Stocks fall despite strong earnings as Covid-19 cases rise

Based on my own personal experience – both as an investor in recent years and an expert witness in years past – rarely do more than three or four variables really count. Everything else is noise. – Martin Whitman, American investment adviser and veteran value investor

Both the S&P 500 Index and the Dow Jones Industrial Average posted modest losses last week in the face of a rising number of Covid-19 cases and a lack of meaningful progress in the ongoing stimulus talks. The technology-heavy Nasdaq Composite Index was the biggest loser with a drop of over 1% as its four-week winning streak came to an end. Although the market has received encouraging news on the prospects for a vaccine and the Federal Reserve remains accommodative, no passage of another economic relief package could spell trouble for the economy and its ability to recover. There remain many important, unresolved issues between Treasury Secretary Steven Mnuchin and House Speaker Nancy Pelosi in their efforts to reach a deal. Unfortunately, even if an agreement is reached, it is unlikely that it would pass before Election Day.  Concerns that there would be a second wave of the coronavirus in the fall also became a reality as some 40 states saw increased case numbers with a rise in hospitalizations. Nevertheless, earnings season continued to surprise investors on the upside with nearly 85% of 135 companies reporting better than expected earnings. Even more impressive was the fact that the amount that companies exceeded analysts’ forecasts was five times greater than the long-term average. The Federal Reserve’s Beige Book, which summarizes the current economic conditions across the country, also painted a favorable picture. It said that economic growth had increased at a modest pace in all of its 12 districts, with manufacturing showing strength and residential housing markets showing strong demand for new and existing homes. Consumer spending growth also remained positive as employment data showed improvement and inflation remained relatively low. Despite worrisome trends of the coronavirus and no stimulus agreement, positive economic data and strong quarterly earnings should continue to support the market over the near-term.

Last Week

For the most part, the economic data last week was better than expected, particularly as it relates to the housing sector. The National Association of Home Builders (NAHB)/Wells Fargo Housing Market Index rose to a record high for the second month in a row as record-low interest rates are keeping demand strong. Existing home sales rose over 9% and beat expectations as low rates were giving buyers more purchasing power. Demand was so strong that the inventory of homes for sale fell, causing home prices to rise. Leading economic indicators rose modestly in September and were lower than in the previous two months and weekly jobless claims were 787,000, far less than expected and the lowest level since March 14^th.  Preliminary manufacturing and services sector data for October were both solidly in expansion territory as confidence among businesses is steadily improving.

For the week, the Dow Jones Industrial Average fell 0.9% to 28,335 while the S&P 500 Index lost 0.5% to close at 3,465. The Nasdaq Composite Index declined 1.1% to close at 11,548.

This Week

Third quarter gross domestic product (GDP) is expected to show a record expansion at a 30% annualized rate after contracting at a 31.4% rate in the second quarter. New home sales in September are forecast to be in line with those reported in August and be at the highest level since 2006. Durable goods orders in September are expected to rise only modestly consistent with the increase last month. The October Consumer Confidence Index is forecast to approximate September’s high reading, but it will still be below pre-pandemic levels.

The most prominent companies scheduled to report third quarter earnings this week are Apple, Facebook, Amazon, Alphabet (Google), Microsoft, Advanced Micro Devices, 3M, GE, Caterpillar, Boeing, Ford Motor, Honeywell, DuPont, Eli Lilly, Merck, Pfizer, Amgen, Visa, Mastercard, Comcast, Kraft Heinz, Chevron and Exxon Mobil.

Portfolio Strategy

Unlike the first week of earnings season that was dominated by financials, last week’s earnings results came from a diverse group of companies that was more representative of the broad-based S&P 500 Index. But like the first week’s results, quarterly corporate profits the past week were again mostly better than expected but largely ignored by investors. The majority of S&P 500 companies have not only beaten analysts’ earnings estimates but forecasted revenue projections as well. Forward earnings guidance has also been decidedly positive, too. Instead of focusing on the fundamentals, though, investors have been fixated on the lack of another economic relief package, the increase in Covid-19 cases and the looming presidential election. This week may be different, however, as roughly a third or nearly 170 S&P 500 companies are scheduled to report their earnings. It is the busiest week of the earnings season and includes blue chips from all sectors of the economy, including the biggest technology companies such as Apple, Alphabet (Google), Amazon, Facebook and Microsoft. Normally, the most significant and relevant story this week would be third quarter earnings, especially given the number of companies reporting and the impact these companies have on the overall market. But this year is anything but normal and the uncertainty over the virus, the stimulus deal and the election will also be on investors’ minds and only add to the volatility.