S&P 500 hits an all-time high on earnings, economic data

To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks. – Benjamin Graham

Both the Dow Jones Industrial Average and the S&P 500 Index hit all-time highs last week, making the lows reached four days after the Brexit vote seem like a distant memory. Since that date, stocks have risen 8% as investors have concluded that any potential negative fallout from the decision will not occur in the near-term. The S&P 500 shattered the old record close of 2,130 set back in May 2015 following a week of favorable economic data, better than expected corporate earnings reports, reassuring news from China and continued easy monetary policies by global central banks. The Federal Reserve’s beige book that summarizes economic activity across the country showed that the economy continues to grow at a modest pace with improved manufacturing, a strong and stable labor market and only limited wage pressures. While the report noted some softening in consumer spending, one would never know it by the release of June retail sales, which rose 0.6% and easily topped estimates. Strong consumer spending is needed to offset weakness in exports and the energy sector due to low oil prices. Second quarter earnings season also got under way last week and the results were generally positive, though they were confined primarily to the financial sector. JP Morgan Chase and Citigroup easily beat expectations and Wells Fargo’s earnings were in line with estimates as profits were hurt by energy loans. Investors also breathed a sigh of relief  when China reported that their gross domestic product (GDP) rose by 6.7%, slightly better than forecast and a welcome sign for the world’s second largest economy. After winning his bid for re-election, Prime Minister Shinzo Abe of Japan immediately implemented additional stimulus measures and the United Kingdom’s central bank indicated that easier monetary policies would likely be in place in August. These moves seemed to reinforce the perception that global central banks are willing to do whatever it takes to get their economies moving again. With Europe and Japan flirting with negative interest rates and the yield on the 10-year Treasury a paltry 1.59%, it’s no wonder that the stock market has surged and now sits in record-breaking territory.

Last Week

The producer price index (PPI) jumped 0.5% in June, higher than expected and the biggest gain in over a year due to higher oil prices. The core PPI, which excludes food and energy, has risen less than 1% percent over the last year. The consumer price index (CPI) rose only modestly in June and is up 1% in the past 12 months with the core CPI up 2.3% over the same period.

In a speech last week, St. Louis Fed President James Bullard said that only one interest rate hike would be needed in the foreseeable future as the U.S. economy is mired in a period of low growth, low inflation and low unemployment.

For the week, the Dow Jones Industrial Average soared 2% to close at 18,516 while the S&P 500 Index rose 1.5% to close at 2,161. The Nasdaq Composite Index also gained 1.5% to close at 5,029.

This Week

June housing starts are expected to drop slightly and existing home sales in June are also forecast to decline modestly from the previous month’s level. June leading economic indicators should rebound slightly after posting a negative reading last month.

In its meeting on Thursday, the European Central Bank (ECB) is expected to discuss the possibility of additional stimulus measures in the aftermath of the Brexit vote.

Second quarter earnings season will get into full swing this week with IBM, Microsoft, Intel, Bank of America, Goldman Sachs, American Express, Morgan Stanley, Johnson & Johnson, Abbott Labs, General Electric, General Motors, Honeywell, AT& T and Union Pacific a few of the heavyweights on the agenda.

Portfolio Strategy

With the stock market at all-time highs and Treasury yields near all-time lows, it would appear that both the bond market and the stock market are fully valued and have limited upside. For bonds, global growth has been challenging and global central bank monetary policy remains accommodative and may even increase as the Bank of England, the European Central Bank and the Bank of Japan all seem poised to ease further over the near term. In all likelihood, the Federal Reserve will raise interest rates only one more time this year, a function of modest economic growth, low inflation and even lower sovereign interest rates abroad. For stocks, the recent rally has left the S&P 500 Index trading at 18 times estimated earnings in 2016 and about 17 times expected earnings in 2017, levels that are above historical norms. However, in the context of Treasury yields that are near historical lows, investors have become increasingly more comfortable with placing a higher multiple on those earnings. Earnings are expected to be down again in the second quarter from a year ago, but so far after one week earnings have been solid and better than expectations. While it is still too early in the earnings season to extrapolate, the results have been encouraging and make investors more comfortable with the estimates for both this year and next year. The upward momentum in stocks could continue as yields on Treasuries and corporate bonds are very low and offer an unattractive option. With improving economic conditions that should lead to growth in corporate earnings in the second half of the year, investors could be rewarded with additional gains in the stock market, although the recent rally in stock prices has probably stolen some of those gains.