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Stocks edge higher but July retail sales disappoint

The key to making money in stocks is not to get scared out of them. – Peter Lynch

The dog days of summer have set in and the major stock averages reflected the August doldrums last week as trading volume was light and stocks were little changed. Although stocks edged slightly higher for the week, the big news occurred on Thursday when the Dow Jones Industrial Average, S&P 500 Index and Nasdaq Composite Index all hit record highs. Not since December 31st, 1999 during the internet and technology bubble have all three major stock averages been at record highs at the same time. Stocks might have remained at their lofty levels to end the week had it not been for July retail sales, which came in flat and were less than expected. The report suggested that consumer spending was slowing down after rising at better than a 4% clip in the second quarter. This was obviously a concern for investors as consumer spending accounts for about two-thirds of gross domestic product. Second quarter GDP increased only 1.2%, which was well-below expectations, and was only slightly higher than GDP growth in the first quarter. To make matters worse, the University of Michigan Consumer Sentiment Index released on Friday was also less than expected. But investors chose to focus on the positives rather than the negatives and the fact that consumer spending is still supported by a strong labor market, improved wage growth, rising home prices and near record stock market valuations. The news on retail sales wasn’t all bad, either, as two of the country’s biggest retailers, Macy’s and Kohl’s, reported quarterly earnings that topped analysts’ estimates. With the stock market near all-time highs and valuations apparently full at 18.5 times estimated earnings for 2016, one would probably conclude that there is little additional upside for stocks. However, in the context of historically low bond yields, zero percent money market fund yields and even negative yields on select foreign sovereign debt, investors in search of returns and yield have little or no choice but to turn to stocks. In this environment, a lack of viable alternatives can lead to even higher stock prices but investors should remain cautious at these levels.

Last Week

Although July retail sales were flat versus an expected increase of 0.4%, June retail sales were revised upward slightly. Wholesale inventories in June were also up slightly, which could mean an upward revision in second quarter GDP. Jobless claims fell last week and have remained below 300,000 for 75 straight weeks, the longest streak since 1970. The producer price index (PPI) for July fell for the first time since March due to lower oil prices and the effects of a stronger dollar. In the 12 months through July, the PPI has decreased by 0.2% as inflation remains benign.

The price of oil ended the week higher as Saudi Arabia hinted that it could take action to stabilize oil prices at the OPEC meeting in September. Apple’s stock price target was raised by an analyst on an upbeat iPhone sales outlook.

For the week, the Dow Jones Industrial Average added 0.2% to close at 18,576 while the S&P 500 Index edged up 0.1% to close at 2,185. The Nasdaq Composite Index rose 0.2% to close at 5,232, a record high.

This Week

The July consumer price index (CPI) is expected to show that inflation remains under control and July industrial production is expected to increase slightly. Housing starts for July should remain strong and consistent with last month’s number while July leading economic indicators are forecast to increase modestly.

Minutes from the Federal Reserve’s July meeting will be released and investors will be looking for any signs that the Fed may be ready to raise interest rates.

Retailers will dominate this week’s earnings reports with Home Depot, Lowe’s, Target, Wal-Mart Stores, TJX Companies and Dick’s Sporting Goods all on the agenda. Other prominent companies scheduled to report quarterly earnings include Sysco, Deere & Co., Analog Devices, Applied Materials and Cisco Systems.

Portfolio Strategy

With the second quarter earnings season winding down and the stock market near all-time highs, there is little on the economic calendar that could propel stocks even higher. For the most part, earnings have been better than expected, even though they are down from a year ago. Economic growth this year has been anemic, with GDP growth at an annualized rate of 0.8% in the first quarter and 1.2% in the second quarter. This current expansion has completed its seventh year and it ranks as the slowest expansion in history with average annual growth of only 2.3%. But it has been one of the longest expansions and expectations are for growth to continue through 2017. The Atlanta Federal Reserve recently forecast that the economy will grow by 3.7% in the third quarter and most economists expect full-year growth of about 2%. For this to happen, though, economic growth during the last half of the year will have to average over 2.5% in the third and fourth quarters, something that is by no means guaranteed. While the strong July employment report was an encouraging sign, it will be up to the consumer to do much of the heavy lifting for economic growth to accelerate and for corporate profit growth to return.