S&P 500, Nasdaq rise 2.5% on better than expected earnings, jobs data

Don’t think that you know more than the market; no one does. And don’t act on insights that you think are your own but are usually shared by millions of others. – John Bogle

The stock market continued its strong momentum last week as all three major averages were higher, propelled by better than expected quarterly earnings and encouraging jobs data. The Nasdaq Composite Index closed above 11,000 for the first time ever and the Dow Jones Industrial Average added over 1,000 points for the week and posted a gain of nearly 4%. Not to be outdone, the S&P 500 Index was also positive and closed the week within 1% of its all-time high set back on February 19th. Since hitting its intraday low on March 23rd, the S&P 500 has rallied more than 50% despite the toll that the coronavirus pandemic has taken on the economy. Earnings season continues to be much better than feared as over 80% of S&P 500 companies have reported results that have exceeded expectations, with most companies beating estimates by a fairly wide margin. The July employment report was also better than forecast as nonfarm payrolls increased by 1.763 million and the unemployment rate fell from 11.1% in June to 10.2%. While the jobs picture has been improving, the number of jobs created was far less than the 4.8 million and 2.7 million jobs created in June and May, respectively. In addition, the total employment level remains nearly 13 million below the level in February before the onset of the pandemic. The pace of the economic recovery is still hostage to the coronavirus pandemic, which continues to spread although new Covid-19 cases have declined on a daily basis from their peak. By week’s end, there was still no new Congressional economic relief bill as both sides remained far apart in negotiations, but the market shrugged it off and believed an agreement would be reached soon, especially in an election year. Over the weekend, the wait ended as President Trump took matters into his own hands and signed executive orders that extended coronavirus economic relief with additional unemployment benefits, deferral of student loan payments through 2020 and a payroll tax holiday through the end of the year.

Last Week

Other jobs data released last week was also somewhat encouraging as weekly jobless claims were 1.186 million, below estimates and the lowest level of claims since the pandemic began. ADP reported that only 167,000 private sector jobs were created in July, far below expectations, but June was revised up to 4.3 million jobs from 2.4 million. The ISM manufacturing index rose to its highest level in 15 months and has now expanded for the third straight month while the ISM non-manufacturing or services sector index was better than expected and signals stronger economic growth ahead.

In addition to tensions with China over the origins of the coronavirus and democracy in Hong Kong, President Trump added to the list by issuing executive orders to address the threat posed by Chinese apps TikTok and WeChat.

For the week, the Dow Jones Industrial Average jumped 3.8% to close at 27,433 while the S&P 500 Index gained 2.5% to close at 3,351. The Nasdaq Composite Index also rose 2.5% to close at 11,010.

This Week

After an increase of more than 7% in retail sales in June, the gain in July is expected to be a more modest 2%. Both the July producer price index (PPI) and the consumer price index (CPI) are expected to increase slightly and confirm that inflation remains benign for now. The preliminary University of Michigan consumer sentiment index for August is forecast to approximate the level in July of 72 but be well below the year’s peak of 101 set in February.

Among the most notable companies scheduled to report second quarter earnings results are Marriott International, Sysco, Duke Energy, Occidental Petroleum, Simon Property Group, Cisco Systems, Applied Materials and Barrick Gold.

Portfolio Strategy

In order to provide much-needed liquidity to the financial system as the economy slid into a recession during the coronavirus pandemic, the Federal Reserve implemented quantitative easing, pumped $1 trillion into the economy and cut interest rates to zero. In addition to buying Treasuries and mortgage-backed securities, the Fed expanded its purchases to include investment grade corporate bonds and even high-yield bonds and has said that interest rates will likely remain near zero until at least 2022. These accommodative monetary policies have caused interest rates to plunge with the 2-year Treasury yielding only 0.13%, the 10-year yielding 0.57% and the 30-year yielding a paltry 1.20%. While investment grade corporate bonds provide some yield advantage over Treasuries, the yield differential is only about 100 basis points across the yield curve. (A basis point is one hundredth of one percent). This results in corporate bond yields of between about 1% for short-term maturities and 1.5% to 2.0% for intermediate-term maturities between 5 and 10 years. Although inflation remains low and below the Fed’s target of 2%, the real yield of these bonds that takes into account inflation is next to nothing. And with interest rates so low and unlikely to go any lower since the Federal Reserve has come out against negative rates, there is little room for bonds to rally in price during an economic downturn. (Bond prices and yields move in opposite directions.) For investors seeking income, dividend growth funds or funds that invest in high dividend-paying stocks are two ways to accomplish this goal. Funds that emphasize companies with above-average dividend yields have significantly lagged the market this year and are usually considered more value-oriented. Two such exchange-traded funds or ETFs with these characteristics are the iShares Core High Dividend ETF (HDV) and the Vanguard High Dividend Yield ETF(VYM). HDV has a current yield of about 4.4% while VYM yields about 3.6% and both funds have reasonable valuations that should provide a margin of safety in the event of a correction or a market sell-off.