S&P and Dow Transportation Average Close at New Record All-Time Highs

Despite all the recent negativity thrown in the market’s way, the S&P ended last week at a new record all-time high at the nice round number of 1900. It was joined at best-ever levels by the Dow Jones Transportation Index as well, which meant that despite such ostensible concerns as the gain of only 0.1 percent for first-quarter G.D.P., which could be revised to negative this week, the severe downside correction in the formerly high-flying social media, internet and biotechnology stocks and the geopolitical issues surrounding the goings-on in Ukraine, the measure that is synonymous with the broadest measure of large stocks is now higher than it has ever been.

As of last Friday, it had also risen for five out of the past six sessions as well. And after a rocky start in the historically challenging month of May, the Dow Jones Industrial Average had turned positive for the month as well.

This best-ever level for the S&P has occurred for a number of reasons, and they include the fact that first-quarter earnings, which are now complete, have risen by 5.5 percent when, after a market correction that bottomed out on April 11, the prediction from the experts was that earnings growth for the first three months of the year would be only 0.9 percent. So as the earnings reporting period improved as more companies reported their results, stocks rose along with profits as well.

In addition, despite the tapering of the bond buying stimulus program by the Federal Reserve to the tune of $10 billion a month, which has now reduced this amount down to $45 billion from the original $85 and at the current rate will end by October, the stock market still has the Fed’s back, so to speak. This is because Fed Chair Janet Yellen, in recent testimony to Congress and in official policy statements from the central bank, has said that policy will remain “highly accommodative” and that they expect inflation to remain well below their two percent target. With that in mind, they do not face a trade-off between their employment and inflation objectives.

The Fed also calmed the markets by saying that “early communication” of their exit strategy (meaning the time that they will begin to raise the federal funds rate from its current record-low level of between zero and one-quarter percent) would “enhance the clarity and credibility of monetary policy.” They concluded their most recent policy statement by adding that while no decisions were taken, “participants generally favored the further testing of various tools” while implying that “normalization (i.e. raising of interest rates) would not begin anytime soon.”

The fact that longer-term interest rates have declined to their lowest level in almost a year has also been helpful for stocks, as the yield on the all-important 10-year Treasury note is currently at only 2.50 percent, and since bonds compete with stocks for investor dollars, these low yields are not very attractive places to put one’s money and as a result, more buying has come into equities.

The situation in Ukraine, which was pointed to as the supposed “explanation” for stocks declining on certain days in the past couple of months, is not really relevant to the U.S. economy because of the scant business that American companies do in that part of the world. For all his blustering, Russian President Putin said on Friday that his country would respect the results of the Ukrainian presidential elections held this past weekend.

He is obviously constrained by how far he wants to push the situation as well, due to the fact that the Russian economy has fallen into a recession, foreign investment capital has fled the country, their currency recently reached an all-time record low against the dollar, and their central bank had to raise interest rates sharply in order to defend the value of the ruble, which has increased borrowing costs for Russian companies.

Economic reports released this past week still show an economy that is trying to shake off the negative effects from the winter slowdown, as April existing home sales rose for the first time in four months, a London-based organization’s estimate for U.S. manufacturing rose to its highest level in three months, and April new-home sales increased to their best level since last October.

On the other hand, weekly jobless claims underwent their largest jump since December, but this was from the lowest level in seven years.

Much has been made recently of the sharp decline in small-cap stocks relative to their larger brethren and how the Russell 2000 Index of such members has declined by 10 percent from its early March high. If we try to equalize the equation by substituting the Russell 1000 Index for the S&P, since it is made up of the larger capitalization stocks, it will be easier to compare it to the Russell 2000 Index.

The former index contains about $20 trillion in market capitalization, whose definition was explained in last week’s column.  The latter makes up just $2 trillion in market cap. From their peaks, the Russell 1000 has lost $265 billion in market cap while the Russell 2000 has lost $155 billion. While these drops in market cap are pretty similar, in percentage terms, they are very different. The former’s drop in market cap is just 1.3 percent, while the latter’s drop is 7.4 percent.

Despite being the worst and third-worst performers in percentage terms, the internet stocks and the Russell 2000 are off by the least in dollar terms. Meanwhile, large cap indices that are only down modestly from recent highs are bigger losers in these terms.

The point is that large percentage declines are not always a threat to the market as a whole. Another important factor is the total size of the decline. The conclusion here is that outsized percentage declines in the momentum and speculative social media and internet stocks have not spilled over and caused similar painful percentage drops in large-cap stocks because the latter are just too big relative to the small caps for the pain trade to be spread to the entire market. This is why the decline in the smaller stocks should not have been the most dominant factor in market performance. It is also why the S&P is at a record high while the other indices mentioned here are not.