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PRUDENTIAL SECURITIES, INC.
One New York Plaza, New York, New York
(October 6, 1997) STOCK INDICES: After watching the broader market make new highs, the Dow Jones Industrial Average and the S&P 500 finally staged their own strong advance and broke out of the trading ranges in which they had been languishing for several weeks. The S&P finally joined other market measures in all-time high territory, leaving the Dow as the only index that did not achieve best-ever levels last week. Still, it put in an excellent showing for the week, gaining 116 points. The Dow had been ahead by 220 points for the week at the height of its gain early Friday, but a late sell-off caused it to give back what had been an intra-day gain of as much as 117 points. The S&P advanced by 20 points for the week while all of the broader measures made new all-time highs on an almost daily basis. Even the advance/decline line, which is the truest measure of market performance, made new highs for the year despite the Dow's struggles.
The primary catalyst for last week's excellent stock market showing was the bond market, where a series of reports continued to show that the economy was indeed back to the “Goldilocks” pattern of moderate growth with no signs of inflation. Despite several individual stock sell-offs due to poor earnings or the pre-announcement of poor earnings, the market remained optimistic that once the earnings announcement period begins in earnest this week, the results will at least meet market expectations, i.e., growth of about 12% for the third quarter.
The economic numbers released last week could not have been better, as they showed an economy that was starting to moderate despite fears that tight labor markets could potentially ignite inflationary pressures. The non-farm payroll report dissipated that notion for the time being, but Friday's spike in oil prices due to potential Mideast tensions caused bond yields to back off from their best levels of the week. Friday's sell-off erased virtually all of the bond market's gains generated by the jobs report. After the report that morning, the 30-year yield had fallen to 6.17%, which was the lowest since February 1996; by day's end, it was virtually unchanged, but still matching the year's low with a yield of 6.29%. The reports that enabled the bonds to fall to this level included the following:
–The non-farms payroll report was extremely friendly for bonds, as it showed moderation in all categories--the increase of 215,000 jobs was well below market expectations for an increase of 325,000. In addition, the August number was revised downward to 40,000 from 49,000. The unemployment rate remained at 4.9% against expectations for a drop to 4.8%; average hourly earnings rose by 3% instead of the 4% that was forecast; and the length of the average hourly work week fell to 34.5 hours from 34.7 hours.
–August personal income rose 0.6% and August personal spending rose 0.3%.
–August new home sales fell by 2.2%.
–September consumer confidence rose to 128.6 from 127.6.
–The Chicago Purchasing Manager's Survey fell to 61.2 in September from 64.3 in August.
–The August index of leading economic indicators rose 0.2%.
–The Johnson-Redbook survey of weekly chain store sales fell by 0.8%.
–The Federal Open Market Committee left interest rates unchanged at its September 30 meeting. It has been six months since the Fed raised the federal funds rate to 5.5% from 5.26% in March.
–The September National Association of Purchasing Manager's Survey fell to 54.2 from 56.8, and supplier deliveries and new orders dropped as well.
–August construction spending fell 0.3%.
–Chrysler and Toyota automotive sales fell by 14% in September.
–Weekly jobless claims rose by 1,000 to 308,000.
–August factory orders rose 1.3%.
–The Economic Cycle Research Institute (ECRI) future inflation gauge fell to 110.3 in September from 110.9 in August.
In a sense, the news was almost “too good to be true” for bonds, and after a huge rally of almost two full points on Friday due to the non-farm payroll report, surging crude oil prices pressured prices to end unchanged for the session. (Iran and Iraq staged military confrontations over the no-fly zone in Iraq, and a U.S. naval vessel was dispatched to the area.) After such a large gain, its complete disappearance had to be construed as a “disappointment.” In turn, the bond market mood spilled over into stocks, as an intra-day gain of 117 Dow points turned into an afternoon loss of 71 points, before another late comeback resulted in a closing gain of 11 points for the session. Every other measure of the broader market closed in all-time high territory, continuing the trend that has been underway during the second half of the year.
The Russell 2000 index of smaller stocks has now closed in record territory for 23 of the last 29 sessions. This follows the pattern set during the third quarter, when it gained 14%, more than half of its year-to-date gain of 27%. The NASDAQ was the main winner during the quarter just ended, with a 16% advance, and it is now 32% ahead in 1997. The S&P 500 gained 7% during the third quarter and is up 30% for the year. The Dow moved up 3.5% during the quarter just ended for a yearly gain of 26%. Despite its lag during the third quarter, the Dow recorded its 11th consecutive quarterly gain, a record for the post-war period. The previous record was 10 straight quarterly advances attained during the 1950's.
Now that every market measure but the Dow has attained record heights, we believe that the stock market will be able to maintain its current levels and could possibly move higher. Thus, 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. We will start recommending positions with the November options this week as conditions dictate.
Don Selkin
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