an increase in the fed funds rate is postponed indefinitely. In fact, the fed-funds futures market is now forecasting that the first rate hike will occur in March 2016 as the odds of a December increase have dropped considerably. Much of the economic data released last week would tend to support this view as the inflation figures were benign and retail sales rose only modestly. Even the bond market was signaling that U.S. economic growth would remain sluggish as the yield on the 10-year Treasury ended the week at 2.00%. While it is still early in the earnings season, the results so far have been encouraging, even though expectations for third quarter earnings had been lowered. The one notable exception came from Wal Mart as the country’s biggest retailer announced that 2016 earnings would be significantly below analysts’ estimates due to higher payroll costs and a huge investment in online sales. Banks and financial services companies, which dominated the earnings calendar last week, generally reported results that were in line with estimates, but blue chips such as Intel, Johnson & Johnson, General Electric and Honeywell exceeded expectations and provided favorable guidance as well. This auspicious start to the earnings season has given investors confidence that this trend will continue, providing support for stock prices in an investing landscape that favors equities over bonds, especially with the Fed on hold for the time being.

Last Week

Although automobile sales were strong again in September, retail sales only rose 0.1% and have risen 4.9% over the past year if gasoline sales are omitted. The producer price index (PPI) fell 0.5% in September due largely to a drop in gasoline prices and has now fallen 1.1% over the past year. The September consumer price index (CPI) also declined modestly and has been flat over the past 12 months. The fact that inflation at the consumer level has shown no increase means that there will be no cost of living increase for social security recipients. U.S. jobless claims fell again last week to 255,000, equaling a 42-year low, even as the pace of hiring has slowed over the last several months.

In international news, China reported weaker than expected trade data in September as both its imports and exports fell amid ongoing fears that its economy is slowing. The International Energy Agency (IEA) warned that oil markets would remain oversupplied in 2016 with the return of Iranian oil to the world market.

For the week, the Dow Jones Industrial Average gained 0.8% to close at 17,215 while the S&P 500 Index rose 0.9% to close at 2,033. The Nasdaq Composite Index jumped 1.2% to close at 4,886.

This Week

In a sparse week for economic data, September housing starts and existing home sales are both expected to post numbers in line with the previous month and confirm continued improvement in the housing sector. Overseas, China releases its third quarter gross domestic product (GDP) report, which is expected to increase about 7%, and the European Central Bank (ECB) Governing Council meets to make a decision on interest rates, which are expected to remain the same.

This promises to a busy week for quarterly earnings results and the most notable companies due to report include 3M, Morgan Stanley, Verizon, AT&T, IBM, Microsoft, Abbott Labs, Coca Cola, Procter & Gamble, McDonald’s, General Motors and Boeing.

Portfolio Strategy

Better than expected earnings from both General Electric and Honeywell on Friday were a surprise and gave the market a much-needed boost as investors had feared that a strong dollar would reduce profits in the industrial sector. While it is widely known that energy sector profits will be down significantly this quarter and that earnings in the materials sector will also be lower due to slowing growth in China, what is less clear is the effect that a strong dollar will have on manufacturing companies. During the first two quarters of this year, companies were able to beat reduced earnings estimates and the same situation could play out this quarter. With the dollar remaining flat since the start of the third quarter, most forecasts that called for a further rise in the greenback that would decrease industrial profits could now prove conservative. Multi-national companies in other S&P 500 sectors that export their products overseas should also benefit from these conservative earnings estimates, posting better than expected results. As the U.S. dollar and the price of oil stabilize, there is the potential for better earnings growth in the fourth quarter and next year as well. Since the strength of the U.S. economy depends heavily on consumer spending, low oil prices should also provide a tailwind and help boost economic growth.