Dow, S&P 500 close at record highs on optimism over economy

Trying to catch the bottom on a falling stock is like trying to catch a falling knife. It’s normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it. – Peter Lynch

Despite rising interest rates, both the Dow Jones Industrial Average and the S&P 500 Index ended the week at record highs while the technology-heavy Nasdaq Composite Index slipped into correction territory on Monday only to rebound and end the week with a gain, breaking a three-week losing streak. The Dow was up each day and turned in its best weekly performance since November. The fact that the 10-year Treasury yield increased to 1.64% on Friday, the highest level since February 2020, did not deter investors from piling into growth stocks again as they had become extremely oversold on a short-term basis. The speed at which the 10-year Treasury yield had risen recently was worrisome as rising rates make future profits of high growth technology stocks less valuable today and more difficult to justify their lofty valuations. But the Nasdaq had declined more than 10% from its 52-week high and the so-called FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks plus Microsoft that were the previous high-flyers had become relatively attractive again. All of these companies are expected to increase sales by double digits this year and their stocks are expected to outperform the overall market. Adding to the positive sentiment on Wall Street was passage of the $1.9 trillion Covid relief bill, which should provide a near-term catalyst for stocks. While less than 10% of the total spending in the bill actually represents Covid-19 relief, the package does include $1,400 checks to most Americans, extends $300 per week in federal jobless aid, expands the child tax credit for one year and provides $350 billion in relief to state and local governments. Investors were also optimistic that as more people are vaccinated, the economy will recover faster as the federal government’s goal is to have states make all adults eligible for vaccinations by May 1. But the stock market will continue to be held hostage by the path of interest rates. As long as rates do not rise too far too fast, stocks, particularly those that are more economically sensitive and more value-oriented, should continue to do well.

Last Week

Both the producer price index (PPI) and the consumer price index (CPI) rose moderately in February and matched expectations, but the core rate of inflation for each index that excludes food and energy edged up only slightly. In the 12 months through February, the core CPI has risen just 1.3% while the core PPI has increased 2.2% over the same time period. There is still plenty of slack in the labor market with at least 18 million Americans on unemployment benefits. Weekly jobless claims totaled 712,000, below estimates of 725,000, as the job numbers improved with more vaccines being administered and Covid restrictions being lifted.

For the week, the Dow Jones Industrial Average surged 4.1% to close at 32,778 while the S&P 500 Index gained 2.6% to close at 3,943. The Nasdaq Composite Index jumped 3.1% to close at 13,319.

This Week

February retail sales are expected to decline slightly after posting a jump of over 5% in January. Housing starts in February are also forecast to drop but the numbers remain near the peak reached during the financial crisis. Leading economic indicators for February should show another increase, continuing its string of monthly increases since April of last year.

The Federal Open Market Committee (FOMC) announces its monetary policy decision and is expected to keep the federal funds interest rate unchanged near zero but may alter its monthly bond-buying program slightly. The Bank of Japan (BOJ) also meets to review its monetary policy and is widely expected to keep its benchmark interest rate unchanged at negative 0.1%.

The most notable companies scheduled to report quarterly earnings this week are Nike, Dollar General, Land’s End, Lennar, Cintas, FedEx, CrowdStrike and Accenture.

Portfolio Strategy

With the Federal Reserve scheduled to meet on Tuesday and Wednesday this week, the stock market will likely take its cue from comments by Fed Chairman Jerome Powell and what happens in the bond market. Expectations are for the Fed to keep interest rates unchanged near zero and offer no time frame on when it might adjust its bond-buying program. The Fed is on record saying that the federal funds rate will remain at this low level until 2023 but bond yields, which move opposite the price, have been rising lately on the belief that the economic outlook is improving. The fact that the $1.9 trillion Covid relief package was signed into law and the vaccine rollout continues only increases the probability that the economy is poised to grow much stronger. For this reason, value and cyclical stocks in sectors such as financials, industrials, consumer discretionary, retail, materials and energy have been the best performers while technology stocks have lagged. The yield on the 10-year Treasury is an important rate since it affects mortgages and other consumer and business loans. Last week it reached 1.64%, which is its highest level in more than a year. The movement of the 10-year Treasury yield should be watched closely in the weeks ahead since investors become more sensitive to stock valuations the higher that interest rates go up.