Strong earnings lift S&P 500 higher, but Facebook’s weak outlook hurts tech sector

Anything can happen in stock markets and you ought to conduct your affairs so that if the most extraordinary events happen, that you’re still around to play the next day. – Warren Buffett

In the busiest week of the second quarter earnings season, the major stock averages closed mixed as the Dow Jones Industrial Average and the S&P 500 Index were higher while the Nasdaq Composite Index dropped more than 1%. By week’s end, over 50% of S&P 500 companies had reported earnings and nearly 80% of them had topped analysts’ estimates. Stronger than expected earnings and favorable developments on trade and tariffs powered stocks to significant gains through Wednesday’s close. President Trump and European Commission President Jean-Claude Juncker met to discuss improving transatlantic trade relations and reached an agreement in principle to avert a trade war and lower tariffs. The Europeans agreed to reduce industrial tariffs and import more U.S. soybeans and natural gas and were amenable to reaching a reciprocal trade relationship with the U.S. This positive trade news coupled with Treasury Secretary Steven Mnuchin’s comment that a deal on the North American Free Trade Agreement (NAFTA) was coming soon lifted a cloud hanging over the stock market. Trade tensions had eased considerably with these announcements and investors turned their attention back to quarterly earnings, which had been excellent. All that changed on Thursday, though, after Facebook missed its revenue target and reported that its global daily active users were much less than expected. The company also announced that its revenue growth for this year would slow from last year, causing the stock to tumble nearly 20% and setting a record for the biggest one-day loss of market capitalization in history. Technology stocks, particularly the high fliers such as Apple, Alphabet (Google), Netflix and Amazon, all sold off in sympathy as investors worried that these stocks were priced for perfection and may have gotten ahead of themselves, too. Growth stocks have had a tremendous run but valuations are stretched and expectations may have to come down before these stocks can resume their upward climb.

Last Week

There was a plethora of economic data last week, the most important of which was second quarter gross domestic product (GDP), which jumped 4.1% for the best growth in nearly 4 years. June durable goods orders were also strong as demand for transportation equipment rebounded and there was solid growth in business spending on equipment. New and existing home sales in June fell more than expected and fewer homes for sale were keeping home prices elevated. Rising building material costs and a shortage of land and labor were also putting a squeeze on the supply of homes. The University of Michigan consumer sentiment index in July fell slightly due to fears over the impact of tariffs on the economy but it still remains at a historically high level.

For the week, the Dow Jones Industrial Average rose 1.6% to close at 25,451 and the S&P 500 Index added 0.6% to close at 2,818. The Nasdaq Composite Index declined 1.1% to close at 7,737.

This Week

The July employment report is expected to show that 194,000 new jobs were added to the U.S. economy and that the unemployment rate fell slightly to 3.9% from 4.0% in June. June construction spending and factory orders are forecast to show modest increases while the ISM manufacturing and non-manufacturing or services sector indices and the July Chicago Purchasing Manager’s Index (PMI) are forecast to show healthy expansion, with levels at or above 60. A reading of 50 or above indicates expansion.

The Federal Reserve meets on Wednesday and is expected to leave interest rates unchanged at 1.75% to 2%. The Bank of England also meets this week and is expected to raise its rate to 0.75%.

Among the most notable companies scheduled to report earnings this week are Caterpillar, Procter & Gamble, Archer Daniels Midland, Kellogg, Pfizer, Apple, Automatic Data Processing, MetLife, Allstate, Berkshire Hathaway, Duke Energy, Consolidated Edison and Devon Energy.

Portfolio Strategy

Although the GDP number of 4.1% growth in the second quarter was the best since the third quarter of 2014, the markets actually may have been disappointed that it wasn’t higher. This disappointment could also have caused the weakness in stocks on Friday. While the GDP growth figure was in line with consensus estimates, it fell considerably short of the highest estimates, which were above 5%. First quarter GDP was also revised higher from 2% to 2.2%, making the average for the first half of the year 3.2%. Strong consumer and business spending, increased government spending and a surge in exports were responsible for the faster growth in the second quarter. Whether or not this level of growth is sustainable is another question. The high level of consumption during the quarter probably will not be repeated and exports of agricultural products such as soybeans may have been pulled forward to avoid the implementation of new tariffs. However, inventories fell during the quarter and were a drag on growth, something that will reverse itself in subsequent quarters as inventories are replenished. All in all, it was an excellent quarter and one that could lay the foundation for 3% plus economic growth for the full year.