Weekly Update

It was an active week for the stock market. The net drop of less than 1 point in the S&P belied the level of volatility and the heavy news calendar.

The most dramatic action came in response to Fed Chairman Bernanke's testimony on Thursday before the Joint Economic Committee of Congress. Before he spoke, the S&P was down 9 points on fears that he would reveal a more aggressive policy stance towards combating inflation. Instead, the market assessed his position as conciliatory. He said the Fed might pause in its current rate hike cycle soon even if the risks of an inflation pick-up persisted.

The S&P shot higher and was up 9 points in early afternoon for an 18 point turnaround. Then the market recognized that his comments reflected little change from the assessment after the release of the March FOMC minutes, and that a "pause" implies a subsequent rate hike. It doesn't signal the end of the rate hikes. The market sold off but still closed the day with a 4 point gain.

That offset the modest net decline that had occurred Monday through Wednesday. The weakness had largely been caused by a sense that the market was overbought and concerns about rising commodity prices. Also contributing was an increase in the 10-year note yield to 5.07% from 5.01% at the end of last week.

Friday was relatively sedate as the S&P 500 index and the bond market closed little changed.

There were plenty of earnings reports this week. The overall effect was to support the conclusion reached last week - that the first quarter was a good quarter, and that second quarter guidance was reasonably good as well.

The most noteworthy report, however, was negative. Microsoft reported earnings below expectations, warned of lower than expected profits for the current quarter, and said that long-term investment would have to increase to maintain growth. The stock was hammered on Friday after the report, and the Nasdaq lost 22 points that day. That accounted for the loss in the index for the week.

Industrial companies were noteworthy this past week for very good reports. Cummins, Caterpillar, Lockheed Martin, Northrup Grumman, US Steel, and Boeing all posted impressive numbers. Oil companies were less impressive. ExxonMobil reported weaker than expected profits even though they captured many headlines with their $8.4 billion in profits. Murphy Oil and Marathon Oil also missed.

The economic data was strong. First quarter real GDP was reported up at a 4.8% annual rate. March durable goods new orders were extremely strong at +6.1%. That followed a 3.4% February gain and shows high levels of business confidence. Surprisingly, both new and existing home sales in March were up. Strength in the Chicago April PMI index was an early indication that manufacturing remains strong.

Every aspect of the economy is strong. Consumer spending, job growth, business investment, and even housing - all are trending strong.

Inflation concerns are mixed. Oil closed the week near $72 a barrel. Bernanke expressed the necessary concern of a Fed Chairman towards all inflationary pressures, but certainly showed no signs of panic. It is possible that the strength in the economy leads to an increase in inflation in the months ahead, but there is great disagreement about the degree of any such problem.

The stock market has thus held up well through earnings season. The prospect of a likely hike in the fed funds rate at the May 10 FOMC meeting, and the possibility of a subsequent one later in the summer have not hurt the market. Neither has the continued backup in the 10-year note yield. Yet, the market now heads into the classic slow period. The May-October time frame has not produced any of the market gain the past fifty years. The summer doldrums could hit again.

We remain skeptical about the chances for significant gains in the months ahead with rising interest rates and building inflationary pressures. Yet, the strong economy and continued earnings growth help provide support to the market.