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Strong earnings and jobs data lift major stock averages to record highs

The one reality that you can never change is that a higher-priced asset will produce a lower return than a lower-priced asset. You can’t have your cake and eat it, too. You can enjoy it now, or you can enjoy it steadily in the distant future, but not both – and the price we pay for having this market go higher and higher is a lower 10-year return from the peak. – Benjamin Graham

Stocks continued their remarkable run last week as all three major averages rose and closed at record highs as quarterly earnings continued to defy expectations, jobs data was stronger than expected and the Federal Reserve unveiled its much-anticipated tapering plans. The S&P 500 Index rose for the seventh straight day on Friday and finished the week with a gain of 2% while the technology-heavy Nasdaq Composite Index jumped over 3% and the Russell 2000 Index of small cap stocks surged over 6% to an all-time high. Corporate profits continued to impress as about 83% of S&P 500 companies that have reported their earnings have topped estimates. The October employment report also contributed to the positive sentiment as it showed that 531,000 jobs were created, higher than the 450,000 estimate, and that the unemployment rate fell to 4.6% from 4.8%. The August and September job reports were also revised substantially higher and wage growth for the month was in line with expectations with a year-over-year increase of nearly 5%. Investors received more definitive plans from the Federal Open Market Committee (FOMC), too, with regard to its tapering plans, which removed some of the uncertainty around the Fed’s intentions. The Fed will begin tapering its bond purchases later this month by reducing them by $15 billion ($10 billion in Treasuries and $5 billion in mortgage-backed securities) each month from the current $120 billion a month and will conclude the bond-buying program by July 2022. Even though the Fed acknowledged that inflation has been higher than central bankers had anticipated, the Fed’s statement still described rising prices as “transitory”. The Fed left interest rates unchanged near zero and could delay any interest rate hikes further into the future if the inflation spike does prove to be temporary. Federal Reserve Chairman Jerome Powell said that the economy is strong enough to withstand a slowdown in its bond-buying program and predicts only one rate hike next year. The markets also received good news from drug manufacturer Pfizer as it announced that its Covid-19 drug cut the risk of hospitalization by nearly 95% at a time when virus trends are improving with vaccinations and boosters.

Last Week

There was more positive jobs news last week as payroll processing firm ADP reported that 571,000 private sector jobs were added in October, much better than expected, and weekly jobless claims were 269,000, better than the 275,000 that were expected and the lowest total during the pandemic. The ISM manufacturing index in October fell slightly from its level in September but was better than forecast while the ISM services sector index rose to an all-time high for the report, the 17th month in a row that it has risen.

For the week, the Dow Jones Industrial Average rose 1.4% to close at 36,327 while the S&P 500 Index gained 2.0% to close at 4,697. The Nasdaq Composite Index surged 3.1% to close at 15,971.

This Week

Investors will get a better read on inflation this week as the October core producer price index (PPI) that excludes food and energy prices is expected to increase more than in September while the core consumer price index (CPI) is expected to do the same with a year-over-year increase of 4.4%. The University of Michigan consumer sentiment index for October is forecast to be slightly higher than in September.

U.S. fixed income markets will be closed on Thursday in observance of Veterans Day.

Among the most prominent companies scheduled to report third quarter earnings this week are Walt Disney, Sysco, Wendy’s, BioNTech, Cardinal Health, AstraZeneca, D.R. Horton, Nexstar Media, Energizer and AMC Entertainment.

Portfolio Strategy

The biggest risk for the stock market appears to be inflation that is running much hotter than expected and this week current inflation data will be released that will help clarify this trend. The recent spike in inflation has been the highest year-over-year increase in over 30 years with the core consumer price index (CPI) expected to rise over 4%, much higher than the Federal Reserve’s target rate of inflation of just 2%. While the Fed has said that it was comfortable letting inflation run above its target, the recent spike has been alarming and could last longer than expected. The Fed has maintained that this jump in prices will prove to be transitory, but the longer it lasts, the greater is the likelihood for an interest rate hike sooner rather than later. With the tapering of bond purchases expected to end by July 2022, an interest rate hike could occur almost immediately. Persistent high inflation could upend these plans altogether, though, and force the Fed to end the tapering process sooner and raise rates earlier and faster. But for now, the markets have been focused on quarterly corporate earnings, and rightly so, as stocks have benefited from strong earnings and positive outlooks. Through the end of October, the S&P 500 Index has risen more than 22% and in the eight times since 1950 when this benchmark has been up more than 20% through October, performance in November and December has been positive in every instance with an average gain of over 6%. High inflation may become a more permanent problem with adverse implications for both stocks and bonds down the road, but for now, the positive momentum of the stock market is likely to continue through year-end.