Dow closes above 22,000 on continued strong earnings

Investing in a startup does not make you an entrepreneur any more than buying a grand piano makes you a concert pianist. – Jeffrey Fry, author and successful entrepreneur

The Dow Jones Industrial Average shattered the 22,000 barrier last week and closed at a record high, gaining more than 1% and marking its 8^th straight record close. The performance of both the S&P 500 Index and the Nasdaq Composite Index was more subdued and probably more representative of the market’s action recently. While it is easy to get caught up in the Dow’s record-setting march and eclipsing yet another milestone, one must keep in mind that this benchmark consists only of 30 blue chip stocks that are weighted by their price. In other words, stocks that command a high price have a disproportionate effect on the average than those with much lower prices. Last week it was shares of 3M (MMM-$208) and Apple (AAPL-$156) that propelled the Dow and the week before it was Boeing (BA-$238) that was responsible for much of the Dow’s advance. Apple reported quarterly revenue and earnings last week that topped expectations as the company sold more iPhones than expected and also raised its revenue target for the fiscal fourth quarter. A far better barometer of the market is the S&P 500 Index, which consists of 500 stocks chosen for market size, liquidity and industry representation. It is a market-value weighted index in which the weight of each stock is proportionate to its market value. But despite the fact that the S&P 500 has posted a year-to-date total return of 11.90%, the index has barely budged in over two weeks and remains in a very tight trading range. That is not to say that second quarter earnings have not been good. Through the end of July, nearly 75% of S&P 500 companies that have reported earnings have exceeded analysts’ estimates on both the top and bottom lines. Ordinarily, such strong earnings would send the market higher, but with stock valuations already at lofty levels, there appears to be a lack of buyers willing to purchase stocks trading at or near all-time highs.

Last Week

The July employment report released by the government last week showed that 209,000 jobs were created, much better than expected, and that the unemployment rate fell to 4.3% from 4.4%, matching the lowest rate in 16 years. The only negative in the report was continued modest wage gains. The ADP private sector payrolls report also was strong as 178,000 new jobs were created and the month of June was revised sharply higher. Other economic data last week was disappointing. Construction spending in June fell more than expected as government construction projects plunged by the largest amount in 15 years. However, most economists believe that this slowdown will be short-lived. Consumer spending also edged up only slightly and the core personal consumption expenditures (PCE) index, the Fed’s preferred inflation measure, rose just 0.1%, making the increase in the last 12 months through June only 1.5%.

For the week, the Dow Jones Industrial Average gained 1.2% to close at 22,092 while the S&P 500 Index edged up 0.2% to close at 2,476. The Nasdaq Composite Index dropped 0.4% to close at 6,351.

This Week

It will be a quiet week for economic reports and data on inflation will be the primary focus. Both the producer price index (PPI) and the consumer price index (CPI) for July are expected to increase modestly, providing further evidence that inflation remains under control. China also issues its monthly report on producer and consumer prices. The Organization of Petroleum Exporting Countries (OPEC) meets to crack down on those member countries that are not complying with agreed upon oil output cuts.

As the second quarter earnings season winds down, the most prominent companies on the agenda this week include Walt Disney, CBS, Marriott International, CVS Health, International Flavors & Fragrances and retailers Nordstrom, Macy’s, Kohl’s and JP Penney.

Portfolio Strategy

The dog days of summer have set in and it appears that they have affected trading in the S&P 500 Index. This widely-followed benchmark is approaching its 75^th consecutive trading session without a gain of 1 percent or more, something that has not happened since early 2007. The last time that the S&P 500 posted a gain in excess of 1% was way back on April 24^th. Many investment strategists have become concerned with the low volatility in the market and compare it to the calm before the storm. The volatility index or VIX remains near all-time lows as investors seem complacent and unconcerned about the quietness of the market and its lack of meaningful ups and downs. This market action is definitely not normal and should give portfolio managers something to think about, especially as we move into the seasonally treacherous months of August, September and October. In all likelihood, volatility will return to the market and it is a question of when it returns and not if it returns. In the late 1990s, it was thought that we were in a new economy and that technology and Internet stocks would go up forever. In 2006, investors held the same view of real estate and home values only to see the bottom fall out in 2007 and 2008. As John Templeton once said, “the four most dangerous words in investing are this time it’s different.”