Mixed economic data leaves stocks flat

Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. – Sir John Templeton

After climbing to within three points of 1,900 and an all-time high earlier in the week, the S&P 500 succumbed to a fear of heights and profit taking on Thursday and ended the week exactly where it started. Small cap stocks as measured by the Russell 2000 Index were not as fortunate as they continued to drop, officially down 10% from their high set back in March. This decline can be technically called a correction and has raised concern among investors that a similar fate may be in store for the broader market. However, past history shows that only about one third of the time does a pullback of this magnitude in the Russell 2000 index lead to similar pullback in the S&P 500. More worrisome could be the action in the bond market, where mixed economic data last week caused bond prices to surge and yields to drop. The 10-year Treasury note yield briefly fell below 2.50% before ending the week at 2.52%. While the jobless claims data were strong and housing starts were encouraging, retail sales were much weaker than expected and industrial production was disappointing. On top of that, the inflation data was disconcerting and the consumer sentiment index was downbeat. The strength in the bond market caused by a sputtering U.S. economy is creating anxiety and nervousness among stock investors, who sense that weak economic data is not a recipe for continued earnings growth and higher stock prices. But a healthy dose of skepticism and widespread pessimism toward stocks may be just what this market needs to keep moving higher.

Last Week

As mentioned above, economic data last week was truly a mixed bag. On the positive side of the ledger, jobless claims fell 24,000 to the lowest level since 2007 and back to pre-recession levels. April housing starts were also strong and at the fastest pace in five months, although most of the gains came in multi-family units. On the negative side, industrial production fell more than expected but the weakness was primarily due to utilities output returning to normal levels. Retail sales were also disappointing and consumers cited a lack of income growth as a major factor affecting consumer sentiment.

While the consumer price index (CPI) and the producer price index (PPI) rose more than expected in April, both the CPI and the PPI have risen only 2% over the past twelve months.

For the week, the Dow Jones Industrial Average dropped 0.6% to close at 16,491 while the S&P 500 Index ended flat and closed at 1,878. The Nasdaq Composite Index increased 0.5% to close at 4,090.

This Week

April existing home sales and new home sales headline a week that is relatively light in terms of economic data. Both reports are expected to improve upon the data from the previous month with higher sales. Overseas, the Bank of Japan meets to discuss monetary policy while the European Central Bank Governing Council also meets but no rate announcement is expected. However, recent moves in bond yields in some European countries would seem to indicate that further monetary easing might be on the horizon.

Retailers will again take center stage this week with their quarterly earnings reports. Among those scheduled to report include Staples, TJX Companies, Home Depot, Lowe’s, Tiffany, Best Buy, Gap and Target.

Portfolio Strategy

Despite the conflicting economic data last week, corporate earnings reports for the first quarter have generally surprised on the upside and have provided a reason to be optimistic about future earnings. With about 90% of first quarter results reported by S&P 500 companies, almost 70% have beaten earnings estimates while 53% have reported revenue above expectations. But forecasting earnings with any degree of accuracy is difficult, especially in an economy that is giving off so many mixed signals. Uncertainty is the bane of stock investors and it is this uncertainty with regard to the strength of the economy and future earnings growth that has caused the stock market to stall at these levels. While a correction cannot be ruled out, it is hard to make a convincing argument for bonds or cash over equities when looking at financial assets. Investors can take comfort in the fact that interest rates aren’t likely to rise as much as feared at the start of the year and should remain low for a considerable amount of time. As long as interest rates remain relatively low, stocks with above-average dividend yields and strong dividend growth prospects should perform well.