Stocks surge on earnings, Yellen comments

I don’t think there is any other quality so essential to success of any kind as the quality of perseverance. It overcomes almost everything, even nature. – John D. Rockefeller

Despite weak economic data last week, the stock market posted its second consecutive weekly gain and has now recovered almost all that it had lost since the start of the year. As has been the case with previous soft economic numbers, investors chose to blame the severe winter weather for the fact that industrial production was weak and that retail sales were well below estimates. Worries about slowing manufacturing growth, weak jobs data and fragile economies in emerging markets seem like a distant memory now as investors chose to focus on recent earnings reports and comments from the new Fed chair, Janet Yellen. In her prepared remarks before Congress last week, she said that the Federal Reserve will continue to provide monetary stimulus to bolster the economy and continue the accommodative policies put in place by her predecessor, Ben Bernanke. She also pointed out that interest rates will likely remain low for the foreseeable future and stressed that the recovery in the labor market has a long way to go. It was these words of assurance that probably did more than anything else to calm the markets and enable stocks to trade higher on the week. Corporate earnings reports for the fourth quarter have also been better than expected and contributed to the positive market sentiment. In fact, with about 90% of the companies in the S&P 500 Index having reported earnings so far, the growth of those earnings has been over 9%. For the market to break out of its recent trading range and begin to set new highs, investors will have to have a much clearer picture of the sustainability of stronger economic growth and the ability of that growth to translate into higher corporate earnings.

Last Week

The most disappointing economic report last week was January retail sales, which dropped 0.4%, compared to expectations of a drop of 0.1%. Although weather was blamed for the weak number, Internet sales were also down 0.6% during January. Since consumers provide the main source of economic growth, this is a worrisome sign as many economists have revised downward their GDP forecasts for the first quarter. January industrial production was also weak as it fell 0.3% and was in keeping with other soft manufacturing data that was released recently.

In addition to Janet Yellen’s soothing remarks about monetary policy, other positive news included data from China that showed that their exports increased more than expected, alleviating some of the concern about their slowing economy. Consumer sentiment was also unchanged in early February, which should be viewed as a positive considering the weak economic data of late. And believe it or not, Congress actually agreed to an increase in the country’s debt-ceiling limit through March 2015 as investors breathed a sigh of relief.

For the week, the Dow Jones Industrial Average jumped 2.3% to close at 16,154 while the S&P 500 Index climbed 2.3% to close at 1,838, within ten points of its all-time high. The Nasdaq Composite Index rose 2.9% to close at 4,244.

This Week

Both the January producer price index (PPI) and consumer price index (CPI) will be released and both are expected to increase only modestly, indicating that inflation is well under control. In addition, data on housing starts and existing home sales for January are expected to decline due to, you guessed it, severe winter weather across much of the country. In overseas news, the Bank of Japan will announce its current monetary policy and the European Union and the U.S. will try to hammer out a free-trade agreement.

Earnings season is winding down but among the most notable companies scheduled to report this week include Duke Energy, Waste Management, Coca-Cola, Medtronic, Devon Energy, Hewlett Packard, Wal-Mart Stores and Nordstrom.

Portfolio Strategy

While consensus forecasts at the beginning of the year called for stronger economic growth, modestly higher inflation along with higher interest rates and declining gold prices, surprisingly weak economic data so far has called into question these predictions. Perhaps the severe winter weather has played a role in slowing the economy as the Fed continues to reduce its monetary stimulus on the assumption that stronger growth is on the way. The bond market has been strong as prices have risen and yields have fallen, with the 10-year Treasury yield at about 2.7%, a move that suggests a weakening economy. And gold has surprised a lot of skeptics as its price has risen to over $1,300 an ounce, suggesting either a dead cat bounce or real concern about global economic growth. Until there is clear evidence that the economy is on a sustainable path to stronger economic growth, investors should exercise caution, as stocks are likely to trade in a fairly narrow range. Although fourth quarter earnings results have generally exceeded expectations, the stock market is forward-looking and will need above-average earnings growth to break out of this trading range and resume an upward trend. The weather has been a convenient excuse for the bulls but the spring could bring the bears out of hibernation if economic data doesn’t improve and earnings don’t follow suit.