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Major stock averages all at record highs as earnings impress

If you can follow only one bit of data, follow the earnings (assuming the company in question has earnings). I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow or next week is only a distraction. – Peter Lynch

For the fourth straight week, all three major stock averages rose and in doing so, the S&P 500 Index, the Dow Jones Industrial Average and the Nasdaq Composite Index established new all-time highs as third quarter corporate earnings continued to impress. In a remarkable turnaround that saw the S&P 500 plunge about 5% in September, this benchmark and the Nasdaq have rallied over 6% in October while the Dow has gained more than 5%. The reason for the rebound in stock prices has been earnings, which have been much better than expected. About half of S&P 500 companies have reported their quarterly results and more than 80% of them have topped analysts’ estimates. Profitability has been high as strong demand has more than offset supply constraints and pricing pressures. Stock buybacks are also surging this year and will likely hit a record in the third quarter as corporate balances sheets are strong. This past week the primary focus was on the five biggest technology companies by market capitalization and their earnings results were a mixed bag. Microsoft and Alphabet (Google) topped both revenue and earnings expectations but Facebook missed on its revenue and monthly user numbers even though it beat earnings estimates. On Friday, Amazon badly missed earnings and revenue estimates and issued disappointing guidance for the holiday season while Apple reported lower than forecast revenue due to supply constraints on iPhones, iPads and Macs. It was the first time that Apple’s revenue had missed Wall Street estimates since May 2017.  Nevertheless, both stocks finished the week higher despite trading down on Friday as investors concluded that any supply chain issues are likely to be short-lived and resolved over time. This positive sentiment along with signs that the Delta variant is peaking and the seasonal tailwinds of the market could provide the catalyst for equities in the final two months of the year.

Last Week

Gross domestic product (GDP) for the third quarter was only 2%, below estimates and down from 6.7% in the second quarter. September durable goods orders fell for the first time since April but were better than expected as manufacturers continue to deal with supply chain bottlenecks. September new home sales topped expectations even though home prices rose to a new high as low mortgage interest rates spurred demand. The core personal consumption expenditures (PCE) index for September, the Federal Reserve’s preferred measure of inflation, rose modestly and was in line with estimates. On a year-over-year basis, the core PCE index has risen 3.6%. Weekly jobless claims were 281,000, better than the 289,000 that was expected. Both the U.S. consumer confidence index and the University of Michigan consumer sentiment index for October were higher than anticipated.

For the week, the Dow Jones Industrial Average rose 0.4% to close at 35,819 while the S&P 500 Index increased 1.3% to close at 4,605. The Nasdaq Composite Index climbed 2.7% to close at 15,498.

This Week

The employment report for October is expected to show that about 435,000 new jobs were created and that the unemployment rate remains unchanged at 4.8%. The Institute for Supply Management (ISM) Manufacturing and Services Purchasing Manager’s Indices (PMI) for October are both expected to be slightly above 60, solidly in expansion territory. September factory orders and construction spending are both forecast to increase modestly.

The Federal Open Market Committee (FOMC) meets this week and announces its monetary policy decision. It is widely expected that the Fed will keep the federal funds rate unchanged at near zero and announce that it will begin tapering its $120 billion-a-month bond buying program.

Among the most notable companies scheduled to report third quarter earnings this week are Qualcomm, Clorox, Kellogg, ViacomCBS, Simon Property Group, Mariott International, Amgen, Pfizer, Moderna, Humana, Cigna, MetLife, Allstate, DuPont, Emerson Electric, ConocoPhillips, Duke Energy and Dominion Energy.

Portfolio Strategy

While it will be another big week for quarterly earnings reports with the October jobs report also to be released on Friday, by far the most important event this week promises to be the Federal Open Market Committee (FOMC) meeting. Expectations are for the Federal Reserve to begin removing its easy monetary policies by reducing the $120 billion monthly bond purchases that were put in place in early 2020 to provide liquidity at the onset of the pandemic. The market expects the Fed to announce that it will reduce its bond purchases by $15 billion a month beginning in either November or December and complete the program by the middle of next year. Investors will also focus on what Federal Reserve Chairman Jerome Powell says about inflation, which is at the highest level in 30 years and has been running well above its 2% target. Past comments by Powell have indicated that the spike in inflation will likely be “transitory or “temporary”, but his assessment now may be different since inflation remains stubbornly high. The market appears to be pricing in three interest rate hikes next year, but the weaker than expected GDP growth of just 2% in the third quarter may allow the Fed to keep interest rates lower for longer, provided inflation does come down.