Ho, hum, the major averages continued to do what they have been doing all year, namely, to grind to higher and higher levels since the 5.8 percent correction that lasted from May 21 to June 24 ran its downward course. For the past four weeks straight, stocks have attained new highs and in the process, the Dow Jones Industrials, the S&P 500 and the Russell 2000 Index of small stocks have now been joined by the Dow Jones Transportation Index in record territory.
In addition to the reasons that have been motivating stocks to the upside, namely, better than expected earnings, the $85 billion monthly stimulus package courtesy of the Federal Reserve and record low interest rates that have been engineered by central banks in Europe and Japan, our central bank decided last week to dampen any speculation that the tapering of their stimulus programs was imminent.
This assurance to the market was given in a speech last Wednesday by Chairman Bernanke in which he said that the Federal Reserve still expects to start scaling back its bond buying program later this year, but at the same time he left open the option of changing that plan if the economic outlook shifted. He did this by saying that nothing was set in a pre-determined pattern as he added that “our asset purchases depend on economic and financial developments, but they are by no means on a pre-set course.” He made that statement in testimony to the House Financial Services Committee.
He mentioned that the current program could be reduced “somewhat more quickly” if economic conditions improved faster than expected. On the other hand, it “could be maintained for longer” if the labor market outlook worsened or inflation did not appear to be moving toward the Fed’s 2 percent target.
He put the icing on the bullish (for stocks) cake when he concluded with the comment that “Indeed, if needed, the F.O.M.C. would be prepared to employ all its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability.”
These remarks have resulted in the yield on the all-important 10-year Treasury note coming back down a bit from the 2.75 percent high that it reached right after the very strong June jobs report earlier this month, as it is currently at 2.47 percent. This is important because 30-year mortgage rates have cooled off a bit from their fast rise up to a recent 4.3 percent earlier this month, and let it be remembered that housing has been one of the mainstays of the economic recovery underway for the past four years.
Also helping to sustain the latest rally is that inflows into Exchange Traded Funds (ETFs) that invest in stocks have risen to their highest levels since September 2008, as $25 billion has been put to work in this area alone, and this is much more than the $10 billion or so that has moved into equity mutual funds in July. Similar to mutual funds, when ETFs receive additional monies, they are obligated to put this cash to work through the purchase of stocks, and this is obviously fueling the upside as well.
Since we are now in the heart of the second-quarter earnings reporting period, the profit picture for the three months just ended and what companies have to say about their prospects going forward is going to dominate trading on any particular day. And so far, with 108 of the 500 S&P companies having already reported, earnings have risen by around 3 percent while revenues have increased by only 1.1 percent. Of the companies that have already reported, 68 percent have beaten on the earnings side while only 43 percent have done better on revenues.
One group that has done very well lately has been the financials, as Dow component BAC in addition to several other large banks such as C have advanced to new 52-week highs after their results. In fact, the projection for this group is for an earnings gain of 21 percent. On the other hand, some important technology companies have disappointed on the downside, with Dow component MSFT and GOOG coming up short in the profit department, and this group is projected to show an overall 8 percent profit decline from a year earlier. This week is going to be the most important one for earnings, with no less than 150 S&P companies expected to announce their results.
As was already mentioned, economic reports have taken a back seat to earnings lately, but the ones that have been released are consistent with an economy that is moving ahead at a measured pace and not running away on the upside. June housing starts declined by 9.9 percent, to their lowest level since August 2012, and building permits, an indicator of future activity, also showed a large decline, while June existing home sales also showed a drop, and this was perhaps the reason that Chairman Bernanke cooled the rhetoric on any immediate tapering of the stimulus programs. The Fed Beige Book of economic conditions in various parts of the country showed that the economy has maintained a “modest to moderate pace” of growth in recent weeks. On the more encouraging side, the July Philadelphia Fed Survey of Manufacturing conditions in the Mid-Atlantic States rose to its best level in more than two years and weekly jobless claims declined last week to their lowest level since early May.
Because the dollar has been weakening somewhat lately on the perception that the Fed is going to keep its stimulus programs intact longer than had been thought, the prices of various commodities have started to move higher, in particular, gold. After having fallen into a bear market with a more than 20 percent decline from its all-time high over $1,900 an ounce almost two years ago, the precious metal actually fell to under $1,200 earlier this month. It has since made a nice recovery back up to over $1,330 an ounce, which probably means that the worst for this one is over. The price of crude oil has been on an upside tear lately as well, causing pain at the pump to gasoline consumers at the height of the traditional summer driving season, which could ultimately have negative effects on overall consumer spending.
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.
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