Economic growth concerns send stocks tumbling

Don’t limit investing to the financial world. Invest something of yourself, and you will be richly rewarded. – Charles R. Schwab

A weaker than expected fourth quarter GDP report and continued global economic growth concerns sent stocks tumbling last week as the S&P 500 Index lost almost 3%. After posting 5% GDP growth in the third quarter last year, the economy slowed considerably with a growth rate of only 2.6% in the final quarter. Most economists had expected at least 3% growth. While consumer spending was much higher than forecast, business spending and capital expenditures recorded the largest decline since the second quarter of 2009. The slowdown in the economy could be short-lived as lower oil and gasoline prices should provide a tailwind for the economy. But these benefits may take some time before they have a real impact on economic growth. Although market leaders such as Apple Computer and Amazon.com reported strong quarterly earnings last week, other blue chip companies such as Caterpillar, Procter & Gamble, Du Pont and Pfizer reported weaker than expected profits and issued disappointing outlooks for the year. The main culprit for these multi-national companies has been the strong dollar, which is negatively affecting their sales overseas. Also, with economies in Europe and Japan weak and China’s economy losing momentum, demand for U.S. exports is not as strong as it might otherwise be. For this reason, the trade deficit in the fourth quarter was also wider than expected as exports were lower and imports were higher. With central banks around the globe now engaged in some form of quantitative easing, investors are beginning to ask themselves if they are running out of ammunition to promote economic growth. While these polices have the effect of suppressing bond yields and making stocks more attractive by comparison, it is less clear about their effectiveness in spurring growth.

Last Week

In addition to the weaker than expected GDP report, U.S. durable goods orders fell 3.4% in December due to a big decline in orders for commercial aircraft. Other economic data released last week was more upbeat. U.S. new home sales rose almost 12% in December and portends rising sales in 2015, helped by strong hiring trends in recent months, lower mortgage rates and more affordable homes. U.S. jobless claims dropped 43,000 to 265,000, the lowest level in almost 15 years, although the data might have been skewed by the Martin Luther King Jr. holiday as fewer claims were processed. Consumer confidence and sentiment readings were also near seven-year highs as optimism about the economy was pervasive.

In overseas news, the anti-austerity party in Greece won control of the seats in parliament, a vote that had been already discounted by the market but one that could have consequences down the road over Greece’s debt obligations.

For the week, the Dow Jones Industrial Average fell 2.9% to close at 17,164 while the S&P 500 Index dropped 2.8% to close at 1,994. The Nasdaq Composite Index declined 2.5% to close at 4,635.

This Week

In terms of economic data, the most important release will be the employment report on Friday. The forecast calls for the unemployment rate to remain unchanged at 5.6% and for the number of non-farm payrolls to increase by 230,000. While the January ISM manufacturing index should show continued healthy expansion in the manufacturing sector, factory orders in December are expected to decline by about 2%.

A steady stream of corporate earnings reports will continue this week, led by Sysco, Exxon Mobil, Walt Disney, Merck, General Motors, Allstate, Archer Daniels Midland, UPS and Automatic Data Processing.

Portfolio Strategy

The Federal Reserve issued its most recent policy statement this week and again emphasized that it will be patient with regard to raising interest rates. In the near-term, inflation is expected to fall further as oil prices, which have plunged almost 60% since June, will help keep prices relatively low. Longer-term, the Fed expects inflation to rise gradually to its 2% target, citing strong job gains, a lower unemployment rate and solid economic growth. Any future policy decisions will also be affected by international developments as well as ongoing economic data released by the government. While a strong and improving labor market suggest a mid-year rate hike, lack of inflationary pressures, weak economies overseas and slowing domestic growth augur for postponing an increase until the fall or even later. The bond market could be signaling that a rate hike has been pushed farther into the future as the 10-year Treasury yield ended January at a paltry 1.68%, down from 2.13% at year-end. The Federal Reserve can afford to be patient as it does not want to tighten too soon and run the risk of sending the U.S. economy into a recession. Earnings estimates have already been reduced for the year as falling oil prices, a soaring dollar and weak global demand will have a negative effect on corporate profit growth.