Stocks tumble on weak retail sales data, earnings

The underlying principles of sound investment should not alter from decade to decade, but application of these principles must be adapted to significant changes in the financial mechanisms and climate. – Benjamin Graham

All good things must come to an end. That was never more evident than last week as Wall Street’s winning streak of six consecutive weekly gains came to a screeching halt with the S&P 500 Index posting a loss of 3.6%. The steep drop in stock prices was primarily due to disappointing third quarter earnings from several retailers, declining oil prices and a weaker than expected October retail sales number. Ongoing anxiety among investors about the implications of a possible Federal Reserve interest rate hike in December also contributed to the weakness in stocks. The string of bad news began when Macy’s, the largest U.S. department store chain, reported a drop in its quarterly same-store sales, missing earnings estimates and cutting its full-year sales and profit forecast. On the heels of Macy’s surprisingly weak report were disappointing earnings and reduced guidance from Nordstrom. To add insult to injury, U.S. retail sales for October rose only 0.1%, less than expected as the normally strong automobile sales number fell after rising in September. Although the November consumer sentiment index released on Friday was well-above expectations, it was not high enough to dispel the fear that consumer spending is not as strong as first thought. With nearly two-thirds of U.S. gross domestic product (GDP) attributed to consumer spending, worries about slowing economic growth have resurfaced yet again. Falling commodity prices last week only seemed to confirm this weakness as the price of oil plunged 8% to close at just over $40 a barrel. Data continue to show a surplus of oil inventories and that coupled with tepid demand has weighed on oil prices. Following the strong October jobs report, it seemed like a foregone conclusion that the Federal Reserve would raise interest rates at its December meeting. This week’s lackluster U.S. retail sales data and continued concerns over slowing global growth make a Fed move less certain.

Last Week

Economic data released last week continue to show that inflation remains under control. U.S. import prices fell for the fourth straight month due mostly to lower oil prices and a stronger dollar that makes foreign goods less expensive. The producer price index (PPI) for October also dropped by 0.4% as the strong dollar and weak global demand have pressured prices. In the 12 months through October, the PPI has fallen 1.6%.

U.S. small business optimism was unchanged in October with no increase in hiring even as more business owners expect higher sales and more investment in the future. Jobless claims were flat last week and continue to be at historically low levels, consistent with a strengthening labor market.

For the week, the Dow Jones Industrial Average dropped 3.7% to close at 17,245 while the S&P 500 Index lost 3.6% to close at 2,023. The Nasdaq Composite Index declined 4.3% to close at 4,927.

This Week

The October consumer price index (CPI) is expected to show a modest increase while October industrial production is forecast to be flat. Housing starts in October should register numbers consistent with last month as the housing market continues its steady improvement and leading economic indicators for October are expected to show that the economy is growing at a moderate pace.

The Federal Reserve releases minutes from its October meeting and investors will look for clues about a possible interest rate hike in December. The Bank of Japan will also announce its decision with regard to interest rates and the expectation is for them to remain unchanged.

Retailers will dominate the release of third quarter corporate earnings reports this week as Wal-Mart Stores, Target, Home Depot, Lowe’s, TJX Company, Best Buy, Dicks Sporting Goods and Staples are all scheduled to report.

Portfolio Strategy

After the drubbing the stock market took last week, the S&P 500 Index is down 1.7% for the year based strictly on its change in price and not including dividends. If dividends are included in the calculation, the year-to-date total return for this benchmark is slightly positive at 0.04%. With stock market gains difficult to come by this year and equity price appreciation expected to be modest near-term, the role of dividends takes on much greater significance in the overall total return for stocks. Corporations have been able to increase dividends by almost 10% this year and are expected to increase dividend payouts next year by about 7%. The reason for this increased generosity has been strong corporate balance sheets that have also allowed companies to buy back their stock, albeit at a slower pace than in the past. With the stock market trading slightly above its historical long-term average, it’s important that investors emphasize companies that have a history of increasing their dividend. Interest rates are probably headed higher and although the process of normalizing rates should be gradual, this scenario is unlikely to produce an expansion of price earnings ratios for stocks. Under these circumstances, individual stocks, exchange traded funds (ETFs) or equity mutual funds with above-average dividend yields and dividend growth prospects can provide almost half of the expected total return if those returns are expected to be only mid-single digits.