Stocks slide on global growth fears

Go for a business any idiot can run because sooner or later, any idiot probably is going to run it. – Peter Lynch

In a roller coaster week that saw stocks record their best day of the year as well as their worst day of the year, the S&P 500 Index plummeted 3% on heightened fears of slowing global economic growth. Following the release of the Federal Reserve minutes from its September meeting on Wednesday, the stock market soared as Fed officials cited global economic weakness as a reason to maintain near zero interest rates. The Dow Jones Industrial Average skyrocketed 275 points, the highest point gain of the year. The next day Germany reported a 5.8% drop in exports in August, which came closely on the heels of an announcement earlier in the week that its industrial production fell 4% in September. This bad news came from the country that most economists felt had the strongest economy in the euro zone. To make matters worse, European Central Bank President Mario Draghi acknowledged the slowing growth in Europe and said that the problems were structural and not cyclical and that reforms were needed for an economic recovery. These unexpectedly weak economic data and sobering comments caused the Dow to tumble 335 points as investors feared that weakness in Europe could negatively impact sales of large U.S. multi-national companies. This point drop was the largest loss for the Dow this year. Needless to say, volatility has returned to the market with a vengeance. Fears about the spread of Ebola and the rise of the Islamic State only added to investors’ anxiety and contributed to the sell-off. The stock market is driven by fear and greed and right now, fear has the upper hand.

Last Week

There was a paucity of economic data last week but the number of people who applied for unemployment benefits dropped below 300,000 for the fourth consecutive week. Not since 2006 has this occurred and it reflects the low level of layoffs by companies. The International Monetary Fund (IMF) reduced its global growth forecast, commented that overall it’s weak and uneven and warned of geopolitical risks. They now expect global economic growth to be 3.3% in 2014 and 3.8% in 2015.

For the week, the Dow Jones Industrial Average fell 2.7% to close at 16,554 while the S&P 500 Index lost 3.1% to close at 1,906. The Nasdaq Composite Index dropped 4.5% to close at 4,276.

This Week

On Columbus Day, the New York Stock Exchange is open but the bond market is closed. The October producer price index is forecast to rise just 0.1%, confirming the absence of inflation at the wholesale level. Retail sales for September are expected to decline slightly from the previous month while September industrial production should show a healthy gain from last month’s modest decline.

Last week’s trickle of earnings reports will become a torrent this week, especially for the banks and financial companies. Among the financials due to report are Citigroup, JP Morgan Chase, Bank of America, Wells Fargo, American Express, Morgan Stanley and Goldman Sachs. Other prominent companies on the calendar include Intel, Google, Johnson & Johnson, General Electric, Honeywell, Philip Morris and Schlumberger.

Portfolio Strategy

Overlooked in last week’s stock market retreat caused by increasing fears of a slowdown in global economic growth were several strong earnings reports. Aluminum maker Alcoa officially began the third quarter earnings season by easily beating analyst estimates for both sales and earnings. Costco Wholesale reported a 13% increase in quarterly profit, topping estimates, while PepsiCo not only beat earnings estimates but also raised its outlook for the full year. While three profit reports are hardly representative of the entire S&P 500 universe, they do offer some optimism that third quarter earnings may be better than expected. Current estimates call for earnings per share of S&P 500 companies to increase by 4.5% with a corresponding revenue increase of just below 4%. A stronger dollar could be a head wind as it makes products sold by U.S. multi-national companies more expensive overseas, forcing companies to cut prices to remain competitive, thereby hurting profit margins. Since the rising dollar occurred late in the quarter, the potential negative impact will probably be felt in the outlook for fourth quarter earnings rather than in actual third quarter profits. With the focus this week squarely on domestic corporate earnings instead of macroeconomics and global growth, there could be less volatility in the market as we get further into earnings season. After investors’ fears drove the stock market lower last week, third quarter earnings results and fourth quarter guidance are likely to take on added importance. We will soon find out if those fears are justified.