Strong retail earnings, Fed minutes propel stocks higher

Price is a creature of the market’s mood. In booms, it is set by the greediest buyer; in busts, by the most fearful seller. – Benjamin Graham  

In the holiday-shortened week characterized by thin trading volume, the major stock averages all posted gains with the Dow Jones Industrial Average leading the way with a gain of nearly 2%. Although this year has seen the worst stock market performance since 2008, the averages have clawed their way back of late as the S&P 500 Index is down only about 16% while the Dow has posted a year-to-date loss of just 5%. The technology-heavy Nasdaq Composite Index has been the worst performer with a loss of 28% through the close of business on Friday. The most important event last week was the much-anticipated release of the minutes from the Federal Reserve’s meeting in November. They showed that the Fed is seeing progress in its fight against inflation and is looking to slow the pace of interest rate hikes with smaller increases in December and the first part of 2023. Some Fed officials expressed concern over the impact rate increases could have on financial stability and the economy. They pointed to the uncertainty of the lag effects of monetary policy on economic activity and inflation as reasons to slow the pace of rate hikes. The worry is that Fed officials are too focused on backward-looking data and ignoring signs that inflation is falling and growth is slowing. With the current federal funds rate at 3.75% to 4.0%, the highest level in 14 years, the market now expects the terminal or peak rate to be about 5%. Cleveland Fed President Loretta Mester even commented last week that rate hikes will continue but could be smaller going forward. The stock market also benefitted from solid quarterly earnings reports last week from several retailers and, for the most part, retail profits have been better than expected as sales and margins have been strong. These better-than-forecast earnings results have signaled some consumer strength even though inflation remains high and the economy is slowing. Right now, Wall Street seems to be betting that interest rate hikes will moderate and that inflation will ease heading into the end of the year.

Last Week

Durable goods orders for October were stronger than expected while weekly jobless claims rose to 240,000, higher than in the previous week and higher than estimates of 225,000. The University of Michigan consumer sentiment index fell in November from October but came in better than expected.

Covid in China surged last week and fears rose that China may have to increase Covid restrictions after reporting deaths from the virus. Hopes of a global economic recovery with China reopening were shelved temporarily.

For the week, the Dow Jones Industrial Average jumped 1.8% to close at 34,347 while the S&P 500 Index climbed 1.5% to close at 4,026. The Nasdaq Composite Index rose 0.7% to close at 11,226.

This Week

The November employment report is expected to show that about 220,000 new jobs were created and that the unemployment rate remained unchanged at 3.7%. The second estimate for third quarter gross domestic product (GDP) is expected to be the same or 2.6%. The consumer confidence index for November is forecast to be slightly less than in October while construction spending is expected to decline slightly. The core personal consumption expenditures (PCE) index for October, the Fed’s preferred measure of inflation, is forecast to have increased 5% year over year, slightly lower than in September.

The most prominent companies scheduled to report third quarter earnings this week are Crowdstrike Holdings, Hewlett Packard Enterprise, Intuit, NetApp, Salesforce, Bank of Montreal, Toronto-Dominion Bank, Royal Bank of Canada, Hormel Foods, Dollar General, Kroger and Ulta Beauty.

Portfolio Strategy

The rally in the stock market over the past several weeks bodes well for stocks as we head into December, a seasonally strong month for the market. The S&P 500 Index now trades at the same level it did back in May despite a lot of bad news that includes high inflation, a series of rate hikes by the Federal Reserve, much higher bond yields and disappointing earnings from technology companies. Although the Fed remains hawkish in its fight to bring down inflation, the yield on the 10-year Treasury actually fell to 3.70% last week and is down about a half-percentage point from its peak in October. Mortgage rates could follow suit and decline toward 6% over the near-term, giving a much-needed boost to the housing market. If the 10-year Treasury yield has seen its peak and settles at this level or goes lower, stocks could do well as the S&P 500 Index trades at a sensible 17 times estimated earnings for next year. But the key to the future direction of the stock market lies in the inflation data that will be released. While there has been progress in recent months in both the consumer price index (CPI) and the producer price index (PPI), more data must be looked at to determine if this, in fact, is a lasting trend. For this reason, markets could remain range-bound over the near-term with two possible outcomes – a soft landing for the economy that results in lower inflation without raising the unemployment level too high and a global recession that means further downside to equities.