Strong earnings lift Dow to record high

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The intelligent investor is a realist who sells to optimists and buys from pessimists. – Benjamin Graham

All three major stock averages rose for the third consecutive week and the Dow Jones Industrial Average closed at an all-time high as third quarter earnings continued to be strong. Unlike the first week of earnings season that was dominated by the major banks and other financial companies, profit reports last week broadened out to include a diverse group of industries and, for the most part, results were still better than expected. Nearly one quarter of S&P 500 companies have reported their earnings so far and 84% of them have topped estimates with quarterly profits on track to increase 35% in the third quarter. This strong growth in the third quarter would be the third highest earnings growth rate of S&P 500 companies since 2010. While there were a few notable disappointments last week, namely from IBM and computer chip manufacturer Intel, other blue chip companies such as Johnson & Johnson, Procter & Gamble, Travelers and Verizon all easily beat earnings estimates. The strength in the stock market came despite the yield on the 10-year Treasury briefly jumping above 1.70%, continued high inflation and worries over possible Federal Reserve tapering as early as next month. The Fed’s Beige Book, a survey of recent economic conditions across the country, showed that the economy is still growing at a ‘moderate’ pace but that labor and supply shortages are slowing the economy. Uncertainty around the Delta variant of Covid-19 is also having an adverse effect. While demand for workers is still high in all twelve Federal Reserve districts, there is a low supply of available workers. Most districts also reported significantly higher prices caused by increased demand and supply chain disruptions. Despite concerns over the spread of the Delta variant, supply chain issues, the China real estate crisis, the possibility of Fed tapering and surging inflation, the stock market has climbed a wall of worry to regain what it had lost during the month of September.

Last Week

Existing home sales rose more than expected in September due to a brief drop in mortgage interest rates in August. Existing home sales are based on closed sales that were likely signed in July and August. Leading economic indicators in September rose modestly and were less than expected due to the Delta variant and supply chain disruptions. Weekly jobless claims fell 6,000 to 290,000, the lowest level since March 2020, and were better than the 300,000 that were expected. Lastly, industrial production in September fell to its lowest level since February.

For the week, the Dow Jones Industrial Average rose 1.1% to close at 35,677 while the S&P 500 Index jumped 1.6% to close at 4,544. The Nasdaq Composite Index gained 1.3% to close at 15,090.

This Week

The preliminary estimate for third quarter GDP is expected to be 3.8%, compared to GDP growth of 6.7% in the second quarter. September new home sales are forecast to be higher than in August while durable goods orders in September are expected to decline slightly after a strong reading the previous month. Both the October consumer confidence and University of Michigan consumer sentiment indices are expected to approximate levels from September and be significantly below the recent peak in early summer as the Delta variant and inflation are affecting consumer optimism.

This is the busiest week of third quarter earnings season and big technology companies such as Facebook, Alphabet (Google), Microsoft, Amazon and Apple will be in the spotlight. Other prominent companies scheduled to report include 3M, General Electric, Lockheed Martin, Boeing, Ford Motor, General Motors, Caterpillar, UPS, Eli Lilly, Bristol Myers Squibb, Merck, AbbVie, Visa, Coca Cola, McDonald’s, Comcast, Starbucks, Chevron, Exxon Mobil, Advanced Micro Devices, Texas Instruments and Automatic Data Processing.

Portfolio Strategy

This week could be a pivotal one for the stock market with the major averages perched at or near all-time highs once again and about 30% of S&P 500 companies reporting their earnings, by far the most of any week during earnings season. Up until now, the profit reports have been mostly excellent but the real test could come this week as the five biggest technology companies by market capitalization – Facebook, Apple, Alphabet (Google), Microsoft and Amazon – are scheduled to report earnings. In addition, there will be representation from every sector of the S&P 500. Last week was a mixed bag for technology as IBM and Intel reported weaker than expected revenue but HP and Nvidia reported strong earnings. Two other things to watch will be the movement of the 10-year Treasury yield and the personal consumption expenditures (PCE) index to be released on Friday.  Last week the yield on the 10-year Treasury eclipsed 1.70% before falling and ending the week at 1.64%. The closing high yield on the 10-year Treasury occurred back in March when it was 1.74%.  Knowing that the Federal Reserve plans to begin tapering its monthly bond purchase program and could hike interest rates during the second half of next year, the direction of the 10-year Treasury yield bears watching, especially with the PCE index, the Fed’s preferred measure of inflation, to be released this week. Inflation has been running at about 5% and a hotter than expected reading could set the wheels in motion faster for both Fed tapering and possible interest rate hikes.