Index investing outperforms active management year after year. – Jim Rogers
The S&P 500 Index posted a modest loss for the third consecutive week as several major retailers reported disappointing quarterly sales and earnings and a stronger dollar weighed on commodity prices. The Dow Jones Industrial Average, which is comprised of large, multi-national companies with significant overseas sales, fell more than 1% as their sales were more affected by the strength in the greenback. Recent tepid growth in first quarter gross domestic product (GDP) was reflected in the earnings reports of Macy’s, Kohl’s, Nordstrom and J.C. Penney as they all reported weaker than expected sales and offered guidance for the rest of the year that was underwhelming. Since consumer spending accounts for about two-thirds of GDP, these poor results coupled with cautious outlooks for the balance of the year are a worrisome sign. What made the sales and earnings weakness of these major retailers even more puzzling was the strong retail sales data for April. Retail sales jumped 1.3% last month, much better than expected and the biggest gain in a year. Automobile sales were particularly strong and internet retailers such as Amazon saw sales soar even as brick and mortar retailers struggled. One explanation for the discrepancy is that the retail sales data was in the past and only measured one month while the guidance issued by the retailers was for the future. Investors will be able to get a better read on the health of the retail sector this week as the earnings calendar is dominated by retail companies. With global growth concerns in China, Europe and Japan and current weakness in the U.S., it is imperative that economic growth accelerates for corporate earnings to improve and for stocks to move higher. Given the importance of consumer spending to GDP growth, much of the heavy lifting may be on the backs of consumers.
Consumer sentiment in May reached its highest level since June 2015 as the jobs outlook has improved and inflation and interest rates continue to be low. One would infer based on this data that the outlook for consumer spending would be positive. Weekly jobless claims, though, rose to 294,000, the highest level in more than a year, but remain at levels associated with a strong labor market. The number of available jobs rose to an 8-month high in March, with the largest number of open jobs in the professional and business sector.
The producer price index (PPI) in April edged slightly higher and wholesale prices remain unchanged in the past 12 months. U.S. import prices, on the other hand, rose 0.3% in April, reflecting an increase in oil prices and a weaker dollar. Most economists expect inflation to pick up but modest U.S. growth and weak global growth are likely to keep inflation low.
For the week, the Dow Jones Industrial Average lost 1.2% to close at 17,535 while the S&P 500 Index fell 0.5% to close at 2,046. The Nasdaq Composite Index declined 0.4% to close at 4,717.
The consumer price index (CPI) for April is expected to increase 0.4% after posting only a slight increase last month. April housing starts and existing home sales should both be consistent with a strong housing sector and higher than the totals in March. Industrial production for April should also be a pleasant surprise after falling in March. Leading economic indicators for April are expected to rise 0.4%, twice the rate in March.
The Federal Reserve releases minutes from the Federal Open Market Committee (FOMC) meeting in April. Overseas, Japan reports its first quarter GDP, which is expected to be positive after declining in the fourth quarter.
Retailers will be in the earnings spotlight this week as Home Depot, Lowe’s Co., Target, Wal Mart Stores, Staples, Dick’s Sporting Goods, TJX Co. and the Gap try to improve upon last week’s retail profit results. Other companies due to report include Cisco Systems, Applied Materials and Deere & Co.
Weak first quarter GDP growth combined with downbeat guidance from major retailers last week has caused investors to question the prevailing view from economists that growth will accelerate in the second half of the year. Most economists expect GDP to range between 2% and 2.5% for the full year. However, second quarter growth has been soft and shows no sign of improving and much of the economic data coming out of China, Europe and Japan has been on the soft side as well. For this reason, the market is forecasting only one Federal Reserve rate hike between now and year-end and not until the meeting in December. The law of diminishing returns seems to apply to the Fed and other central banks as additional stimulus measures and monetary easing efforts have accomplished less and less and have generally failed to boost economic growth in a meaningful way. While corporate earnings are expected to increase by 7% or 8% in 2017, this forecast is by no means certain. Since we are not even half way through the year, it’s too early to value the current stock market on next year’s earnings. The market’s valuation on this year’s earnings appears to be full and does not lend itself for much upside unless economic growth begins to improve. As the market enters the traditionally weak season over the summer months, stocks will likely move sideways and be in a trading range until the uncertainty over growth has been resolved and there is clear evidence that the economy is gaining traction.