Lower oil prices, retail sales data lift S&P 500 to new high

My favorite time frame is forever. – Warren Buffett

In what could be described as a slow news week without any potential market-moving data, the major stock averages posted modest gains on their way to new all-time highs. With the third quarter earnings season winding down and a shortage of economic data, the S&P 500 Index still managed to edge higher on better-than-expected retail sales for October and the belief that lower oil prices will benefit retail sales in the future. After declining in September, retail sales bounced back last month with a gain of 0.3%, which exceeded expectations. When the volatile components that include gasoline, automobiles, building materials and food services are omitted, core retail sales actually jumped 0.5%. This increase certainly bodes well for the holiday shopping season and could be partly the result of lower gasoline prices. From a 52-week high of $115 a barrel, the price of oil has fallen more than 29% as oversupply and weak demand have both contributed to the precipitous drop. The price of oil is now at a 4-year low and the Organization of Petroleum Exporting Countries (OPEC) meets in two weeks to discuss cutting oil production to boost prices. Shelling out less money at the gas pump provides consumers with extra money that can be used for discretionary purchases this holiday season. This trend may have already benefited retail giants Macy’s and Wal Mart Stores as both companies reported better-than-expected earnings for the third quarter and were optimistic about the outlook for earnings in the current quarter. As long as the drop in oil and gasoline prices holds, consumers are likely to spend more, benefiting both the economy and retailers alike.

Last Week

Although jobless claims rose by 12,000 to 290,000 last week, it was the ninth straight week that the number of claims was below 300,000, signaling that layoffs remain very low and that the employment outlook is improving. Gross domestic product (GDP) in the euro zone grew by a better-than-expected 0.2% during the third quarter, bringing a sigh of relief to investors who feared that Europe might be falling back into recession. As a result, the European Central Bank (ECB) will likely take a wait-and-see approach before implementing any additional stimulus measures.

In merger and acquisition news, Warren Buffett and Berkshire Hathaway agreed to buy Duracell, a unit of Procter & Gamble, for $4.7 billion and Halliburton is in talks to acquire competitor Baker Hughes.

For the week, the Dow Jones Industrial Average edged higher by 0.35% to close at 17,634 while the S&P 500 Index added 0.4% to close at 2,039. The Nasdaq Composite Index rose 1.2% to close at 4,688.

This Week

Industrial production for October should be fairly strong as the manufacturing sector continues to show improvement, helped partly by declining oil prices. Both the producer price index (PPI) and the consumer price index (CPI) are expected to drop modestly in October due primarily to the decrease in gasoline prices.  Housing data for October in the form of existing home sales and housing starts are expected to post healthy increases and provide further evidence of a steadily improving housing sector. Leading economic indicators for October should also surprise on the upside and portend moderate economic growth in the months ahead.

Retailers will again dominate the corporate earnings calendar this week as Home Depot, Target, Lowe’s, Gap, Best Buy, TJX Companies, Staples and Dick’s Sporting Goods are due to report. Other notable company reports include Medtronic, Tyson Foods and J.M. Smucker.

Portfolio Strategy

With interest rates at historically low levels, it is widely presumed that the only direction for interest rates to go is up. Most economists have forecast that the Federal Reserve will begin to raise the federal funds rate, which is currently between 0% and 0.25%, by mid-2015 and that by the end of next year, the rate will be at about 1%. The federal funds rate is the overnight lending rate that banks charge one another on funds held on deposit at the Fed. The yield on the 10-year Treasury note is only about 2.30% and is likely to remain relatively low due to weak economic growth in Europe, a stronger dollar and declining oil prices and only moderate GDP growth in the U.S. By contrast, the yield on the 10-year German government bond is just 0.8%, about one-third less than a comparable Treasury note. Unless wage growth accelerates, the economy will probably be characterized by low inflation of 2% or less and only modest GDP growth of 2.5% to 3%. In this type of environment, the stock market has historically performed fairly well and this time should be no different. While caution should be exercised in the near-term given the recent steady rise in equity prices from the lows reached in mid-October, positive economic data and continued easy monetary policies should provide a favorable backdrop for stocks as we look to next year.