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Stocks close higher on positive news for treatment of Covid-19

Brand-name growth stocks ordinarily command the highest P/E ratios. Rising prices beget attention, and vice versa – but only to a point. Eventually their growth rate can diminish as results revert towards normal. Maybe not in all cases, but often enough to make a long-term bet. Bottom line: I wouldn’t want to get caught in a rush for the exit, much less get left behind. Only when big growth stocks fall into the dumper from time to time am I inclined to pick them up – and even then, only in moderation. – John Neff

The recent trend of an up week being followed by a down week was broken last week as the stock market added to its gains on better than expected economic data and positive news on the treatment for Covid-19. Despite the fact that the S&P 500 Index rose nearly 2% last week, the benchmark has been virtually flat for the past month as increased volatility has neutralized the performance. The Nasdaq Composite Index, on the other hand, continues to defy gravity as it closed at yet another record high with a gain of 4%. While recent improvements in the jobs data and more positive economic data signal better days ahead, the rising number of Covid-19 infections is worrisome and could cause parts of the economy to shut down again. Although fatalities from the virus have been lower, there has been a noticeable spike in coronavirus cases in the sun belt states that is particularly troubling. The total number of confirmed U.S. cases of the virus now tops 3 million and there were a record 60,000 new cases reported on Tuesday. The rising number of cases and large outbreaks could force parts of the country to go on lockdown again according to infectious disease expert Dr. Anthony Fauci. Fortunately, there were a number of positive developments last week with regard to potential vaccines and treatments for the virus. The U.S. government awarded drug manufacturer Novavax a $1.6 billion contract to develop a coronavirus vaccine, the biggest amount yet granted by the White House, and Moderna’s coronavirus vaccine candidate will likely enter phase 3 trials by the end of July. There also was good news on the treatment of the virus as Gilead Science said that its drug, remdesivir, showed a marked improvement in clinical recovery and a better than 50% reduction in the risk of mortality. Next week the focus for investors will shift from the coronavirus pandemic and economic data to second quarter corporate earnings, which are forecast to be weak but could beat rather low expectations.

Last Week

The ISM non-manufacturing or services sector index rose to 57 in June, topping estimates of 50, and solidly in expansion territory. However, the big increase from May could be overstated since the growth occurred after a few months of very low activity with much of the economy shut down. The producer price index (PPI) for June fell slightly compared to the forecast of a moderate increase. Through the 12 months ended in June, the PPI has fallen nearly 1% as inflation remains benign. Weekly jobless claims fell to 1.31 million, a 4-month low, and were less than anticipated but there could be an increasing number of claims in coming weeks after a surge of new virus cases and an increase in business closures.

For the week, the Dow Jones Industrial Average gained 1% to close at 26,075 while the S&P 500 Index added 1.8% to close at 3,185. The Nasdaq Composite Index surged 4% to close at 10,617, another record high close.

This Week

The consumer price index (CPI) for June is expected to edge up slightly and confirm that inflation remains under control while June retail sales are forecast to show another solid month of gains after jumping nearly 18% in May as the economy reopened after being on lockdown. The preliminary University of Michigan consumer sentiment index for July should continue its trend higher.

The second quarter earnings season begins this week and the banks will lead the way as JP Morgan Chase, Citigroup, Bank of America, Wells Fargo, US Bancorp, PNC Financial, Goldman Sachs, Morgan Stanley and Blackrock are all scheduled to report. Other notable companies on the agenda include Pepsico, United Healthcare, Johnson & Johnson, Abbott Labs, Delta Airlines, Alcoa and Netflix.

Portfolio Strategy

The only certainty about the upcoming second quarter earnings season is the fact that it promises to be bad, the worst quarterly performance since the Great Recession more than 10 years ago. Due to the coronavirus pandemic and the forced shutdown of the economy, earnings are expected to decline by about 44% with all 11 sectors of the S&P 500 Index expected to post negative earnings growth. Forecasting earnings for companies in the second quarter has been made more difficult by the fact that many companies have withdrawn guidance because of the uncertainty over the effects of Covid-19. Despite knowing that the earnings will be horrendous, investors have bid up the price of stocks and, as a result, the S&P 500 Index is basically flat for the year on a total return basis. But the relatively strong performance of this benchmark is deceptive and obscures the reality that the majority of companies in the index are underperforming. Through the close of business on May 31st, there were six stocks in the S&P 500 whose combined average total return was 16.6%: Facebook, Apple, Alphabet (Google), Amazon, Netflix and Microsoft. The rest of the companies in the index were actually down over 9%. The S&P 500 is a capitalization-weighted index of 500 stocks whose market capitalizations are among the largest companies in the U.S. Only Netflix is not among the top five companies in the index in terms of market capitalization. These five companies have a combined weighting of more than 20% of the index. This concentration in a few names increases the risk for the broader stock market and magnifies the importance of earnings performance of a smaller group of companies. Other technology stocks that have performed well during the pandemic could also be at risk if they report earnings that don’t live up to expectations. Even though the S&P 500 has weathered the storm and performed well, this strength masks the fact that the majority of companies in the index have not.