Stocks close modestly higher as first quarter earnings season begins

One of my greatest complaints about forecasters is that they seem to ignore their own records. The amazing thing to me is that these people will go on making predictions with a straight face, and the media will continue to carry them. – Howard Marks, American investor and founder of Oaktree Capital Management

In anticipation of the first quarter earnings season that begins in earnest this week, stocks took a breather last week and consolidated recent gains. The S&P 500 Index rose modestly while the Dow Jones Industrial Average closed virtually flat. Investors received a taste of the quarterly profit reports on Friday when JP Morgan Chase and Wells Fargo both reported better than expected revenue and earnings. Although Wells Fargo issued disappointing guidance, JP Morgan Chase maintained its earnings outlook for the year as it reported record profits that were helped by higher interest rates and strong consumer banking results. Investors should be encouraged by these initial results, but this week will be key as nearly fifty S&P 500 companies are scheduled to report first quarter earnings. The other important news items last week were minutes from the March Federal Reserve meeting and the European Central Bank (ECB) meeting to review monetary policy. The Fed minutes showed that the majority of its officials thought that the economic outlook was such that interest rates could be left unchanged for the entire year. Because of softening data on consumer spending and housing, weaker global economic growth and benign inflation, the Fed can afford to be more patient and should be much less inclined to hike rates. The ECB also made no changes to its monetary policy, announcing that it would not raise its benchmark interest rate until at least the end of 2019. The euro zone economy is weaker than the U.S. and risks there remained skewed to the downside as growth continues to slow. Investors had also become concerned recently about slowing growth in China, but the country reported stronger than expected export data in March, nearly double what economists had expected. There were positive developments in the ongoing trade talks with China, too, as both sides were close to agreeing on enforcement mechanisms when a deal is finally reached.

Last Week

Inflation data released last week indicated that prices remain under control. The consumer price index (CPI) in March recorded its biggest increase in over a year, but excluding food and energy, prices barely budged and the CPI has increased less than 2% during the last 12 months. The March producer price index (PPI) was also higher than expected but the core rate (excluding food and energy) of wholesale inflation was flat. Excluding petroleum, import prices in March edged up slightly and were flat for the past 12 months. February factory orders fell and were worse than expected due to weakness in machinery, transportation and electronics orders. Weekly jobless claims fell by 8,000 to 196,000, the lowest level since October 1969 and a sign that the labor market remains strong.

In corporate news, Walt Disney announced a new streaming service that would compete with Netflix and Chevron announced plans to acquire Anadarko Petroleum for $33 billion in cash and stock. In overseas news, European Union leaders agreed to postpone the deadline on Brexit until October 31.

For the week, the Dow Jones Industrial Average fell 12 points to close virtually flat at 26,412 and the S&P 500 Index rose 0.5% to close at 2,907. The Nasdaq Composite Index added 0.6% to close at 7,984.

This Week

Leading economic indicators and retail sales for March are both expected to rebound strongly after posting tepid numbers in February that might have been weather-related. Housing starts and industrial production should also see an improvement over the previous month.

Among the most notable companies scheduled to report first quarter earnings this week are Citigroup, Goldman Sachs, Morgan Stanley, Bank of America, Charles Schwab, US Bancorp, SunTrust Banks, American Express, IBM, Johnson & Johnson, UnitedHealth, Abbott Labs, PepsiCo, Philip Morris International, Union Pacific, Honeywell and Schlumberger.

Portfolio Strategy

If the first quarter earnings results from JP Morgan Chase and Wells Fargo are any indication, this earnings season could be better than most people expect. While two profit reports are a small sample size, the results were impressive and could set the tone for the remaining reporting season. We certainly will find out over the next two weeks as nearly 40% of S&P 500 companies are scheduled to report their earnings. Earnings are expected to decline about 4% from the year-ago quarter and analysts’ estimates have come down since the start of the year, lowering the bar that companies need to clear. The S&P 500 has risen over 16% this year and is now less than 1% from its all-time high, a move upward that has been the result of an expansion in the price earnings ratio, which is now at about 17 times forward earnings. This higher multiple could be the result of the Federal Reserve’s more dovish monetary policy and its more patient approach with regard to raising interest rates. It also could be due to the belief among economists that economic growth will increase in the second half of the year, leading to stronger corporate profit growth that would justify higher stock prices. For this reason, the outlook that companies provide for the balance of the year will be just as important as their first quarter earnings results.