An investment in knowledge pays the best interest. – Benjamin Franklin
Despite a huge sell-off in stocks on Friday that saw the technology-laden Nasdaq Composite Index lose more than 2.5% and the S&P 500 Index drop more than 1%, stocks generally were able to close higher for the week. In a pattern recently that has become all too familiar, stocks were relatively strong throughout most of the week but surrendered gains at the end of the week, leaving investors scratching their heads about the future direction of stocks. For the most part, the economic news was positive as both the manufacturing and services sector data confirmed continued expansion, construction spending and factory orders rose and automobile sales were better than expected. Fed Chair Janet Yellen also helped stocks with her dovish remarks that interest rates would remain low for as long as necessary to get the economy back on track and the labor market back to normal. Even the March employment report on Friday was encouraging as the U.S. added 192,000 jobs with upward revisions in jobs for both January and February. Although the jobs number was somewhat less than expected, stocks initially cheered the news and went up before reversing course and ending the day in the red. Most of the damage was in so-called momentum stocks that had become overvalued and were due for a correction. This week the focus will be clearly on first quarter corporate earnings reports, which will hold the key in determining the near-term direction of stock prices.
In an effort to revive its slowing economy, China plans to implement stimulus plans that includes upgrading its rail system, improving low-income housing and providing small business tax incentives in order to create faster growth. Whether or not it will be enough is questionable as the amount set aside pales in comparison to the $650 billion spent in 2008.
With the stock market trading near all-time highs and corporate balance sheets in excellent shape, it is no wonder that merger and acquisition activity is booming. The volume of such deals rose 15% in the first quarter and the total volume of all mergers and acquisitions was at the highest level since 2007. This activity along with increased dividends and share repurchases are ways that corporations are utilizing their cash stockpiles to increase shareholder value.
For the week, the Dow Jones Industrial Average rose 0.6% to close at 16,412 while the S&P 500 Index increased 0.4% to close at 1,865. The Nasdaq Composite Index, however, dropped 0.7% to close at 4,127.
Corporate earnings reports for the first quarter will begin in earnest this week as Alcoa leads the confessional on Tuesday followed later in the week by retailers Family Dollar Stores, Bed Bath & Beyond and Rite Aid and financial heavyweights Wells Fargo and JP Morgan Chase. The big question mark for companies will be the effect that the harsh winter weather had on earnings results. If profits fail to meet analyst estimates, expect companies to blame the weather for falling short.
In other news, the minutes from the March Federal Open Market Committee (FOMC) meeting will be released and the Senate Judiciary Committee will review the merger between Comcast and Time Warner Cable. The producer price index (PPI) is expected to rise only 0.1% and jobless claims are forecast to decline, continuing the improving trend in the labor market.
While both the Labor Department and ADP reports on jobs were definitely better than in previous months, they were not good enough to cause the Fed to tighten monetary policy sooner or change any of its monthly tapering plans. For this reason, it still left unresolved the strength of the economic recovery and how much first quarter corporate earnings will be affected by the unusually cold and snowy winter. While it seems to be a foregone conclusion that earnings will be much weaker than first thought, most analysts have not changed their full year estimates. That means that earnings growth in the second quarter will have to rebound and accelerate throughout the year. Weather cannot be used as an excuse going forward. For bondholders, the employment data was just right as it suggested that the economy is growing modestly and that the labor market is improving gradually. The yield on the 10-year Treasury barely budged for the week and currently yields about 2.73%. Investment grade corporate bonds with intermediate maturities offer good value and should perform well in a slow growth, low inflationary environment. They offer a significant yield advantage over comparable Treasury securities. Even more attractive are high quality municipal bonds with similar maturity structures for those investors in high enough tax brackets to benefit from these securities.