Global central bank policies propel stocks higher

In the short run, the market is a voting machine, but in the long run it is a weighing machine. – Benjamin Graham

The S&P 500 Index extended its winning streak to four straight weeks as third quarter corporate earnings reports continued to surprise to the upside and global central banks remained accommodative with easy monetary policies. The gains in the stock market were enough to propel the S&P 500 above its 2014 close, putting the benchmark index in positive territory again for the year. Technology heavyweights Google, Amazon.com and Microsoft all reported better than expected earnings on Friday, capping off a week in which most companies beat already reduced analyst estimates even though less than 50% of companies so far have beaten revenue targets. While earnings growth in the energy sector remains problematic, all of the other sectors of the S&P 500 have generally reported earnings results that have been much better than feared. As a result, investors have breathed a collective sigh of relief and embraced equities again as the asset class that offers the best potential for attractive returns. The stock market also received encouraging news from the European Central Bank (ECB) and the People’s Bank of China as well. The ECB agreed to leave interest rates unchanged and President Mario Draghi talked the euro down to help European exports and hinted that there could be additional stimulus on the way as early as December. China’s central bank also contributed to the good news by cutting its benchmark interest rates again in order to help boost economic growth. Earlier in the week, China allayed fears that its economic growth was slowing significantly by reporting third quarter gross domestic product (GDP) of 6.9%, better than expected but still the slowest growth in six years. Although we are only about half way through the third quarter earnings season, more of the same in the way of corporate profit results should bode well for stocks as we approach the seasonally strong months of November and December.

Last Week

Housing data released last week was upbeat as the October National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index that measures home-builder confidence rose to the highest level since 2005. Housing starts for September also rose 6.5%, a near 8-year high, as housing demand remains strong. Although jobless claims rose slightly, they were less than expected and the 4-week average is at the lowest level since 1973, an encouraging sign for the labor market.

For the week, the Dow Jones Industrial Average rose 2.5% to close at 17,646 while the S&P 500 Index gained 2.1% to close at 2,075. The Nasdaq Composite Index jumped 3% to close at 5,031.

This Week

In contrast to last week, this week’s economic calendar is full. September durable goods are expected to drop slightly, the second consecutive monthly decline. The initial reading on third quarter gross domestic product (GDP) is forecast to be only 1.8%, far less than the 3.9% growth reported for the second quarter. New home sales for September should be in line with sales from the previous month and October consumer confidence should be strong, helped by low gasoline prices and a steadily improving job market. The Federal Reserve also has a two-day meeting and no changes are expected in terms of its current monetary policy or its stance on interest rates.

This promises to be another busy week for quarterly earnings results with health care companies leading the way. Among these include Merck, Pfizer, Baxter International, Amgen and Bristol-Myers Squibb. Other prominent companies due to report include Apple, Walgreen, Du Pont, UPS, Starbucks, Exxon Mobil and Chevron.

Portfolio Strategy

For the most part, the reasons for increased stock market volatility and the 12% correction in August and September have been resolved and it appears that stocks could continue their upward trend. Economic data in China has stabilized recently and the country’s stated goal of 7% GDP growth for 2015 and about 6.5% growth for next year are definitely attainable. China’s central bank is also serious about boosting economic growth as evidenced by its decision to cut interest rates last week. While the timing of a Federal Reserve interest rate hike is still uncertain, for now the stock market is comfortable with the bad news is good news theme as stocks seem to offer the best value in a low interest rate environment. The market may have preferred a small increase in rates with a dovish message on future increases but has since adjusted its thinking. It’s possible the Fed could raise rates at next week’s meeting or in December, but far more likely for liftoff to occur next year. Heading into the third quarter earnings season, many investors feared that corporate profits would fall short of analyst estimates given the uncertainties over China’s slowing economy, the Federal Reserve and the strong dollar. Those fears have obviously been way overblown as earnings so far have generally been better than anticipated, though revenue growth in many cases has disappointed.  Companies are finding it much easier to beat a lower hurdle after analysts factored in these uncertainties and reduced their earnings expectations. Barring something unforeseen happening in the geopolitical area, the stock market appears to have the wind at its back for now.