Stocks rally on Greece resolution, strong earnings

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A combination of positive overseas news involving Greece and China as well as a strong start to the second quarter earnings season caused U.S. stocks to post impressive gains last week. While the broad market as measured by the S&P 500 Index was up over 2%, the Nasdaq Composite Index soared over 4% on strong technology earnings from the likes of Google and Intel. The catalyst for the rally in stocks began on Monday when euro zone leaders reached an agreement with Greece to enact tough reforms in exchange for bailout funds. Following the Greek parliament’s approval of the austerity measures, investors could finally breathe a sigh of relief, although this will probably not be the last time that we hear from Greece. The Chinese stock market also provided some good news for investors as it stabilized and rose 2% for the week after the Chinese government reported that gross domestic product (GDP) increased 7% in the second quarter, better than had been expected. After tumbling almost 30% since mid-June, the fact that the Chinese stock market was able to recover was encouraging to investors. News on the domestic front was also favorable. Although the economic data reported last week was decidedly mixed, earnings were mostly positive, especially from the financials. JP Morgan Chase, Citigroup and Bank of America all reported earnings that beat analyst estimates. General Electric and Honeywell, two heavyweights in the capital equipment sector, also posted strong results that were better than expected.   Even though expectations were for a weak second quarter earnings season, the fact that companies are beating these lowered estimates should bode well for stocks in the near-term. The Federal Reserve contributed to the positive backdrop for the stock market, too. In her testimony before Congress, Fed Chair Janet Yellen was confident that the U.S. labor market and overall economy would improve and strengthen by year-end. Without Greece occupying the headlines anymore, investors can now turn their attention to earnings, which are what ultimately drive stock prices in the long run. And so far the news from the earnings front has been favorable.

Last Week

The economic data released last week was a mixed bag. Retail sales in June registered their first decline in four months and the prior two months were revised lower as well. Expectations were for an increase in retail sales and the data suggest that consumers are saving more and showing little desire to spend more.  The Philly Fed manufacturing index was also well-below forecast as the strong dollar reduced exports. On a positive note, home builder confidence was near a 10-year high and U.S. housing starts and building permits also rose, indicating a rapidly strengthening housing market. Weekly jobless claims fell by 15,000, a sign that the labor market is solid.

The June producer price index (PPI) and consumer price index (CPI) were up 0.4% and 0.3%, respectively, due primarily to the increase in gasoline prices. The tone of the Federal Reserve’s beige book was optimistic about the U.S. economy as the central bank’s 12 districts mostly described growth as being moderate.

For the week, the Dow Jones Industrial Average climbed 2.0% to close at 18,086 while the S&P 500 Index rose 2.4% to close at 2,126. The Nasdaq Composite Index jumped 4.3% to close at 5,210, a record high close. 

This Week

There is little in the way of economic data on the calendar this week. June leading economic indicators should nudge slightly higher while existing and new home sales for June should both show modest improvement.

The focus this week will be squarely on second quarter earnings as a number of companies are scheduled to report. Among the most notable include Morgan Stanley and American Express in the financial sector, Microsoft, IBM and Apple in the technology sector, Abbott Labs and Eli Lilly in the health care sector, Coca Cola, McDonald’s and Starbucks in the consumer sector, GM, Caterpillar and 3M in the capital equipment sector and Verizon and AT&T in the telephone utilities sector.

Portfolio Strategy

With last week’s close of the S&P 500 Index at 2,126, this benchmark is once again knocking at the door of 2,130, the upper end of the trading range for stocks this year. Now that the crises in Greece and China have been resolved and with inflation under control thanks to low oil prices and a strong dollar, the key for stocks going forward will be revenue growth and continued corporate earnings reports that consistently beat expectations. Aside from the energy sector, whose profits are expected to fall by about 60% during the second quarter, earnings growth should be fairly good with double-digit increases for the financial sector, the health care sector and the consumer discretionary sector. Last week’s earnings reports from the banks show that they have recovered fully from the financial crisis by cutting costs and boosting fee income. Banks could also benefit if interest rates should rise as their net interest margins would expand. Health care companies have seen the strongest revenue growth due to the introduction of promising new drugs and that trend should continue. Consumer discretionary companies also are expected to post strong profit growth as an improving labor market, higher wages and lower gas prices should help increase consumer spending. Analysts are favorably disposed toward technology companies, too, as they should benefit from increased business investment and capital expenditures by corporations. With valuations stretched and the S&P 500 Index trading at about 17 times forward earnings, earnings will have to play catch up with stock prices in order for this market to make new highs.