Major stock averages close at record highs on stimulus hopes, strong earnings

Risk and time are opposite sides of the same coin, for if there were no tomorrow there would be no risk. Time transforms risk, and the nature of risk is shaped by the time horizon: the future is the playing field. – Peter L. Bernstein, American financial historian and economist

Stocks continued their upward climb last week as investors remain optimistic that another stimulus bill will be passed and that the rollout of vaccines will enable the economy to fully reopen and allow for the economic recovery to live up to expectations. The Dow Jones Industrial Average, S&P 500 Index and the Nasdaq Composite Index all ended the week at record highs and the Russell 2000 Index of small cap stocks also rose and has now outperformed the S&P 500 by 11 percentage points for the year. It appears that investors are assuming a best case scenario of an additional $1.9 trillion economic relief package being signed into law, even though there is no guarantee that this will happen. The rollout of vaccines has also been anything but smooth and has been affected by supply shortages and problems with distribution. Federal Reserve Chairman Jerome Powell offered a more realistic assessment of the current economy in a speech before the Economic Club of New York. He painted a bleak picture of the state of U.S. employment, saying that the country is a long way from where it needs to be as the pace of job creation has slowed considerably. More than 10 million workers are still without jobs and Powell reiterated that monetary policy alone can’t solve our economic problems. Once again he called upon the federal government to provide fiscal stimulus and for the private sector to contribute as well. Stock prices tend to reflect earnings results, though, and the news there has been positive. Of the S&P 500 companies that have reported quarterly earnings so far, more than 80% of them have beaten analysts’ estimates. Profits are on pace to handily beat expectations and corporate earnings estimates for the balance of the year are being revised higher. But a lot of this good news in the form of more fiscal stimulus, continued easy monetary policy and strong earnings is already priced into the market. What the market needs to see now is a broader economic recovery with a broader reopening and faster and wider distribution of the vaccines.

Last Week

The consumer price index (CPI) in January rose modestly and matched expectations, mainly due to higher gasoline prices. It was the sharpest rise in the CPI since July but in the 12 months through January, the CPI has only risen 1.4%. Weekly jobless claims were 793,000, which were higher than the forecast of 760,000 and an indication of the continued weakness in the job market. The National Federation of Independent Business (NFIB) Small Business Optimism Index fell slightly in January as the share of small business owners that expected economic conditions to improve over the next six months fell to its lowest level since November 2013.

For the week, the Dow Jones Industrial Average rose 1.0% to close at 31,458 while the S&P 500 Index added 1.2% to close at 3,934. The Nasdaq Composite Index jumped 1.7% to close at 14,095.

This Week

The core producer price index (PPI), which excludes food and energy prices, is expected to increase slightly in January and show that inflation remains low. Retail sales in January are expected to rebound after falling in December while January housing starts are forecast to be slightly less than in December, which were at the highest level since the 2006-2007 housing bubble.

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

The most notable companies scheduled to report quarterly earnings this week are Agilent, Analog Devices, Applied Materials, Owens Corning, Marathon Oil, Occidental Petroleum, Devon Energy, Consolidated Edison, Southern Co., AIG, Barclays, CVS Health, Waste Management, Walmart, Deere, Hilton Worldwide, Hyatt Hotels and Marriott.

Portfolio Strategy

Prospects for a $1.9 trillion fiscal stimulus package that could be passed by Congress are improving, causing interest rates to rise and igniting worries among investors about inflation. While Republicans were hoping for a smaller, more targeted stimulus bill that focused on Covid-related aid, President Biden and the Democrats prefer to go big and include more spending that doesn’t necessarily pertain to the crisis at hand. Through a process called budget reconciliation, they would be able to pass such a bill with just a simple majority. The strong possibility of this huge spending bill being passed would most certainly increase economic growth, which is why interest rates have risen lately and inflation expectations have also moved higher. Although short-term interest rates remain low with the federal funds rate at or near zero, the 10-year Treasury yield has risen to 1.20% while the yield on the 30-year Treasury has climbed to 2.0%. At the moment, inflation has been benign as the consumer price index (CPI) in the past 12 months through January was only 1.4% and the producer price index (PPI) for January is forecast to increase just modestly. The Federal Reserve’s preferred measure of inflation, the personal consumption expenditures (PCE) index, has also been running below its 2% target rate of inflation. The Fed has said that interest rates would likely remain near zero until 2023 and also has said that it would tolerate inflation above its 2% target. But with the passage of a new massive stimulus package, the economy could begin to run hotter, prompting a change in Fed monetary policy.