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Strong bank earnings propel Dow, S&P 500 to record highs

Outperforming the majority of investors requires doing what they are not doing. Buying when others have despaired and selling when they are full of hope, takes fortitude. – John Templeton

For the fourth consecutive week, both the Dow Jones Industrial Average and the S&P 500 Index posted gains and closed on Friday at record highs with the Dow above 34,000 for the first time ever. The Nasdaq Composite Index registered its third straight weekly gain and closed above 14,000, just shy of its all-time high. The primary focus for investors last week was the start of first quarter earnings season, which was dominated by the big money center banks and investment companies. Among the banks, JP Morgan Chase, Citigroup, Bank of America and Wells Fargo all reported better than expected revenue and earnings on strong trading results and the release of loan-loss reserves that were set aside for the pandemic. For the investment companies, the news was also positive as Goldman Sachs and Morgan Stanley reported strong trading and investment banking results that beat analysts’ estimates on both the top and bottom lines. In addition to the strong start to quarterly earnings season, economic data released last week also topped expectations as retail sales surged and weekly jobless claims plunged. The consumer price index (CPI) for March was also much higher than expected, raising concerns that the emerging economic recovery was causing inflation to increase. But instead of rising on this news, the yield on the 10-year Treasury actually fell to end the week at 1.57%, about 20 basis points (a basis point is one hundredth of one percent) less than its highest level reached in March.  One possible explanation for the decline was the recommendation by the Food & Drug Administration (FDA) for a pause in the Johnson & Johnson Covid-19 vaccine after reported cases of blood clotting. Halting the use of this vaccine could slow the reopening of the economy, but both Pfizer and Moderna said that they would be able to make up for any shortfall in the supply of vaccines. Despite this setback, there is still optimism that the economy will fully reopen in the second half of the year.

Last Week

As mentioned above, retail sales rose nearly 10% in March, much higher than expected, as consumers spent their stimulus checks and weekly jobless claims fell to 576,000, the lowest level since the early days of the Covid-19 pandemic and a sharp decline from the previous week’s total of 769,000. The University of Michigan consumer sentiment index in April rose to a one-year high and housing starts in March were much higher than in February. The CPI in March was higher than expected as gasoline prices surged, but the core CPI that excludes food and energy rose modestly and is up only 1.6% year-over-year. Most economists expect the increase in the CPI to be temporary.

The Federal Reserve Beige Book, a collection of anecdotes about the economy from the Fed’s 12 regional districts, showed that the economic recovery accelerated to a moderate pace over the last two months, buoyed by an easing of pandemic-related restrictions, an increase in vaccinations and strong fiscal support.

For the week, the Dow Jones Industrial Average rose 1.2% to close at 34,200 while the S&P 500 Index climbed 1.4% to close at 4,185. The Nasdaq Composite Index gained 1.1% to close at 14,052.

This Week

Both March existing home sales and new home sales are forecast to be higher than in the previous month as mortgage interest rates continue to be near historic lows. Leading economic indicators for March are expected to be higher than in February with forecasts calling for 5.5% growth in GDP for the year.

The European Central Bank (ECB) announces its monetary policy decision and is expected to keep its benchmark short-term interest rate unchanged at negative 0.5%.

Among the most notable companies scheduled to report first quarter earnings this week are Abbott Labs, Johnson & Johnson, CSX, Lockheed Martin, Union Pacific, Honeywell International, Whirlpool, Netflix, Intel, IBM, Northern Trust, Travelers, American Express, Procter & Gamble, Coca Cola, Mattel, Verizon, AT&T, Southwest Airlines, Schlumberger and Baker Hughes.

Portfolio Strategy

With little in the way of important economic data to be released this week, the focus will again be on quarterly earnings announcements. Unlike last week when banks and other financials companies dominated the earnings agenda, this week will bring a profit reports that cover a wide range of industry groups. While it is still very early in the earnings season, companies are trouncing estimates by a wide margin and profit growth for S&P 500 companies has been strong. But commodity prices have risen dramatically recently and the price of fuel, lumber and copper has soared, which could affect the profit margins of companies in sectors such as industrials, materials and consumer-oriented companies. While the headline consumer price index (CPI) showed a big increase in inflation due primarily to a surge in gasoline prices, this increase is expected to be temporary since it is compared with data from last year when the pandemic hit and the economy was virtually shut down. This may partly explain the decline in the yield of the 10-year Treasury to 1.57%. Because the 10-year Treasury yield affects mortgage and consumer loans and has had an impact on the stock market recently, it definitely bears watching in the weeks ahead. As long as it stays below 1.80%, the stock market should continue to do well provided earnings also continue to top estimates.