It has been a problem since the dawn of the retail brokerage business: Brokers have a strong incentive to get customers to trade when it might be in clients’ interests to do nothing. – Business Week, July 14, 1997
At the risk of sounding like a broken record, Federal Reserve Chairman Ben Bernanke was in the spotlight again this past week. While his message was basically the same as in the previous week, the audience that he delivered it to was different. Speaking before Congress, Bernanke emphasized that it’s too early to pass judgment on Fed tapering and that monetary stimulus would likely continue for now. He hinted at the possibility of reduced bond buying but not until late in the year and only if economic data warrants such a move. This reassurance from the Fed allowed investors to breathe a collective sigh of relief as they no longer need to worry about higher interest rates – at least in the short-term. While Bernanke’s comments were music to the stock markets’ ears, second quarter earnings reports also were cause for celebration, especially for the money center banks. Bank of America and Citigroup followed JP Morgan Chase and Wells Fargo last week with reports of strong quarterly profits that handily beat analysts’ estimates. All of this good news propelled the stock market to another record close last week and saw the yield on the 10-year Treasury fall to 2.48%. For investors, the best course of action was no action at all, provided they’re comfortable with their risk level and current asset allocation.
It was difficult to find much in the way of bad news last week as most of the economic data and earnings reports were positive. Retail sales rose only 0.4% in June, which was about half of what economists had expected. Despite seemingly greater confidence in the direction of the economy, consumers still remain cautious. U. S. housing starts also fell in June by 9.9% and were a surprise given how strong the housing market has been in the midst of tighter fiscal policy and weak economic growth. After Google and Microsoft, two technology bellwethers, both missed earnings estimates with announcements after the bell on Thursday, the market shrugged them off and closed slightly higher on Friday. Also on Friday, news that the city of Detroit filed for bankruptcy was a shock, considering that at one time it was the country’s fourth largest city.
But the preponderance of favorable news this past week lent support to stocks. U. S. consumer prices rose 0.5% in June, which was higher than expected, but when the volatile energy and food components were stripped out, the CPI was up only 0.2%. The Fed Beige Book also showed that the economy was growing at a modest pace and that manufacturing was still expanding in most areas of the country. The Philly manufacturing index hit a 2-year high and claims for jobless benefits were the fewest since May. On the earnings front, Morgan Stanley easily beat earnings estimates as did Goldman Sachs, while Johnson & Johnson beat estimates and raised their guidance for the rest of the year. And if all of this news wasn’t positive enough, Bank of America Merrill Lynch raised their 2013 target for the S&P 500 Index to 1,750.
For the week, the Dow Jones Industrial Average rose 79 points or 0.5% to close the week at 15,544. The S&P 500 gained 12 points to end the week at 1,692, an increase of 0.7%, a new record. The Nasdaq fell 13 points, or 0.4%, to 3,588 on the heels of disappointing news from Google and Microsoft.
News on the earnings front should dominate the headlines in the coming week. Among companies reporting include Kimberly Clark, Halliburton and Texas Instruments, with the likes of Ford Motor, Boeing, PepsiCo and Caterpillar all reporting quarterly results on Wednesday. Although the economic calendar is relatively sparse this week, information from these few reports could prove to be significant. Existing home sales in June should increase 6% from the number reported in May and new home sales should rise 7% in June, helped in part by an improving job market and a sense of urgency among home buyers to lock in mortgage rates before they rise any further. Durable-goods orders should also increase about 2% for June, somewhat less than in May. Weekly jobless claims, while difficult to predict from one week to the next, should rise modestly and continue the trend of an improving employment picture.
While it is still early in the earnings reporting season, the results so far have been a pleasant surprise. For the most part, earnings for the quarter have modestly beat estimates, with revenues on the soft side. This is a continuation of results from prior quarters as companies are squeezing costs and expenses while struggling to deliver top-line growth. Earnings should remain the focus through the end of the month as no comments from the Federal Reserve are expected until their next meeting on July 30th and 31st.
Although stocks are trading at all-time highs, the market from a valuation standpoint is reasonable as the S&P 500 is trading at about 15 times estimated earnings for 2014. Granted, earnings growth has slowed during the last several quarters, but economic growth should begin to accelerate as we head into year-end, which should provide a catalyst for equities. Fund flows also suggest that the momentum in stocks could continue as investors have added over $24 billion to U.S. equity ETFs in the first two weeks of July. In overseas markets, Europe is on the mend and offers cheaper valuations than the U.S. while emerging markets, whose performance has been disappointing this year, offer attractive valuations and above-average growth rates on a long-term basis. Those investors underweighted in these asset classes might take a second look.
For fixed income investors, the sluggish economy and low inflation should bode well for both taxable and tax-exempt bonds. Bill Gross of PIMCO sees the Fed Funds rate at between 0% and 0.25% until 2016 and still believes the recent bond sell-off was overdone. He believes that the 10-year Treasury yield should be 2.20% instead of the current 2.48%. Despite what happened in Detroit, which should be viewed as a one-off event, municipal bonds look very attractive, and in some cases, have a higher yield than Treasuries even before taking into account their tax advantage.