Sleepy Hollow? If Rip VanWinkle had gone to sleep on the floor of the New York Stock Exchange on New Year’s Day, he might wake up today and wonder if anything happened while he was asleep. The Dow is almost exactly where it was at the beginning of the year, though of course it’s had a lot of ups and downs. The markets fell significantly in January, but February through June saw a steady rise. They set new records in late June.
Downs and ups. That suggests the markets fell and rose rather than rose and fell. That pattern continued last week, too. Several days, the markets opened lower. To use the Rip Van Winkle analogy: Traders would awaken from their slumber in New York, see what was going on in the Middle East and other troubled spots, and retreat. Then U.S. economic news or earnings reports would come out, and traders would decide things weren’t so bad, pushing the markets up. Though I should say that the trend not only for the week, but for the past month, has been in a negative direction.
Sanctions. Among other overseas stories, traders were watching reports Russia would impose a food import ban in retaliation for U.S. and European sanctions. But the ban could hurt Russians more than Americans, since Russia takes less than 1 percent of U.S. agricultural exports, and droughts in Russia have created spot food shortages there in recent years.
Good economic news. Here at home, the news was mostly positive. We got better-than-expected reports on the U.S. service sector. The Institute for Supply Management’s service index climbed to 58.7 in July, its highest reading since December 2005. Any number above 50 indicates growth, and the higher the number, the faster the growth. So July’s number means not only is the sector growing, that growth rate is accelerating. U.S. factory output also rose in June, by 1.1 percent.
Earnings reports remain positive. Earnings season is winding down. By law, most companies are supposed to report within 40 days of quarter-end. For a company with a June 30 quarter-end, that’s now. But not all companies have quarter-ends at the end of the calendar quarter. Some retailers, for example, push their year-ends back to account fully for holiday sales. So we’ll see retailers and a few others continuing to report for the next week or two. Luxury retailer Coachis one of those that reported last week, with revenue numbers better-than-expected. NewsCorp, which owns The Wall Street Journal and Fox News, beat earnings expectations. It’s important to note that most companies beat earnings expectations. They attempt to manage expectations precisely so they can. In fact, according to Thomson Reuters, about 63 percent of companies beat expectations each quarter. But this quarter, that percentage is closer to 70 percent, and that’s very strong.
Employment improves. The employment picture continues to improve. Thursday’s weekly employment report said new applications for unemployment benefits fell 14,000 to a healthy 289,000. The labor market is changing, and there are aspects of the employment picture that are still unhealthy. But this indicator, at least, is now back to pre-Great Recession levels.
So why are stock prices down? Last week, the answer mostly involved geopolitical risks, and that’s still an important reason. The situation in Iraq, Israel and Gaza, the Ebola outbreak in Africa, Russian economic sanctions—there are still a lot of reasons to be cautious. But there’s more to it than that. For one thing, the markets had risen to near record levels, and a correction is no surprise. It’s also important to note that the Federal Reserve has been artificially pumping up stock prices by pouring billions into the economy every month. Over the past six months, it’s been dialing back that artificial stimulus. That is causing a predictable sag in stock prices. Also, the January to June surge in stock prices drove the price-to-earnings ratio up to about 19, higher than historical norms of 15 or so. The good news is that this new batch of earnings reports is strong, and with the stock market pull-back, the price-to-earnings ratio is dropping again toward historical averages. So while we might see the markets going sideways for a while, the underlying performance of publicly traded companies does support current stock prices.
The week ahead. Earnings season is winding down. Sometimes that brings some surprises. And the reports from retailers are particularly instructive, since consumer spending is still the main driver in the economy. On Wednesday, the Commerce Department releases retail sales numbers for July, and of the hundreds of economic reports that get released each month, that’s one the markets watch and often react to. We should be watching, too.