Risk comes from not knowing what you are doing. – Warren Buffett
Continued weakness in so-called momentum stocks in sectors such as technology, the Internet, social media and biotechnology spread to the broad market last week as all the major averages fell by more than 2%. There was really no place to hide as earnings season for the first quarter began with mixed results. While Wells Fargo, Alcoa and Rite Aid reported earnings that topped analyst estimates, bellwether JP Morgan Chase disappointed investors as its earnings were weaker than expected. Other than the fact that many of these high fliers had become significantly overvalued and were due for a correction, the only other discernible reason for the stock sell-off was nervousness and uncertainty over what lies ahead for corporate earnings. For the most part, the economic news and Federal Reserve minutes released last week were positive and should have cheered investors. Jobless claims fell to a seven-year low, much better than economists had expected and a reason for them to raise their outlook for GDP growth to 3.5% in the spring. U.S. consumer sentiment also rose to a nine-month high in April. A review of the Fed minutes indicated that they are in no hurry to raise interest rates and will take into account a wide range of information, including labor market conditions, inflation data and financial developments, before making a decision. While the declines in these momentum stocks are a bit unnerving, the overall health of the rest of the market appears to be fine as valuations are still reasonable in a low inflation, low interest rate environment.
U.S. wholesale prices as measured by the producer price index (PPI) rose 0.5%, which was the largest increase in nine months. However, on a year over year basis, wholesale costs are only up 1.4%, indicating that inflation continues to be tame.
The International Monetary Fund (IMF) weighed in on prospects for global economic growth this year and concluded that emerging markets will grow their economies by 4.9%, less that initially thought as tensions between Russia and Ukraine have led to economic uncertainty and slower growth. The IMF also forecasts 2.2% growth in developed countries worldwide and 2.8% growth for the U.S. economy.
For the week, the Dow Jones Industrial Average lost 2.3% to close at 16,026 while the S&P 500 Index declined 2.7% to close at 1,815. The technology-laden Nasdaq Composite Index slid 3.1% to close at 4,000.
On the economic calendar this week, retail sales are expected to show a healthy increase as strong automobile sales are forecast. March housing starts and industrial production also should surprise on the upside as the negative effects of winter begin to wane. The consumer price index (CPI) is expected to increase by just 0.1% for March.
While the Fed releases its beige book of economic conditions in the U.S., China will release first quarter GDP growth and other economic data that will be watched closely for signs that the world’s second largest economy is slowing.
Last weeks’ earnings reports were a trickle compared to the torrent of releases that are expected this week. Among the heavyweights that are scheduled to report are Citigroup, Bank of America, Goldman Sachs and Morgan Stanley in the financial sector, Johnson & Johnson and Abbott Labs in the health care sector, Pepsico and Coca Cola in the consumer non-durables sector, Intel, IBM and Google in the technology sector and General Electric in the capital goods sector.
Despite the difficult week for stocks, most portfolios have either a conservative or balanced investment objective with a heavy dose of fixed income investments and value-oriented equity investments that help limit the overall damage. On the fixed income side, the Loomis Sayles Bond Fund is widely held and has performed remarkably well as the fund manager has the ability to invest a certain percentage of the total assets in high yield securities, common and preferred stocks and foreign securities in addition to core fixed income investments. As an alternative investment, real estate investment trusts (REITs) offer both added diversification and above average income as their yields tend to be very attractive. The Vanguard REIT ETF has performed very well this year with a total return of more than 10%. With regard to the equity allocation, most portfolios have exposure to so-called value or equity income funds that have above average dividend yields and below market price earnings ratios. Funds such as the American Century Equity Income Fund and the iShares High Dividend ETF are more conservative and focus on undervalued companies with attractive dividends. As interest rates remain stable or decline, these funds usually perform very well, although they should not be viewed as a substitute for bonds or bond funds. They act to reduce the overall risk of the portfolio and serve to provide the potential for higher returns in the future. All of these investments should give investors peace of mind during periods of stock market volatility such as what occurred last week.