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Dow falls for 8th straight week as high inflation takes toll on earnings

What to do when the market goes down? Read opinions of the investment gurus who are quoted in the Wall Street Journal. And, as you read, laugh. We all know that the pundits can’t predict short-term market movements. Yet there they are, desperately trying to sound intelligent when they really haven’t got a clue. – Jonathan Clements 

The stock market’s losing streak continued last week as the Dow Jones Industrial Average fell for the eighth consecutive week while the S&P 500 Index and the Nasdaq Composite Index declined for the seventh straight week as there was evidence that soaring inflation was taking a toll on corporate earnings. The first sign of trouble occurred on Tuesday when retail giant Walmart missed earnings estimates and lowered its profit expectations even though it raised its sales outlook for the year. The real shocker, though, happened the next day when Target reported first quarter earnings that were much lower than expected due to higher costs for fuel and increased labor costs. It appeared that shoppers were finally beginning to feel the effects of high inflation as consumer demand for discretionary items was constrained. Target’s stock plunged more than 25% after the announcement and the negative sentiment spread to the entire market as the S&P 500 Index dropped 4% that day.  Federal Reserve Chairman Jerome Powell also may have unnerved investors when he commented last week that the Fed will not hesitate to keep raising interest rates until inflation recedes closer to its 2% target. While he said that the labor market remains strong with low unemployment and higher wages, he was also hopeful that the Fed could achieve a soft landing by bringing down inflation without drastically slowing the economy or causing a recession. This goal may be attainable, but right now investors remain highly skeptical as concerns have risen over slowing U.S. economic growth, higher interest rates and the effects of high inflation on corporate earnings. Stocks have been repriced and equity valuations adjusted downward to reflect both higher inflation and the Federal Reserve tightening cycle, which has just begun. The stock market is in the process of bottoming and the fact that investor sentiment is overwhelmingly negative could mean that a bottom might be near. With the Nasdaq already in a bear market and the S&P 500 down nearly 20% year-to-date, the stock market is approaching a level that historically has indicated growth concerns have been priced in.

Last Week

Despite weak earnings results from some of the major retailers last week, retail sales in April were up nearly 1% and rose for the fourth straight month, providing evidence that the consumer was holding up well in this inflationary environment. Leading economic indicators in April fell and were less than forecast, reflecting a drop in consumer confidence and a decline in residential building permits amid rising interest rates. Existing home sales in April fell to their lowest level since the Covid pandemic began due to higher mortgage rates and tight supply.  Weekly jobless claims rose to 218,000, an increase of 21,000 from the previous week, and higher than expected. A bright spot was April industrial production, which rose twice as much as expected.

For the week, the Dow Jones Industrial Average fell 2.9% to close at 31,261while the S&P 500 Index declined 3.1% to close at 3,901. The Nasdaq Composite Index dropped 3.8% to close at 11,354.

This Week

April durable goods orders are expected to increase moderately on a par with March orders while new home sales in April are forecast to be slightly less than last month. The second estimate of first quarter GDP is expected to show a decline of 1.4% and S&P Global will release its manufacturing and services sector indexes for May, both of which are expected to show continued healthy expansion.

The Federal Open Market Committee (FOMC) will release minutes from its May monetary policy meeting.

This will be another busy week for retail earnings as Costco Wholesale, Macy’s, Best Buy, Dick’s Sporting Goods, Nordstrom, Gap, Burlington Stores, Dollar Tree and Dollar General are scheduled to report. Other notable companies on the agenda include Dell Technologies, Autodesk, Nvidia, Zoom Video Communications, Agilent Technologies, Advance Auto Parts, Toll Brothers, Medtronic, Bank of Montreal and Toronto Dominion Bank.

Portfolio Strategy

This week could be another volatile one for the stock market as there are a slew of retailers that are scheduled to report their quarterly earnings. Ordinarily, investors would not be worried about these results but after last week’s disappointing earnings from both Walmart and Target, there is ample reason for investors to be wary. The huge earnings miss from Target was the primary catalyst for the plunge in the stock market on Wednesday as retailers face higher costs for fuel and labor which depress profit margins. The high inflation is causing consumers to spend more on essentials such as gasoline and food, which leaves less money to be spent on discretionary items. The personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, will also be released on Friday and will give the Fed important data on prices as well as information on consumer spending and income. The consumer price index (CPI) in April was slightly less than in March, but it is still near the highest level in more than 40 years. The Fed raised the federal funds rate by a half-percent this month and is expected to increase it again in June and July by 50 basis points (a basis point is one hundredth of one percent) each time. After that, the Federal Reserve is likely to return to 25 basis point hikes and by year-end, the federal funds rate could be as high as 2.75% or 3.00%. These increases could be a headwind for the stock market and problematic for bonds as higher interest rates mean lower bond prices. (Bond prices and yields move in opposite directions). The Federal Open Market Committee (FOMC) also releases minutes this week from its last monetary policy meeting, which could give investors clues as to the Fed’s current thinking and its intentions going forward.