Stocks close modestly lower as earnings mostly better than feared

Bankers are people who lend their umbrella in good weather, but who want to have it back as soon as it starts raining. – Mark Twain

The first quarter earnings season was the primary focus for investors last week and the results were decidedly mixed, leading to only modest losses of less than a half percent for the major stock averages. Unlike the previous week that was dominated by the big money center banks, earnings reports last week broadened out to include companies from a diverse group of industries that comprise the S&P 500 Index. Among additional financial companies, Charles Schwab and Bank of America topped earnings expectations but Schwab reported a 30% decline in deposits from a year ago due to the fallout from the collapse of Silicon Valley Bank and Signature Bank as depositors sought the perceived safety of big banks. Two other previous highflyers whose stock prices have been volatile reported mixed results. Tesla slightly beat revenue expectations while earnings were in line with analysts’ estimates, but net income was 20% lower than a year ago as the company has prioritized growth over profitability as it cuts prices on its electric vehicles. Netflix also reported a mixed bag as the company topped earnings estimates and added more subscribers than expected but fell short of revenue estimates. But a number of blue-chip companies such as IBM, Johnson & Johnson, Abbott Labs and Procter & Gamble announced solid results that beat on both the top and bottom lines. While there is a long way to go in the earnings season, about 75% of S&P 500 companies that have reported so far have beaten analysts’ earnings estimates and the amount of the earnings beat has been nearly 5%. Despite this mostly positive start, investors still have plenty of worries about the economy, inflation, the Federal Reserve and interest rates, all of which could have significant bearing on corporate earnings for the balance of the year. The markets believe that the Fed will cut interest rates later in the year when the economy slows to avoid a recession while the Fed has signaled that rates will remain at the same level after another hike in May since the economy has proved to be resilient and inflation must be reduced to its target of 2%. Either way, the stock market is forward-looking and its relatively strong start to the year could be signaling that earnings going forward will not be as bad as feared.

Last Week

The Conference Board’s leading economic index fell more than expected in March as it portends a mild recession in mid-2023. Housing starts and existing home sales in March both declined more than expected as prospective buyers may have been put off by the economic uncertainty with the news of two failed banks. Weekly jobless claims totaled 245,000, an increase of 5,000 from the previous week and higher than the estimate of 240,000. The Federal Reserve’s Beige Book noted that lending volumes and loan demand have dropped for consumers and businesses following the two bank failures.

China’s GDP rose by 4.5% in the first quarter, the fastest growth since the first quarter of last year and retail sales also were much higher than forecast.

For the week, the Dow Jones Industrial Average fell 0.2% to close at 33,808 while the S&P 500 Index edged slightly lower by 0.1% to close at 4,133. The Nasdaq Composite Index declined 0.4% to close at 12,072.

This Week

First quarter GDP is forecast to have grown at an annual rate of 1.8% compared to a 2.6% increase in the fourth quarter and 2.1% for all of last year. March new home sales are expected to be less than in February and durable goods orders in March are expected to increase slightly. The core personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, is forecast to increase 4.5% in March from a year earlier, slightly less than the previous month.

Among the most prominent companies scheduled to report first quarter earnings this week are Coca-Cola, PepsiCo, McDonald’s, Visa, Mastercard, UPS, 3M, General Electric, General Motors, Boeing, Caterpillar, Honeywell, Alphabet, Microsoft, Texas Instruments, Meta Platforms, Amazon, Intel, Dow, Raytheon Technologies, General Dynamics, Amgen, Bristol Myers Squibb, Eli Lilly, Merck, Abbvie, Verizon, Chevron and Exxon Mobil.

Portfolio Strategy

Investors with a Balanced investment objective using a mix of 60% equities and 40% fixed income or bonds suffered last year as the Federal Reserve raised interest rates multiple times to combat high inflation. After starting the year at 1.5%, the yield on the 10-year Treasury rose to 3.83% at the end of 2022 and resulted in a loss of 13% in the Bloomberg U.S. Aggregate Bond Index, the second-worst year ever for the index. (Bond prices and yields move in opposite directions). With a negative total return of 18% in the S&P 500 Index, a portfolio of 60% equities and 40% bonds lost about 16% last year as stocks and bonds both cratered. Stocks are known for their volatility and wild swings, but bonds normally are designed to provide a ballast in a portfolio since they tend to remain stable and don’t fluctuate much in value. While some people now claim that such a portfolio allocation does not have a future, the performance this year has been looking much better. Through the end of the first quarter, a classic 60/40 portfolio has returned nearly 6% as the S&P 500 is up 7.5% and the Bloomberg U.S. Aggregate Bond Index has gained 3%.  With the Federal Reserve near the end of its tightening cycle and the federal funds rate at 4.75%-5%, bond yields are far more attractive now than they have been in a long time. The 2-year Treasury yield is currently 4.2% while the 10-year Treasury yield is 3.6% and investment grade corporate bonds rated BBB or better by Standard & Poor’s yield even more. With stock valuations more reasonable and bond yields once again generating decent income for investors, annualized returns for a 60/40 portfolio could approximate 6% or 7% a year longer-term.