S&P 500 advances despite weak technology earnings

Generally, the greater the stigma or revulsion, the better the bargain. –  Seth Klarman, American billionaire who founded one of the world’s largest hedge funds

The S&P 500 Index came with 1% of eclipsing its all-time high set in May 2015 before fading later in the week on disappointing earnings from Alphabet (parent company of Google) and Microsoft. Alphabet missed analysts’ estimates on both the top and bottom lines while Microsoft posted earnings slightly below estimates and issued weaker than expected guidance. Earlier in the week, IBM also provided disappointing guidance and Intel announced that it would cut 12,000 jobs due to weak personal computer demand. Stocks still managed to post modest gains as U.S. economic data was mixed and first quarter earnings generally exceeded lowered estimates despite weakness in the technology sector. Earnings reports have been lackluster, down about 7% from a year ago, but everything is relative and compared to expectations, the results have been a pleasant surprise. Another bullish sign has been the breadth of the market or the number of stocks that are advancing compared to the number of stocks that are declining. This trend is usually a positive signal that a rally still has legs as there is greater participation among a broader range of stocks. The vast majority of stocks are also above their 200-day moving average, another bullish indicator. Nevertheless, for the stock market to continue its march higher, corporations will have to deliver profit growth, something that investors might be sensing in the second half of the year. The market certainly didn’t get much help from the economic data last week as conflicting reports probably did more to confuse and confound investors. Housing data was mixed, jobless claims continued to fall and oil prices appeared to be stabilizing, albeit at higher prices as crude oil ended the week at nearly $44 a barrel. The dollar also weakened again last week and that, coupled with a better performing high yield bond market, could lay the foundation for another attempt by the stock market at all-time highs.

Last Week

Housing starts fell almost 9% in March, the lowest level since October, and building permits also plunged to the lowest level since March of last year. Existing home sales in March, however, surged nearly 6%, much better than expected, as strong jobs data has helped support the housing market. Jobless claims fell 6,000 to 247,000 last week, the lowest level in 42 years, a healthy sign that usually is associated with strong employment growth. Leading economic indicators rose slightly in March, suggesting only modest growth this year.

European Central Bank President Mario Draghi commented last week that he expects interest rates to remain at or below current levels for an extended period of time.

For the week, the Dow Jones Industrial Average added 0.6% to close at 18,003 while the S&P 500 Index gained 0.5% to close at 2,091. The Nasdaq Composite Index fell 0.7% to close at 4,906 as technology stocks weighed on performance.

This Week

March durable goods orders are expected to post modest gains after falling in February while March new home sales should increase modestly over the previous month’s number. The initial estimate for first quarter gross domestic product (GDP) is forecast to be less than 1%, with estimates as low as 0.4% and as high as 0.9%. The April Chicago purchasing managers index (PMI) is expected to be 53.0, comfortably above 50, which is expansionary.

The Federal Reserve Open Market Committee (FOMC) meeting is on Tuesday and Wednesday and most analysts expect that the Fed will leave interest rates unchanged, although what comments the Fed makes with regard to its decision could have an influence on the markets. The Bank of Japan also is expected to make an announcement about monetary policy and it’s possible that additional stimulus measures could be implemented.

It promises to be another busy week of first quarter earnings reports as AT&T, Boeing, Apple, Facebook, Bristol Myers Squibb, Eli Lilly, Amgen, Procter & Gamble, 3M, Du Pont, United Parcel Service, Ford Motor, Exxon Mobil, Chevron and Berkshire Hathaway are just a few of the companies scheduled to report.

Portfolio Strategy

Only about 20% of first quarter earnings reports have been released so far and while the results have been down compared to prior year results, they have mostly exceeded expectations that were reduced early in the year. After starting the year at $125 for earnings of companies in the S&P 500 for 2016, the estimate was slashed to between $115 and $118 during the correction in January and February. But with a rebound in oil prices, a weaker dollar, accommodative foreign central bank policies and the likelihood of fewer interest rate hikes by the Federal Reserve this year, the outlook for stocks has become brighter. A positive tone to earnings season in the first two weeks has caused analysts to raise their estimates to between $118 and $123 for the year. With the year almost a third over, earnings estimates for 2017 are coming into view and early forecasts call for $130 based on an improving outlook for growth beginning in the second half of the year. If these earnings estimates prove correct, the S&P 500 is currently trading at 17 times 2016 earnings and 16 times 2017 earnings, making stocks a little rich relative to historical valuations. Provided interest rates remain at these low levels and profit growth returns, a case could be made that stocks are reasonably valued. But there is no guarantee that earnings will reach the level that analysts have forecast for either 2016 or 2017.