wmeubank@ocp.kcmo.com
PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(September 29, 1997) STOCK INDEXES: All of last week's “noise” from the swings and sways of various stocks and indexes was for naught, as both the Dow Industrial Average and the S&P 500 ended the week virtually unchanged from the previous week. Just to show how calm it was, there was not a single session last week in which the Dow moved 1%, despite its record for moving that much on 29% of this year's trading days (up to last week). For the week, the Dow rose a mere 5 points while the S&P 500 was 5 points lower. Even the Russell 2000 Index of smaller stocks, which has been the market hero of late by scoring record highs for the better part of the last three weeks, ended with just a small gain of 1.5 points. To complete the “going nowhere” scenario, December T-bond futures ended the week virtually unchanged, with the yield at 6.36%. It appears that end-of-quarter portfolio adjustments, combined with a watchful, waiting attitude as the third-quarter earnings period approaches, has kept the market on a steady course.
The economic numbers released last week were not earthshaking. That could change this week with Tuesday's release of Leading Economic Indicators and the monthly nonfarms payroll report on Friday, October 3. Last week's reports included:
–The Johnson-Redbook survey of weekly chain store sales fell by 0.8%.
–The Treasury auction of two-year and five-year notes came in more or less in line with market expectations, at 5.794% and 5.960%, respectively.
–August durable goods orders rose a strong 2.7%, which was the largest increase since February. However, electronics goods orders soared by 28.4%; excluding this component, durable goods actually declined by 1.7%.
197>August existing home sales rose by 3.3%, which was the largest increase since December 1993.
–Weekly jobless claims fell by 2,000 to 306,000.
–Final second-quarter GDP growth was revised downward to 3.3% from 3.6%, but the price deflator rose slightly to 1.8% from 1.5%.
–The University of Michigan Consumer Sentiment numbers for early September were revised downward slightly to 106 from 106.8.
Federal Reserve Board Governor Susan Phillips said that spending indicators have strengthened and factory utilization was “a bit taut.” Although prices are rising at a subdued pace, “We cannot let our guard down and declare victory against the battle of inflation,” she added. These statements appear to be more of the same rhetoric that we have heard for months as the Fed has stood pat since the last interest rate increase in March. Thus, it seems almost a certainty that the Fed will do nothing at its meeting on Tuesday, September 30.
Of more significance to future stock market behavior will be third-quarter earnings. Despite the early warnings from some of the large consumer stocks that earnings will fall short of expectations, U.S. companies overall are expected to post strong profit growth not only versus last year's third-quarter levels but also this year's second quarter.
The consensus is that the companies that comprise the S&P 500 will earn $11.35 per share during the second quarter, a return about 12% higher than year-ago levels. This achievement also would mark the 21st consecutive quarter in which earnings have grown by at least 10%, a factor that has been the primary underlying support for the bull market. This sort of increase is possible despite the aforementioned shortfalls because adverse effects on earnings have been specific to individual companies (e.g., from foreign currency fluctuations) rather than to an entire industry.
Earnings growth for stocks in the Russell 2000 Index is expected to be even more impressive, with gains of 28% from year-ago levels. Moreover, the fourth-quarter discrepancy is projected to widen further, with the Russell showing potential gains of 36% while the S&P 500 could see profit increases of 14%. In fact, the market might be anticipating just such an earnings pattern, as the Dow has underperformed the smaller companies during the second half of the year. Since July 1, the Dow has risen only 4% and the S&P 500 is up just about 8%. Meanwhile, the Russell 2000 Index has gained about 13% while the NASDAQ is ahead by about 16%. If these earnings projections hold, the trend for smaller stocks to outperform larger ones is likely to continue for the remainder of the year. In the first half of the year, the situation was completely opposite, with the blue-chips leading the way. For the year-to-date, all of the major measures are up just about the same amount, with a net nominal nod toward the smaller issues.
Despite the overall averages staying pat this past week, there was certainly a lot of action in individual issues, both up and down. Stocks that moved lower were primarily affected by earnings shortfalls, either pre-announced or realized.
Many issues rallied last week in response to this year's ongoing record pace of mergers and acquisitions.
Several stocks found strength to rally beyond their initial public offering price on their first day of public trading.
Because we believe the Dow and S&P should be able to maintain their broad trading ranges for the near future, if not exhibit a slight upward bias, we have entered into a bull put spread with the October S&P options–buying the 680 put and selling the 750 put at a 30- point credit. Assuming the market can sustain itself at current levels or above, we will add other positions as conditions dictate.
Don Selkin
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