S&P 500 closes modestly lower as earnings, economic data mixed

In many ways, the stock market is like the weather in that if you don’t like the current conditions all you have to do is wait a while. – Low Simpson, former chief investment officer for Geico, a Berkshire Hathaway subsidiary

Quarterly corporate earnings and economic data were decidedly mixed last week and that is exactly how the major stock averages finished with the Dow Jones Industrial Average and the S&P 500 Index posting losses while the Nasdaq Composite Index was slightly positive. The week began on an ominous note when investment banking giant Goldman Sachs reported its worst earnings miss in a decade as the company’s loan loss provisions were higher than anticipated and it was cautious about its outlook for the year. But competitor Morgan Stanley followed that report with better-than-expected earnings due to record wealth management revenue. There was continued good news on the inflation front as the producer price index (PPI) for December recorded its biggest decline since April 2020 due primarily to a drop in energy prices. For the year, PPI rose 6.2%, the lowest annual level since March 2021 and down substantially from the 10% annual increase in 2021. However, there was also evidence that consumer spending was slowing significantly as retail sales in December fell more than forecast and overall holiday sales growth was less than expected. Since consumer spending accounts for about two-thirds of total economic activity, the weak data ignited recession fears once again. The Federal Reserve’s Beige Book, a survey of economic conditions from the Fed’s 12 regional banks, confirmed the slowing growth of the economy and a weak housing market, but showed that inflation was declining despite a strong labor market. The Fed’s tighter monetary policies are having a real impact in combating inflation and most economists are expecting the Fed to raise interest rates by only 25 basis points (a basis point is one hundredth of one percent) at their next meeting on February 1^st. Federal Reserve Governor Lael Brainard also commented last week that interest rates need to remain high even though there are signs that inflation has begun to ease. But many investors fear that the Fed will make the mistake of maintaining interest rates too high for too long, causing the economy to tip into a recession sometime this year.

Last Week

Overall housing starts in December fell for the fourth straight month, but single-family housing starts which account for the bulk of homebuilding increased by over 10%. Existing home sales in December also declined for the 11^th straight month, falling to the lowest level since 2010 as higher mortgage rates and steep home prices have hurt demand. Weekly jobless claims fell 15,000 to 190,000, compared to the forecast of 214,000 claims, suggesting the labor market remains tight.

The Bank of Japan (BOJ) left its short-term interest rate unchanged at negative 0.1% as the central bank wants to keep rates low to stimulate the economy.

Microsoft announced plans to lay off about 10,000 employees and Alphabet (Google) said it will lay off 12,000 workers as part of their efforts to cut costs.

For the week, the Dow Jones Industrial Average dropped 2.7% to close at 33,375 while the S&P 500 Index fell 0.7% to close at 3,972. The Nasdaq Composite Index rose 0.6% to close at 11,140.

This Week

Gross domestic product (GDP) for the fourth quarter is expected to have grown by 2.5%, compared to a 3.2% increase in the third quarter. Durable goods orders for December are forecast to rebound strongly after declining in November and the December Leading Economic Index is expected to decline again but not by as much as in November. New home sales in December are expected to be less than in November as the housing market remains weak.

Among the most prominent companies scheduled to report quarterly earnings this week are 3M, Danaher, General Electric, Lockheed Martin, Union Pacific, Boeing, CSX, General Dynamics, Dow, Johnson & Johnson, Abbott Labs, Texas Instruments, IBM, Tesla, Intel, Microsoft, Verizon, AT&T, Comcast, Visa, Mastercard, U.S. Bancorp, American Express, Travelers, Southwest Airlines and Chevron.

Portfolio Strategy

This week will be one of the busiest weeks in the earnings season with reports from some of the largest companies in the world. While it is still early in the quarterly earnings reporting period, only about 60% of companies are topping expectations, less than usual, with the amount that companies beat estimates by also less than in previous quarters. Netflix surprised investors last week as the company reported that it added 7.66 million paid subscribers in the fourth quarter, much more than expected, as its revenue was also in line with estimates. This good news gave investors hope that other corporate earnings results, especially from the big technology companies whose stocks have been hammered, will not be as bad as feared. While earnings are forecast to decline in the 4^th quarter, projections have improved recently and after expected slight declines in the first two quarters of the year, profits are forecast to rebound in the second half of 2023. The action in the bond market last week suggests that a recession is unavoidable as the yield on the 10-year Treasury fell to 3.5% while the 2-year Treasury yield declined to 4.2%. Slowing economic growth and falling inflation have been responsible for declining bond yields and this week the release of the personal consumption expenditures (PCE) index for December will provide more clarity on inflation. This is the Federal Reserve’s preferred measure of inflation and it is expected to rise just slightly and show that core prices that exclude food and energy have risen 4.4% year-over-year, down from the reading in November. In fact, over the last three months, this measure has been running at only a 3% annualized pace, still above the Fed’s target of 2% but well-below the annual pace of nearly 5%. This recent trend should give investors hope that the Fed’s work is almost done.