Stocks decline on Iraq fears, higher oil prices

Most investors want to do today what they should have done yesterday. – Larry Summers, American economist

The stock market suffered its first weekly loss in four weeks and although a number of reasons were cited for the decline, stocks were due for a breather after spending a month in rarefied air. After a slow start to the year, the S&P 500 Index had risen over 6% since mid-April and the law of gravity made it due for a pullback. News out of Iraq that the country may be on the verge of civil war most certainly caught investors by surprise as crude oil prices spiked to levels not seen in nine months. These unforeseen events were not on anyone’s radar screen and could put a damper on already weak global economic growth. Political news out of Washington also may have spooked investors as House Majority Leader Eric Cantor was upset in the Virginia GOP primary by a virtual unknown Tea Party candidate. This stunning defeat likely solidifies continued government gridlock at a time when the economy could use some fiscal help. Disappointing economic news could also be cited for the weakness in stocks last week. The World Bank lowered its projections for global economic growth and the International Monetary Fund cautioned that persistent low interest rates have led to substantial increases in home prices, which could lead to another housing crash. Retail sales and consumer sentiment were also lower than expected, giving investors an excuse to take profits. After all, trees don’t grow to the sky and the market’s winning streak was bound to come to an end.

Last Week

After two consecutive large increases in the producer price index (PPI), wholesale prices fell 0.2% in May, surprising economists who had expected prices to rise modestly. Although retail sales only rose 0.3% in May and were much less than expected, the number for April was revised up substantially. Most economists believe that consumer spending will increase as the year progresses, but the amount of wage growth will likely hold the key.

In corporate news, Intel raised its second quarter revenue outlook on improving demand for personal computers by businesses and its stock was strong. Mergers and acquisitions heated up last week as Tyson Foods, Priceline Group and Merck announced agreements to purchase other companies as a way to boost their sales and increase revenue.

For the week, the Dow Jones Industrial Average declined 0.9% to close at 16,775 while the S&P 500 Index fell 0.7% to close at 1,936. The Nasdaq Composite Index lost 0.2% to close at 4,310.

This Week

In economic news this week, the consumer price index (CPI) for May is forecast to rise just 0.2% as pricing pressures remain well under control. Housing starts for May are predicted to decline slightly from their pace in April while leading economic indicators should register a modest increase over the previous month. While better weather should help the housing market, home prices have risen dramatically and there seems to be a lack of quality inventory at affordable prices.

The Federal Reserve Open Market Committee (FOMC) meets and will likely confirm that its tapering of bond purchases each month remains firmly in place. Fed Chair Janet Yellen will hold a news conference that will shed light on the Fed’s thinking on the economy, including GDP growth, the unemployment rate and job growth and the inflation outlook.

Among the companies that report quarterly earnings this week are Adobe Systems, Oracle, Bob Evans Farms, Darden Restaurants, Kroger and FedEx.

Portfolio Strategy

Since the stock market’s low reached back in March 2009 during the financial crisis and the Great Recession, the S&P 500 Index has risen 190% and there has been no correction of 10% or more in over 30 months. The situation in Iraq and its potential effect on oil prices and the fragile global economic recovery gave investors pause last week about the future direction of stock prices. But with the U.S. becoming more energy independent and more of a service-based economy than a manufacturing one, any spike in crude oil prices would have less of an adverse effect. As the market heads into the summer doldrums, trading volume will likely remain low and stocks are expected to drift higher in the absence of alternative investments that offer prospects for higher returns. While fixed income returns have been positive this year, stronger economic growth could lead to higher interest rates, negatively impacting returns. With the S&P 500 Index up about 5% for the year and second quarter earnings forecast to rise 5%, stocks could continue their strength during the summer months in an environment characterized by modest growth and an abundance of liquidity. Although valuations still seem reasonable relative to earnings growth and low interest rates, there is not a lot of upside, either. An improving economy and stronger earnings growth should lend support to the stock market, but any near-term gains are likely to be limited.