S&P 500 manages small gain in a volatile week of trading

The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer. – Warren Buffett

It was another volatile week for the stock market, but when the closing bell rang on Friday, the S&P 500 Index managed to eke out a small gain after falling more than 10% from its January 3^rd record close. Monday’s stock market action said it all as the Dow Jones Industrial Average rallied to end the day higher after being down 1,115 points at its low while the Nasdaq Composite Index turned positive after being down nearly 5% during the day. The extreme volatility was primarily due to nervous anticipation around the Federal Open Market Committee (FOMC) meeting later in the week and the fear that the Fed might tighten monetary policy more than expected. While the Fed left interest rates unchanged at near-zero, it reiterated that it would soon be appropriate to raise the federal funds rate with inflation well above 2% and a strong labor market. After the meeting, Fed Chairman Jerome Powell said there was “quite a bit of room” to raise interest rates before it would hurt the labor market and said prices could go higher as “inflation risks are still to the upside”. Traders took his comments to mean that the Fed will probably be more aggressive in tightening monetary policy with the monthly bond-buying program ending in March and coinciding with a quarter-percentage point rate hike, the first increase since December 2018. Markets are expecting at least four such rate increases by the end of the year, leaving the federal funds interest rate at about 1% as consumer prices have risen at the fastest pace in 40 years. Last week was also a busy one for quarterly earnings reports and, for the most part, the results continue to exceed expectations. About one third of S&P 500 companies have announced their quarterly numbers and over 75% of them have beaten analysts’ estimates while nearly 70% of them have topped revenue forecasts. Beneath the surface, though, it’s apparent that earnings growth has slowed and companies are beating estimates by less than in previous quarters. Earnings estimates for the first quarter have also come down and guidance for the full year is weaker than first anticipated, although company profit growth should still be in the mid-single digits.

Last Week

Fourth quarter gross domestic product (GDP) rose 6.9% from the prior year, better than expected as 2021 ended up with a 5.7% increase in annualized growth, the strongest rate of growth since 1984. December durable goods orders fell more than expected due to a large drop in transportation orders. December new home sales jumped to a nine-month high and were better than expected but January consumer confidence declined as concerns about the increase in Omicron cases and rising inflation weighed on consumer’s outlook for the future. Weekly jobless claims were 260,000, slightly less than estimates and a decline of 30,000 from the previous week. The core personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, rose 4.9% from a year ago, the biggest increase since September 1983.

Geopolitical tensions are also weighing on the markets as Russia builds up its military presence at the Ukrainian border.

For the week, the Dow Jones Industrial Average rose 1.3% to close at 34,725 while the S&P 500 Index added 0.8%% to close at 4,431. The Nasdaq Composite Index closed flat at 13,770.

This Week

The January employment report is expected to show that 150,000 new jobs were created and that the unemployment rate remains unchanged at 3.9%. Both the ISM Manufacturing and Services Purchasing Managers’ Indices (PMI) for January are expected to be near 60, still comfortably above the 50 threshold that indicates expansion.

The European Central Bank (ECB) meets this week and announces its monetary policy decision. It is widely expected that the ECB will keep its benchmark interest rate unchanged at negative 0.5%, a level that could remain in place for the entire year.

The most notable companies that are scheduled to report quarterly earnings this week are Advanced Micro Devices, Alphabet (Google), Meta Platforms (Facebook), Qualcomm, Amazon, Exxon Mobil, Conoco Phillips, General Motors, Ford Motor, Emerson Electric, Waste Management, Honeywell, Starbucks, United Parcel Service, Abbvie, Cigna, Eli Lilly, Merck, Bristol Myers Squibb, D.R. Horton, MetLife and Allstate.

Portfolio Strategy

The roller coaster ride for investors will likely continue this week as the stock market tries to find a floor in the midst of a change in Federal Reserve monetary policy and a slowdown in corporate earnings growth. Investors have been accustomed to an accommodative Fed with zero interest rates but that is changing as the Fed combats high inflation that saw consumer prices rise 7% in the last year. The selloff in stocks began with the most overvalued technology names that had little or no earnings and spread to other growth and tech stocks whose valuations had become stretched. The technology-heavy Nasdaq Composite Index has shed 15% from its all-time high back in November while the S&P 500 is down about 8% from its record high. In his comments after the Federal Open Market Committee (FOMC) meeting last week, Fed Chairman Jerome Powell spooked the markets when he hinted that there could be more than four interest rate hikes this year. This prompted the market to price in five increases for 2022 with the distinct possibility that the Fed will also reduce the bond holdings on its balance sheet. While fourth quarter earnings have mostly been better than forecast so far, companies are only beating estimates by about 5%, which is far lower than the average beat over the previous four quarters.  Nevertheless, the economy should continue to expand and earnings growth should still be positive, just not as strong as last year. While it’s possible that the S&P 500 put in its low last Monday when the stock market plunged only to recover later in the day, it’s also possible that the market could retest that low before finally establishing a bottom. Earnings are likely to play a key role in the stock market’s action this week and investors should remain cautious as volatility will probably remain elevated.