Stocks lose momentum but still manage to post modest gains for week

Look at market fluctuations as your friend rather than your enemy. Profit from folly rather than participate in it. – Warren Buffett

What started as a promising week for the stock market ended with a fizzle as stocks sold off on Thursday and Friday and nearly wiped out the earlier gains. Strong earnings were the catalyst for the S&P 500 Index for the first three days as companies such as Bank of America, Goldman Sachs, Morgan Stanley, Johnson & Johnson and UnitedHealth topped earnings estimates. Netflix also helped spur a rebound in the technology sector as the company reported higher than expected subscriber growth. In addition to better than expected earnings reports, China announced that its first quarter economic growth was better than forecast as exports were particularly strong. There was also good news on the geopolitical front. After the U.S. retaliated against Syria by attacking their chemical weapon sites, fears of an escalating conflict in Syria seemed to ease. But the stock market could not keep the momentum going through the end of the week. Taiwan Semiconductor Manufacturing, a major Asian computer chipmaker, issued a disappointing forecast and the announcement weighed on the entire technology sector. The stock of Apple also took a hit after Morgan Stanley said its iPhone sales for the June quarter would disappoint Wall Street. The most troubling news, however, came in the form of a rise in the yield on the 10-year Treasury to 2.95% after ending the previous week at 2.83%. The yield on the 2-year Treasury also rose to 2.46%, resulting in a flattening of the yield curve (the difference between short and long-term interest rates). But with the recent tax cuts and passage of the $1.3 trillion spending bill, one would think that the forecast for economic growth would accelerate, leading to a steeper yield curve. Another concern has been the earnings guidance going forward for those companies that have reported their quarterly earnings. Companies that have raised their second quarter earnings estimates have seen their stock price rise while those that have lowered estimates have seen a decline in their stock price. Even though nearly 80% of S&P 500 companies that have reported earnings have managed to top estimates, it is the direction of earnings forecasts in the future that affect stock prices.

Last Week

U.S. retail sales in March rebounded strongly and were better than expected. High consumer confidence, strong job growth and the impact of tax cuts should lead to more consumer spending in the months ahead. Housing starts also rebounded in March and beat estimates while industrial production was better than expected. Although the leading economic indicators in March recorded their smallest increase since last September, they still pointed to solid growth for the rest of the year.

The Federal Reserve’s Beige Book reported that economic growth was at a “modest to moderate pace” in March and early April with modest wage growth and inflation pressures and a continued tight labor market. Concerns were also expressed about trade tariffs and a possible trade war with China.

For the week, the Dow Jones Industrial Average gained 0.4% to close at 24,462 while the S&P 500 Index rose 0.5% to close at 2,670. The Nasdaq Composite Index added 0.6% to close at 7,146.

This Week

Both March existing homes sales and new home sales are expected to be up slightly over the previous month. March durable goods orders are forecast to decline from February’s strong number but should still post a moderate increase. The preliminary first quarter gross domestic product (GDP) is expected to show 2.2% growth compared to 2.9% in the fourth quarter. April consumer confidence data should continue to hover at near record levels.

The European Central Bank (ECB) meets and is expected to leave interest rates unchanged.

This will be the busiest week of the earnings season and the most notable companies scheduled to report include 3M, Caterpillar, Ford Motor, Boeing, Union Pacific, Eli Lilly, Amgen, PepsiCo, Starbucks, Verizon, AT&T, Visa, Facebook, Amazon.com, Intel, Microsoft, Alphabet (Google), Exxon Mobil and Chevron.

Portfolio Strategy

With the S&P 500 basically flat this year and returns on bonds slightly negative, investors have not had much to cheer about in terms of performance. One beaten down sector that has performed well has been the energy sector, which has been helped by a surge in oil prices. The price of West Texas Intermediate crude oil closed at $68 a barrel on Friday as oil inventories have been falling over the past few months. One of the reasons for the higher prices has been production cuts by Saudi Arabia and other OPEC countries as they target $80 for crude oil prices. While the Energy Information Administration (EIA) forecasts that oil will average about $60 next year, the outlook for oil prices is much better than it has been in a long time. Increased demand is also responsible for higher prices along with rising tensions in the Middle East and turmoil in Venezuela. These higher prices for oil should translate into higher earnings estimates for energy companies. The iShares U.S. Energy ETF (IYE) is up 2.4% for the year through April 20^th while the actively managed Vanguard Energy Fund (VGENX) has posted a total return of 5.1%. If oil prices remain at these levels, energy stocks should remain attractive and provide above-average returns for investors.