S&P 500 closes higher on optimism over U.S. and China trade talks

One of my greatest complaints about forecasters is that they seem to ignore their own records. The amazing thing to me is that these people will go on making predictions with a straight face, and the media will continue to carry them. – Howard Marks

The Dow Jones Industrial Average brushed aside worries over Turkey’s currency problems and posted solid gains last week, adding 356 points for an increase of 1.6%. The S&P 500 Index also closed modestly higher while the technology-laden Nasdaq Composite Index slipped on valuation concerns and mixed quarterly earnings reports. To be sure, stronger than expected corporate earnings continue to be the driving force in this market as the earnings season winds down. Retailers were in the spotlight last week and they did not disappoint. Home Depot, Walmart, Macy’s and Nordstrom all reported better than expected revenue and earnings. In the technology sector, the news was mixed as Cisco Systems topped expectations but semi-conductor equipment manufacturer Applied Materials missed estimates and issued disappointing guidance for the fourth quarter. Although the Turkish lira rebounded later in the week after hitting a record low, the financial crisis in Turkey remains serious. Turkey’s central bank said it would provide as much liquidity as needed to help an economy faced with a soaring inflation rate well above its 5% target. While Turkey is not a member of the European Union or the euro zone and has no exposure to European banks, there is fear that Turkey’s dire financial situation could spread to other emerging market countries. Emerging market stocks, which had been performing poorly prior to the crisis in Turkey, have fallen even further as contagion fears have spread. There was good news last week on the geopolitical front, however, as the U.S. and China announced that they will resume trade talks later this month. Even more encouraging were reports that President Trump and Chinese leader Xi Jinping were planning to meet to discuss U.S. and China trade issues. While these announcements were certainly cause for optimism, worries over Turkey’s financial situation, a stronger dollar, commodity weakness and unsettled emerging markets could affect the market in the near term.

Last Week

U.S. retail sales in July were much better than expected but the number in June was revised lower. Nonetheless, core retail sales (excluding autos, gasoline, building materials and food services) were particularly strong and these correspond more closely to the consumer spending component of GDP. Import prices in July were flat as the strong dollar kept inflation pressures in check. Industrial production in July rose slightly but June was revised sharply higher as manufacturing has been helped by strong domestic and global economies. July housing starts were less than expected due to rising mortgage rates and higher home prices. Finally, the National Federation of Independent Business (NFIB) small-business optimism index in July fell slightly but was still among the best readings in history.

For the week, the Dow Jones Industrial Average jumped 1.4% to close at 25,669 and the S&P 500 Index rose 0.6% to close at 2,850. The Nasdaq Composite Index lost 0.3% to close at 7,816.

This Week

July existing home sales and new home sales are expected to be modestly higher than the number reported in June. Durable goods orders in July are forecast to decline slightly after posting a relatively strong reading in June. The Federal Reserve releases minutes from its meeting earlier this month.

Among the most prominent companies scheduled to report earnings this week are TJX Companies, Kohl’s, Target, Lowe’s, Gap, Toll Brothers, JM Smucker, Hormel Foods, Medtronic, Analog Devices, HP and Autodesk.

Portfolio Strategy

On Wednesday August 22^nd, the S&P 500 Index will likely set a record for the longest bull market in history, eclipsing the old record that lasted from 1990 to 2000. From its low back on March 9^th, 2009, the S&P 500 has risen over 320%. While there is some disagreement as to the exact starting and ending dates for bull and bear markets, there is no disagreement over the importance of this milestone. Risks to the current bull market can generally be narrowed down to five pre-conditions but none of these seem to exist right now. Rising and accelerating inflation above the Federal Reserve’s 2% target rate would be one such risk, but the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) index, is running slightly below 2%. Inflation has been held in check largely due to wage growth that has remained under 3%. Tighter monetary policy would also be problematic for stocks, but even though the Fed has increased interest rates twice this year, it has done so gradually and at a measured pace. Despite these increases, rates remain at historically low levels. Recessions are another reason why bull markets come to a screeching halt, but second quarter GDP growth was 4.1% and full-year economic growth is forecast to be about 3%. If the index of leading economic indicators turns negative, a recession is likely but this index has been solidly in positive territory. Another warning sign that a bull market is nearing its end is excessive euphoria on the part of investors. This irrational exuberance has been notably absent, though, as the market has climbed a wall of worry to get to these levels. Finally, while valuations are relatively high compared to historical averages, they remain reasonable when low interest rates are taken into consideration. The S&P 500 currently trades at about 17 times estimated earnings for 2018 versus the average of 15 or 16 times, but the yield on the 10-year Treasury is only 2.87%. While the threat of increased tariffs, trade wars and unforeseen geopolitical events like Turkey may increase volatility in the near term, it looks like this bull market will be able to weather these storms and grind higher.