Stocks tumble as the economic data goes from bad to worse

The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go. – Benjamin Graham

All three major stock averages closed lower last week as they could not overcome a plethora of bad news about the economy, quarterly earnings, rising tensions with China and sobering comments by Federal Reserve Chairman Jerome Powell and infectious disease expert Dr. Anthony Fauci. It was the worst week for the S&P 500 Index since way back on March 20th, posting a drop of 2.3% as investors came to grips with the toll that the coronavirus pandemic has taken on the economy. Worries began to creep in that without a vaccine or treatment for the virus, the markets could also be vulnerable. Weekly jobless claims soared again, totaling 2.981 million and bringing the total to an astounding 36.5 million over the past two months. While there have been some encouraging earnings reports, they have been few and far between. First quarter earnings are on track to fall nearly 14% from a year ago compared with expectations of about 5% growth at the start of the year. With relations between the U.S. and China already strained because of the origin of the Covid-19 virus and the fact that China did not contain the disease, tensions rose last week and prompted fears of another trade war. The Trump administration took steps to block semi-conductor shipments to Chinese company Huawei, which could spark retaliation by China against U.S. companies. As states began to reopen their economies and relax restrictions on businesses, there were also worries that the risk of more positive cases of Covid-19 could lead to increased hospitalizations and deaths. Dr. Anthony Fauci warned that the U.S. could face more “suffering and death” if states begin to reopen too quickly. Federal Reserve Chairman Jerome Powell also commented about the uncertainties that lie ahead and the downside risks that the virus imposes on the economy. He cautioned that an economic recovery will take time but that “the passage of time could turn liquidity problems into solvency problems.” He also suggested that while additional fiscal stimulus would be costly, it would greatly reduce long-term economic damage and lead to a stronger recovery. On a positive note, he downplayed the idea of negative interest rates, which have not worked in Europe and Japan, and said that the U.S. economy should see a strong economic recovery once the virus is under control. With economies reopening and restrictions being lifted, we may be seeing the first green shoots and initial signs of a recovery.

Last Week

Retail sales in April fell by 16.4%, which was worse than expected and the biggest decline ever recorded for this piece of economic data. Likewise, industrial production recorded its largest drop in its history in the month of April. The producer price index (PPI) in April registered its largest decline ever as plunging oil prices were responsible for most of the drop. The consumer price index (CPI) also fell and core CPI, which excludes food and energy, dropped by the biggest amount since records have been kept. On a year-over-year basis, core CPI rose only 1.4%, the smallest increase since April 2011. The preliminary University of Michigan consumer sentiment index for May rose slightly to 74, a far cry from the lofty levels it was at as recently as February.

A $3 trillion fiscal stimulus bill was passed in the Democratic-controlled House but it is unlikely to be approved in the Senate.

For the week, the Dow Jones Industrial Average lost 2.7% to close at 23,685 while the S&P 500 Index dropped 2.3% to close at 2,863. The Nasdaq Composite Index fell 1.2% to close at 9,014.

This Week

April housing starts are expected to show a sharp decline the likes of which have not been seen since 2015 while April existing home sales are also expected to plunge. Leading economic indicators for April are forecast to decline nearly 6%, a slight improvement from the March reading which was the steepest drop in the history of the index.

Among the most notable companies scheduled to report quarterly earnings this week are Home Depot, Lowe’s, Walmart, Target, TJX Cos., Best Buy, Analog Devices, Agilent Technologies, Nvidia, Palo Alto Networks, Hewlett Packard Enterprise, McKesson, Medtronic and Deere.

Portfolio Strategy

In recent years, so-called value stocks have significantly underperformed growth stocks and the disparity between the two in terms of relative valuation has never been greater than it is now. In fact, the spread between the two styles is wider now than it was during the technology bubble in 1999 and 2000 and the financial crisis of 2008 and 2009. Growth stocks are companies that have consistent and above-average growth of sales, earnings and cash flow and typically have high valuations such as high price earnings ratios and low dividend yields. They also tend to reinvest their earnings back into the company to provide for continued growth in the future. Value stocks, on the other hand, are less expensive and tend to have sales and earnings growth that is slower. Their dividend yields are usually higher and their price earnings ratios are lower and they tend to be less volatile and risky than the overall market. While the S&P 500 Index is down about 11% for the year, the average value fund is down more than 20%. The S&P 500 Index is a market-capitalization weighted index whose top five holdings (Microsoft, Apple, Amazon.com, Alphabet (Google) and Facebook) are all considered growth stocks in the technology sector, which has been the best performing sector of the market. These names are partly responsible for the benchmark’s relatively strong performance so far this year. Historically, value investing has outperformed growth investing but many investors have thrown in the towel on value investing and wonder if it will ever come back. With the federal government and the Federal Reserve now providing massive stimulus to the economy, cheaper than ever value stocks could benefit from the trillions of dollars being spent. This could finally be the catalyst that value stocks need to regain their luster.