Overseas equities rebound on growth prospects

It is better to hang out with people better than you. Pick out associates whose behavior is better than yours and you will drift in that direction. – Warren Buffett

 In a rather lackluster week that saw stocks surrender gains after starting strong, the broad-based S&P 500 Index finished virtually flat while the technology-laden Nasdaq Composite Index and the Russell 2000 Index of small cap stocks suffered losses of 2.8% and 3.5%, respectively. With concern mounting that economic growth will not improve as mush as expected, small companies that rely almost exclusively on domestic sales were hurt the most. Technology and biotech stocks that comprise the Nasdaq also were the victims of profit-taking as investors sold the names that have had the best performance. While U.S. stocks struggled for the week, overseas equities, particularly those in emerging markets, reversed their recent weakness and surprised investors on the upside. Part of the reason for the strength in developing markets was China’s announcement that it would support its slowing economy in an attempt to spur faster growth. Another reason might be sluggish economic growth in this country coupled with the Federal Reserve’s plan to reduce the monthly stimulus program. The bond market also seems to be saying that growth will only be modest at best as the 10-year Treasury yield has actually fallen since mid-December when tapering was first announced. At the start of the year, the consensus among economists was for stronger growth and higher interest rates. While it has been convenient to blame the weather on the economy’s ills, spring has sprung and weather can no longer be used as an excuse for sub-par growth. Perhaps that is why investors looked overseas last week for better growth opportunities both in emerging markets and developed countries, not to mention more attractive valuations.

Last Week

The situation in the Ukraine has calmed down considerably, although Russia still has troops near the border after it annexed Crimea. Whether or not Russia will attempt to accomplish the same with Ukraine is everyone’s fear, but, for the time being, there has been no movement of Russian troops across the border. As a result of Russia’s actions, it has been removed from the G-8 and its economy is likely to suffer the consequences.

Concerns about Janet Yellen’s comments the previous week regarding the possibility of higher interest rates sooner rather than later continued to haunt the bond market as the yield on the 10-year Treasury note rose to 2.73% on Friday. However, geopolitical risk in Ukraine and weaker than expected payroll numbers in March could reverse this trend and lead to higher bond prices and lower yields.

For the week, the Dow Jones Industrial Average edged up 0.1% to close at 16,323 while the S&P 500 Index fell 0.5% to close at 1,857. The Nasdaq Composite Index dropped 2.8% to close at 4,155.

This Week

While February construction spending and factory orders will be released this week, the most anticipated announcement will come on Friday when the March non-farm payrolls and unemployment rate are reported. Most economists are expecting the number of new jobs to be in the neighborhood of 195,000, a sizable improvement over last month’s number. The unemployment rate is expected to decline slightly to 6.6% from 6.7% in February. Both pieces of data should not be affected by the weather, which marred the two previous months’ readings. Better than expected jobs data could help boost stocks as investors become comfortable with the notion of a sustained economic recovery.

The European Central Bank (ECB) meets to discuss monetary policy and may decide to implement further steps to ease policy to increase economic growth and combat deflation.

As the first quarter winds down, earnings reports are fewer and fewer with the most notable companies scheduled to report being Monsanto, Micron Technology, Jos. A. Bank Clothiers and CarMax.

Portfolio Strategy

With the end of the first quarter upon us, the S&P 500 Index has been virtually flat for the year as investors try to gauge the strength of the U.S. economy and what effect the severe winter weather will have on corporate earnings. Up to this point, stocks have been given the benefit of the doubt as much of the economic data has been weak, a victim of the snow and the cold weather. As a result, estimates for first quarter earnings have been reduced considerably and there have been numerous negative preannouncements. In fact, estimates for first quarter earnings growth have been reduced from 6% to 7% at the beginning of the year to about 1% or 2% now. For stocks to break out of their recent trading range and advance to new highs, earnings will have to exceed analyst estimates, albeit at lower levels, and guidance going forward will have to be positive. A favorable employment report on Friday will be a hopeful first sign that the economy is on solid footing and that companies are poised to deliver stronger earnings growth.