Positive start to earnings season fails to lift stocks

The man who begins to speculate in stocks with the intention of making a fortune usually goes broke, whereas the man who trades with a view of getting good interest on his money sometimes gets rich. – Charles Henry Dow

Despite mostly positive quarterly earnings reports, particularly from the banks, and some favorable economic data last week, the S&P 500 Index posted its biggest weekly loss since late May. This broad-based benchmark and the Nasdaq Composite Index each fell more than 1% while the Dow Jones Industrial Average fared somewhat better but still posted a slight loss. While the earnings season is still in its infancy, of the 15% of S&P 500 companies that have reported earnings, nearly 80% of them have beaten analysts’ estimates. Last week it was the banks that dominated the earnings parade and, for the most part, they did not disappoint. Among the financials that topped expectations were Citigroup, JP Morgan Chase, BankAmerica, Wells Fargo, Goldman Sachs and American Express. Two companies in the technology sector, Microsoft and IBM, also reported better than expected revenue and earnings as the former saw a surge in cloud revenue while the latter affirmed its earnings guidance for the year. The most encouraging piece of economic data last week was June retail sales, which were much better than forecast as they grew at the fastest pace in over ten years. It was the fourth consecutive strong month for retail sales as jobs remain plentiful, layoffs remain low, incomes are rising and interest rates are low. All of these favorable conditions lead to higher consumer confidence which, in turn, leads to increased consumer spending. Since consumer spending accounts for over two-thirds of gross domestic product (GDP), this bodes well for the economy going forward. While the trade war and Federal Reserve monetary policy took a back seat to quarterly earnings reports last week, they were still in the news. President Trump commented that there “is a long way to go” in finalizing a trade deal with China while Federal Reserve Bank of New York President John Williams said that the Fed needs to act quickly by cutting interest rates in order to quash signs of economic weakness. Both remarks seemed to be largely ignored by the markets as the focus was squarely on earnings last week and will continue to be in the weeks ahead.

Last Week

Regional manufacturing surveys can be very volatile from month to month but the Philadelphia Fed manufacturing index in July was much higher than expected and the highest reading in a year. The June leading economic indicators declined by the largest amount in three years and suggests that U.S. growth will slow in the second half of the year. The preliminary University of Michigan consumer sentiment index was slightly less than expected but better than in June and indicative of consumers that are still upbeat about the economy.

For the week, the Dow Jones Industrial Average shed 0.7% to close at 27,154 and the S&P 500 Index declined 1.2% to close at 2,976. The Nasdaq Composite Index fell 1.2% to close at 8,146.

This Week

June existing home sales are expected to remain flat while June new home sales are expected to increase slightly. Durable goods orders for June are forecast to rebound slightly after posting a small decline in May. The advance estimate for second quarter GDP is expected to slow to 1.8% after increasing 3.1% in the first quarter.

The European Central Bank (ECB) meets on Thursday and is expected to either cut its benchmark interest rate or signal a rate cut before its September meeting. The ECB has indicated that it needs to cut interest rates or implement another bond-buying program to stimulate slowing economic growth in the Eurozone.

Over one quarter of S&P 500 companies will report their earnings this week and the most notable of these include Texas Instruments, Facebook, Alphabet (Google), Amazon, Intel, United Technologies, Ford Motor, Caterpillar, Boeing, 3M, General Dynamics, Visa, Coca Cola, Starbucks, McDonald’s, Kimberly Clark, Bristol Myers Squibb and AT&T.

Portfolio Strategy

While it is still early in the earnings reporting season, the results so far have been encouraging. Major banks and financial companies monopolized the agenda last week and their earnings results were impressive, topping expectations across the board. This week will be the true litmus test for the market as all of the sectors of the S&P 500 will be represented. The market will also get a read on the economy as second quarter gross domestic product (GDP) will be released. Forecasts call for growth of just 1.8%, far less than the 3.1% growth in the first quarter. Weakness is also showing up in China, which reported 6.2% growth in the second quarter, the slowest pace in at least 27 years. Slowing growth has plagued Europe, too, and the European Central Bank (ECB) will probably increase its stimulus measures when it meets this week. With no trade agreement in sight and tariffs in place for the foreseeable future, companies are likely to be conservative and lower their earnings guidance going forward. This could create increased volatility for stocks as the S&P 500 trades at 18 times estimated earnings for 2019, above its historical norm. A Fed rate cut of 25 basis points may help, but it may already be priced into the market and a 50 basis point cut seems overly optimistic and not necessary at this time. (A basis point is one quarter of one percent). As long as the economy can keep expanding, albeit at a slower pace, and inflation and interest rates remain low, the stock market should be able to do well.