Stocks soar as quarterly earnings reports better than feared

I think the secret is if you have a lot of stocks, some will do mediocre, some will do okay, and if one or two of them go up big time, you produce a fabulous result. And I think that’s the promise to some people. – Peter Lynch

Led by the technology-laden Nasdaq Composite Index, stocks posted impressive gains last week as first quarter corporate earnings have been better than expected, although expectations had been ratcheted down considerably. Not since March 2000 during the dot-com era and the early stages of the bursting of the technology bubble has the Nasdaq been in such rarified air. Friday’s close of 5,092 surpassed the previous closing high of 5,048 as technology companies such as Google, Microsoft and Amazon.com led the charge by posting positive earnings surprises. Additional stimulus measures announced by China also helped spur the rally in stocks. After contributing to some of the sell-off in stocks the previous week, China’s central bank lowered the reserve requirement ratio for all of its banks in an effort to combat slowing growth. The country also announced plans to open its market for clearing domestic bank card transactions, allowing companies such as Visa and MasterCard direct access to an almost $7 trillion market. Meanwhile, earnings continued to be mostly favorable compared to already reduced analyst estimates as about 75% of reporting companies have topped expectations. But the same cannot be said for revenue growth as sales have generally been weaker than anticipated and somewhat disappointing. Economic data released last week also tended to be on the soft side but investors were willing to look past that in the belief that the economy is likely to improve. In their minds, harsh winter weather, a surging dollar and falling oil prices were to blame for tepid GDP growth and below average earnings in the first quarter. The stock market is a forward-looking mechanism and the resilience it displayed last week lends credence to the notion that the economy is likely to improve.

Last Week

For the most part, the economic data was weaker than expected last week and certainly not a reason for the strength in stock prices. The one exception were existing home sales for March, which jumped over 6% as mortgage rates have remained low and hiring trends have stayed strong. New home sales in March, though, tumbled over 11% and registered the biggest drop in more than eighteen months. Unfortunately, it is new home sales that drive growth in the economy and not existing home sales. Although March durable goods orders rose 4%, the increase was mainly due to purchases of vehicles and aircraft, which are often very volatile. Excluding the transportation sector, durable goods actually fell modestly.

U.S. business investment plans fell for the seventh straight month, hurt by the strong dollar, which erodes corporate profits and lower energy prices, which reduce demand for equipment.

For the week, the Dow Jones Industrial Average climbed 1.4% to close at 18,080 while the S&P 500 Index jumped 1.8%% to close at 2,117, a new closing high. The Nasdaq Composite Index soared 3.3% to close at 5,092, an all-time high.

This Week

The Federal Reserve Open Market Committee (FOMC) meets this week and no changes are expected in monetary policy or interest rates. Investors will be watching closely to see if any guidance is given with regard to the timing of an increase in the federal funds rate.  The Commerce Department is also scheduled to release its first estimate of first quarter gross domestic product (GDP), which is expected to increase just 1%.

Other data of note include April consumer confidence and the Michigan sentiment index, both of which should be higher than the previous month and a possible good sign for consumer spending going forward. The April ISM Manufacturing Index should be above 50, indicating a still-expanding manufacturing sector, while March construction spending is expected to post a healthy increase.

Although last week was considered the heart of earnings season, this week’s lineup is almost as full. Among the most notable blue chip companies due to report include Apple and Automatic Data Processing in the technology sector, Merck, Pfizer and Bristol Myers Squibb in the health care sector, Exxon Mobil and Chevron in the energy sector, Ford Motor in the capital equipment sector, Visa, MasterCard and Time Warner in the consumer cyclical sector and General Dynamics in the defense sector.

Portfolio Strategy

On Friday of this week, we begin the month of May, which brings us to the old stock market saying that it’s time once again to “sell in May and go away”. The reason for this adage is that there is a belief among investors that the stock market tends to lag between the first of May and the end of October while registering its best performance from November through April. Based on historical data dating back to 1928, the S&P 500 Index increased an average of almost 2% in the May-October time period but climbed slightly more than 5% in the November-April time frame. In the current bull market, which began on March 9, 2009 and is now in its seventh year, an investor in the S&P 500 Index would have fared much worse if he had sold the index in May and gone away until November. Attempting to time the market in such a way is a fool’s game that is almost impossible to achieve with any regularity of success. Not only does an investor have to be right on when to exit the market, but he also must be right on when to re-enter the market. For these reasons, the best investment approach is to rely on asset allocation, research and analysis and make changes to allocations in accordance with an investor’s investment plans, risk tolerance and time horizon.