The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable. – Warren Buffett
The stock market reversed course last week and relinquished most of the gains from the previous week as economic data proved to be weaker than expected. With first quarter corporate earnings due to be released in just a few weeks, investors decided to take profits ahead of what could be a challenging earnings season. Slower than expected economic growth, a strong dollar and weak oil prices have caused concern that quarterly earnings will probably be disappointing, leading investors to question current stock valuations and equity performance going forward. Consensus forecasts are calling for a modest drop in earnings for the S&P 500 from a year ago, which would be the first year-over-year decline since the third quarter of 2012. Excluding the energy sector, whose earnings are expected to be very weak, the rest of the S&P 500 sectors should report mid-single digit earnings growth. While most of the overall anticipated weakness in earnings can be attributed to the strong dollar, plunging oil prices and the harsh winter weather, these factors have already been taken into account and earnings projections have been adjusted accordingly. Companies must merely beat these lowered estimates in order to claim success in their profit reports. Nonetheless, the fact that orders for durable goods dropped 1.4% in February spooked investors who had expected the number to be positive. A strong dollar and weak global demand likely caused the drop. It marked the third decline in orders in four months and if the volatile transportation sector was excluded, orders have declined now for five straight months. Although hiring has been strong, business investment has been weak, partly due to falling oil prices affecting the once booming energy sector and partly due to a lack of clarity from Washington with regard to trade and tax policies. With little in the way of economic news on tap until earnings season begins, the stock market may be in a holding pattern for the next few weeks.
Aside from the unexpected decline in durable goods orders, the other economic data released last week was mixed. The February consumer price index (CPI) rose 0.2%, the first increase in four months and the result of stabilizing oil prices and higher costs for food, energy, housing and automobiles. Excluding the often-volatile food and energy components, consumer inflation has risen 1.7% over the past twelve months. February U.S. new home sales were much better than expected, hitting a 7-year high despite a brutal winter. Weekly claims for jobless benefits fell more than expected while U.S. GDP was unrevised and stayed at 2.2% in the fourth quarter. Estimates for first quarter growth range from 0.9% to 1.4%.
Kraft Foods Group agreed to a merger with H.J. Heinz and will become the fifth largest food and beverage company in the world, with revenue of about $28 billion.
For the week, the Dow Jones Industrial Average lost 2.3% to close at 17,712 while the S&P 500 Index fell 2.2% to close at 2,061. The Nasdaq Composite Index dropped 2.7% to close at 4,891.
The most anticipated piece of economic news will come on Good Friday, a day that the markets are closed, in the form of the March employment report, which should show an increase of about 284,000 new jobs and an unemployment rate that remains unchanged at 5.5%. February construction spending and factory orders are expected to range from flat to a modest increase while the Chicago purchasing managers index (PMI) should rebound with a reading above 50, an indication that manufacturing continues to expand. Several Federal Reserve governors are also scheduled to give remarks and make speeches this week on the economy and monetary policy, including Fed Chair Janet Yellen.
Only a handful of companies are expected to report earnings this week, with Monsanto being the most prominent and lesser-known companies CarMax and Micron Technology also on the calendar.
The sharp losses suffered in the S&P 500 Index last week wiped out the previous week’s strong gains, resulting in a stock market that has been flat for the year. Fortunately, small and mid-cap stocks have performed better, with returns of about 3% and 4%, respectively, as they have not been affected as much as large cap stocks by the surging dollar. International equities have also surprised investors to the upside as the Dow Jones World ex-U.S. Index is up 3.4% for the year, with Europe leading the way with a total return of about 6%. Easy monetary policies in Japan coupled with the European Central Bank’s recent decision to implement a bond-buying program to suppress interest rates and stimulate growth have forced investors into equities by making fixed income securities less attractive. With the U.S. ready to embark on a plan to eventually raise interest rates, global central banks that have just begun the easing process stand to benefit. Despite the recent outperformance of European equities, stocks there are relatively cheap, trading at about 15.5 times forward earnings compared to a price-earnings ratio of 17 for U.S. stocks. Almost half of the total gross domestic product in euro zone countries depends on exports. The steady drop in the euro relative to the dollar has enabled European exports to be far more competitive on the world market and some experts believe that the euro could fall to a level on a par with the dollar or even lower. To reference an old adage, ‘don’t fight the Fed’ could also apply to other central banks that have adopted easy monetary policies designed to stimulate growth, which ultimately leads to higher corporate profits and stock prices.