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(May 5, 1997) STOCK INDEXES: Last week's market action seemed to finally change the prevailing bearish attitude in the stock market that had resulted from (1) the Dow and the S&P 500 10% corrections from their respective mid-March and mid-February highs to their mid-April lows and (2) the severe internal deterioration that had begun in late January when the NASDAQ and other broader measures of smaller stocks underwent even more serious declines of between 15- 20%. The early negativity last week stemmed from bond yields at 7.14% which were at their highest level since September and exactly the same level they attained on April 14 when the Dow made its intra-day low of 6355. In addition, despite the Dow's recovery from that low, the broader market was lagging badly, with the number of new daily lows exceeding the number of new highs for 10 of the 11 trading sessions from April 14-28. Lastly, other measures such as the NASDAQ, Value Line, Mid-Cap Index, and the Russell 2000 were all lower for the year when last week began.
These negative attitudes were given widespread credence the previous weekend by Barron's, which quoted certain commentators who said the stock market would now turn its attention to the negative effect of higher interest rates rather than the positive effects of earnings, which had caused the Dow to finish higher on a weekly basis since mid-April. Fortunately, this analysis turned out to be completely wrong as the stock market turned in perhaps its best overall performance this year. Not only did the Dow end the week with a rousing gain of 94 points, but for the first time since January, the broader market finally started to participate on the upside. By week's end, the troops were actually outperforming the generals on the way up, a rarity in 1997. For example, on Friday, the NASDAQ made a record one-day gain of 35 points. Also, the Dow Transports closed at an all-time high. Another rarity was that the number of advancing issues beat decliners by 4:1 for two days. Last week's Dow gain of 332 was the largest weekly point gain on record, surpassing the 312-point rise of three weeks ago; Friday's close of 7071 is only 14 points shy of the all-time high. In addition, the last three Tuesdays (April 29, 22 and 15) have seen the second-, third- and fourth-largest point Dow gains ever, at 179, 173, and 135, respectively. Last Tuesday's 179-point upside barn burner was the best one-day percentage gain (2.62%) by the Dow since December 1991 when it gained 3% in one session. In an astonishing display even more dynamic than the recovery from last July's lows, the Dow has now recouped the entire mid-March to mid-April sell-off in three weeks; last year it took two months to recover the previous losses.
The major motivating upside force for stocks last week was that the bond market rallied steadily after hitting the 7.14% yield level on Monday and ended the week at 6.88%, which was the lowest level since the Fed raised rates on March 26. The astounding turnaround was due to several economic reports that showed the economy was cooling from its torrid first-quarter pace. Perhaps of even greater importance was that it appeared the White House and Congress had finally reached agreement on a five-year balanced budget plan. The reports included:
--March New Home Sales fell by 2.5%, but the February number was revised upward to the highest level since April 1986. In addition, the inventory of homes for sale fell to its lowest level in three years.--The Employment Cost Index for the first quarter rose by only 0.6% against expectations of a 0.9% gain. This was the result of wages that grew by 0.9%, but were offset by benefits that expanded only 0.1%.
--March Durable Goods fell by a greater-than-expected 3.0%, which was the largest decline since August and much lower than the expectations for a 0.3% increase. In addition, the February number was revised downward to 0.8% from 1.5%.
--April Consumer Confidence fell to 116.8 from 118.5.
--The Johnson-Redbook survey of weekly chain store sales rose only 0.2%.
--First-quarter GDP rose by a larger-than-anticipated 5.6%, which was the biggest gain since the 6% growth in the fourth quarter of 1987; the deflator rose only 2.3%. However, this large growth figure was skewed upward by a staggering $46 billion inventory buildup, which will almost certainly reduce the growth rate in the second quarter.
--The Chicago Purchasing Manager's Survey for April fell to 57.2 from 57.5 in March.
--Weekly jobless claims rose by a very large 28,000 to 347,000.
--In March, personal income rose 0.6% and personal spending rose 0.5%.
--The National Association of Purchasing Managers' Survey for April fell to 54.2 from 55 in March; the prices paid component also declined.
--Construction spending for March fell 0.2%.
--March Leading Economic Indicators rose 0.1%.
--Non-farm payrolls rose 142,000 in April, less than the consensus forecast of 200,000, while the March figure was revised downward to 139,000 from 175,000. In addition, average hourly earnings fell one cent to $12.14, and the average work week declined to 34.6 hours from 34.9 hours. Offsetting this somewhat was the unemployment rate, which fell to 4.9% from 5.2% to reach its lowest level since December 1973.
Of course, one of the major factors powering the recent advance in stocks is that earnings have been coming in above expectations. As the first-quarter reporting period is winding down, 437 companies in the S&P 500 have announced their results as follows: 262 firms, or 60%, have reported positive surprises; 103 firms, or 23.6%, have reported disappointing earnings; and 72 firms, or 16.4%, met analysts' expectations. So far, these earnings are running 3.3% above expectations, or about 16% higher than year-ago levels. For the entire year, earnings are now projected to increase by 12%. Ironically, money flows into stock funds fell to $10.51 billion in March from $18.16 billion in February. The first-quarter inflows of $57.75 billion were down from the $72.54 billion for the same period in 1996. In addition, April appears to have been the third consecutive month that flows will be less than year-ago levels. But, remember that these figures tend to reflect reactive rather than anticipatory action. For example, money moved out of stock funds on a net basis last July, coinciding with the market's bottom. These figures are almost a contrary indicator as they show the small investor reacting to what has happened rather than anticipating a potential advance from lower levels, as has taken place recently.
One constant is the one-day destruction of second-tier stocks that report disappointing earnings.
Technology stocks exhibited particular strength last week, especially those that had retreated an astoundingly large percentage from their yearly highs and had not been following mighty Intel and Microsoft higher. Networkers and semiconductors were particularly favored. The rallies in these issues last week was the major factor in broadening the market's participation to the upside. Also, it allowed them to catch up to the other two technology leaders that seem to make new highs almost on a daily basis-Texas Instruments and Dell Computer. The technology surge was ignited by a report showing global shipments of personal computers rose by 16% in the first quarter, while U.S. shipments increased by 20% for the best quarterly gain since the fourth quarter of 1995. Indeed, the rally in these stocks and other secondary issues was so powerful by week's end that every measure of the market was higher for the year with the exception of the Russell 2000.
This week's powerful market action, coupled with confirmation in the bond market, makes us believe the lows seen a few weeks ago will not being taken out soon. Thus, we will return to the strategy of recommending bull put spreads with the S&P options, using strikes below recent lows to take advantage of our opinion that the April lows will hold.
Don Selkin
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