Dow And S&P Reach New Highs For the Third Straight Week

Ho, hum — for the third straight week, most of the major stock averages attained new all-time-high levels once again, with the Dow finally breaking above the nice round 15,000 level and the S&P also attaining its best ever level as well with a strong close above the 1600 round number as well.

And what has been driving things higher are basically the same overall factors that have contributed to this year’s 15 percent Dow advance, 14 percent S&P gain and the Nasdaq’s 13 percent rise, namely the fact that corporate earnings have been better than expected and that central banks around the world have been very generous with their stimulus measures to keep interest rates at record-low levels. In fact, the Reserve Bank of Australia joined its brethren in the U.S., the E.U., England and Japan in lowering rates to record-low levels, at 2.75 percent in that country. These actions have forced investors to seek out better returns in the equity market as bond yields give a person very little and actually lose money after taxes and inflation are factored in.

I had mentioned in last week’s column that AAPL and IBM were able to issue three-year notes at a whopping .45 percent yield and both of these issues were well oversubscribed, primarily from institutional investors like insurance companies who have to put their clients’ policy premiums somewhere “safe,” so to speak, whereas for an individual investor this is a very poor option. As an example of why this is not a good choice for the retail investor, one could purchase the shares of either of these companies and get a dividend yield of 3 percent for the former and 2 percent for the latter with the additional potential for price appreciation as well, although obviously this is not a guarantee.

In fact, just to show how stock markets around the world have been counting on the various central bank stimulus efforts to keep equity prices moving higher, last Thursday’s sole down-day of the week resulted from comments by Philadelphia Fed President Charles Plosser that he wants the Fed to start cutting back on the extent of its bond buying program as soon as the next F.O.M.C. meeting in June. Of course, there is no way that this is going to happen because the central bank said at their last meeting that they will maintain their current bond buying program at $85 billion a month and is “prepared to raise or lower the level of purchases as economic conditions evolve.” But they also said that they plan to keep their target interest rate near zero as long as unemployment remains above 6.5 percent and the inflation outlook does not exceed 2.5 percent. Mr. Plosser said that he expects unemployment to decline to 6.5 percent by 2014 and added that the Fed would be limited in its capacity for additional stimulus and the unwinding of the current stimulus measures would be higher than expected.

Aside from the continued advance in equities, we have also seen a rise in bond yields, as for instance the all-important 10-year Treasury note, upon which the majority of home mortgages are based, advanced from the record-low level it reached two weeks ago at 1.63 percent when a private forecasting service predicted that the April jobs report would continue to show a weaker overall trend. When that did not take place, as also detailed in last week’s column, bond yields started to advance on the perception that the U.S. economy will avoid the prediction from market observers that the second quarter will witness a sharp slowdown in growth. This perception that things are better than expected, which of course is the primary reason for the ongoing stock market advance, was aided by last week’s jobless claims, which declined to their lowest level since January 2008. Yesterday’s April retail sales report also helped ease ideas of a second-quarter slowdown as they unexpectedly edged up by 0.1 percent after a 0.5 percent decline in March when another loss was predicted. This was important because retail sales account for 30 percent of consumer spending, which makes up 70 percent of the economy.

The component of retail sales known as “core sales,” which eliminates automobiles, gasoline and building materials, and which corresponds most closely with the consumer spending component of G.D.P., rose by 0.5 percent after being up by 0.1 percent in March as well. This increase in core sales, coming on the heels of that better April jobs report, has done a lot to reduce fears of an abrupt slowdown early in the second quarter even as government budget cuts as a result of the sequestration process are straining other parts of the economy such as manufacturing. The fact that gasoline prices have declined from their record-high levels in February and March as the start of the summer driving season approaches could potentially give consumers more room for discretionary spending as well.

The first-quarter earnings season is mercifully winding down, and with 450 S&P companies reporting their results, 70 percent have beaten their profit estimates, which compares to the average from the last four quarters at 67 percent and the average from 1994 of 63 percent. Revenues have only beaten in 47 percent of the companies, which continues to show that much of these profit gains have resulted from cost-cutting measures. This revenue beat rate compares to the average of 62 percent in the past year and 52 percent since 1994. Earnings are now projected to gain 5.3 percent, which is finally above the January estimate of 4.3 percent and well above the April 1 projection of only 1.5 percent, which is one of the primary reasons for stocks having done so well lately.

Even from current record-high prices in the Dow Jones Industrial Average, S&P, Russell 2000 Index of small stocks, the mid-cap indexes and the Dow Jones Transports, things could still advance further because investors have put more money into bond funds this year relative to stock funds to the tune of $85 billion versus $74 billion after pulling out $900 billion from the latter and plowing $1.4 trillion into the former since 2006. In addition, polls show that only 52 percent of Americans say they own stocks outright or through mutual funds and retirement accounts, the lowest since 1997 and well off the 65 percent in 2007.


 

Donald Selkin is the Chief Market Strategist at National Securities in New York, a veteran in the securities industry for 36 years who is widely quoted in the financial media. If you have any questions, contact dselkin@nationalsecurities.com .


 

This report is for informational purposes only. It is not intended to be, nor should it be inferred as, a recommendation to purchase, sell, hold or sell short any security, or engage in any securities or commodities related transaction. Before entering into ANY investment, one should consult a financial professional.