Red Hot July Stocks

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The temperatures in Alabama weren’t the only thing that was hot during the month of July. All of the major equity indexes were higher by around 7% for this past month, the biggest month investors have enjoyed since a year ago. Investors flip-flopped throughout July, buying stocks on strong earnings reports and then subsequently selling on weaker-than-expected economic numbers. For the sizzling month, the Dow rose 7.1 percent, its best showing since it rose 7.8 percent in July 2009. Meanwhile, both the S&P 500 and the Nasdaq Composite managed to tack on 6.9% in July, with the S&P 500 now resting just above the key 1,100 level. The Russell 2000 index of smaller-cap stocks moved higher by 6.8% for the month

However, stock prices lost momentum the last week of the month and were basically flat, after government data showed that economic growth had slowed to 2.4% last quarter from 3.7% earlier this year, and 5% at the end of 2009.The Dow Jones Industrial Average ended last week up 0.4%, to 10,466. The Standard & Poor’s 500 lost a point or 0.1% while the Nasdaq Composite Index fell 0.7%, to 2,255, and the Russell 2000 was flat. On a year-to-date basis, the Dow Jones Industrial Average is now slightly higher by 0.36% while the S&P 500 and the Nasdaq Composite are still to the negative, -1.21% and -0.64% respectively. The Russell 2000 continues to lead the major indexes, as it is in the black by 4.08%. July’s gains were fueled mainly by the fact that over 70% through the second earnings season, profits look to have grown 42% and profit margins are hitting nearly 10% which is a record, according to Standard & Poor’s. On the flip side, trading volumes have been extremely thing, hitting the daily turnover average just twice during the month. In addition, a robust economic recovery remains far from certain, with persistently high unemployment crimping consumption.

Still, July’s gains came in the face of a raft of pretty dismal economic data, a reflection perhaps of lowered investor expectations. The key driver of the market continues to be the story of earnings. Over half the S&P 500 corporations have reported (304 to be precise) and so far the season has been rather jolly with 75% beating bottom-line estimates and even 63% doing likewise on the revenue line – both above average (of 70% and 60%, respectively in recent quarters). It now looks like EPS growth is going to test +50% on a year-over-year basis, which is quite impressive. Thus the question remains as of late; why aren’t the equity markets reacting even better? After contemplating such at length, a few reasons might include the following: First, a lot of this good news was already priced in to begin with. Second, the second quarter is a bit like ancient history right now – guidance has not been that good with three companies providing downbeat assessments for the coming quarter for every one that had something positive to say about the near-term outlook. Over the long-term, that negative-positive ratio is generally closer to two-to-one than three-to-one.Third, analysts have stopped raising their estimates for the year – in fact, for every one that is doing so there is another one who is cutting forecasts. Fourth, while revenues have been above expectations, they are running at about one-fifth the pace of profit growth and as a result margins are hitting new highs. What happens when they begin to compress (especially with 80% of the incoming economic data disappointing over the past month)? Fifth, with the monetary and fiscal policy stimulus behind us, we can see what the economy looks like – back-to-back declines in retail sales, durable goods orders and shipments, and household employment. Not to mention consumer and producer prices. Thus, we enter the month of August with excellent backward-looking earnings numbers, but economic data which is slightly on the softer side. These facts along with continued volatility should make for an interesting last month of the summer! As to the bond market, treasury yields continued their slide southward last week, with the benchmark 10-year note yield dipping briefly below 2.90% Friday before ending at 2.91%, down seven basis points on the week. Thus, mortgage rates dropped to the lowest level on record for the fifth time in six weeks, making home buying and refinancing the most attractive in decades. Freddie Mac said that the average rate for 30 year-fixed loans this past week was 4.54 percent, down from 4.56 percent last week.That’s the lowest level since Freddie Mac began tracing rates in 1971. The 30-year bond yield moved back under the 4% mark, to just under 3.99%, a net decline of a basis point. On the shortest end of the maturity curve, the two-yield note yield also set another record low last week of just 0.539%, about a basis point below the previous mark. The two-year note yield, which reflects expectations about future monetary policy, came off after St. Louis Federal Reserve Bank President James Bullard published an article asserting the U.S. is closer to Japan-style deflation than at any time in recent history.

Investors will be looking forward to this week’s broad mix of earnings and macroeconomic releases. On Monday, the Department of Commerce releases its June construction spending report, which is expected to show a drop of 1%. Tuesday brings June personal income and spending reports which are slated to demonstrate milder growth of 0.2% and 0.1%, respectively. Wednesday kicks off with the first of a series of July jobs data, as the ADP employment report offers a look at private sector job growth.

Economists are looking for 30,000 jobs to be added to private sector payrolls, after growth of 13,000 in June, according to Briefing.com. By the end of the week, the labor market will dominate the spotlight. The Labor Department will give its weekly read on initial weekly jobless claims on Thursday before its much-anticipated July employment report on Friday. Economists expect the economy lost 116,000 non-farm payrolls in the month while the unemployment rate is expected to rise to 9.6% from 9.5% previously.

Sources: Barron’s, The Wall Street Journal, CNN, The New York Times, The Financial Times, Bespoke Investment Group, Econoday

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