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Stocks fall on weak 1st quarter GDP report

People need to have the incentive that if they invest and succeed, they can make a fair profit. Otherwise, they’ll stop investing. – Steve Jobs

The stock market fell victim to another case of acrophobia last week as a surprisingly weak first quarter gross domestic product (GDP) report spooked investors and stocks tumbled from their lofty heights. After closing at record highs the previous week, both the S&P 500 Index and the Nasdaq Composite Index were unable to tack on additional gains. The damage could have been much worse had it not been for a broad-based rally on Friday that saw stocks advance about 1%. GDP expanded at only 0.2% during the first quarter, much worse than expectations for 1% growth, which was considered weak compared to 2.2% growth in the fourth quarter. There were many reasons for the disappointing GDP number. Harsh winter weather affected consumer spending while energy companies slashed spending in the face of low oil prices. A strong dollar and the since-resolved labor dispute at West coast ports also contributed to the weakness. Although the dollar weakened last week relative to other major currencies, a relatively strong dollar will likely continue to be a headwind. The Federal Reserve Open Market Committee (FOMC) meeting also may have contributed to some of the uneasiness among investors. The Fed concluded that the reasons for the first quarter slowdown were “transitory” and was confident that the economy would begin to expand at a moderate pace. But this upbeat assessment about economic growth only meant one thing to investors and that was an interest rate hike might occur sooner rather than later. Offering no timetable for raising rates, the Fed made it clear that its decision will be on a meeting-by-meeting basis. There will be two employment reports issued before the Fed’s next meeting in June, giving the central bank important data with which to make a decision. With the notable exception of social media stocks, first quarter earnings reports continued to be fairly good last week. So far this earnings season, profits have risen about 5% for companies that have already reported. However, revenue growth has been negative, which is a concern that will likely weigh on stocks until investors are assured that moderate economic growth is sustainable.                                                            

Last Week

The S&P/Case-Shiller Index of housing prices that is tracked in 20 U.S. cities rose 5% year-over-year in February. There was also good news in the data for pending home sales, which rose over 1% in March to the highest level since June 2013. The ISM manufacturing index was slightly above 50 in April, indicating continued expansion, but U.S. construction spending slipped to a six-month low. Both reports were troubling as they indicated a lack of strong momentum.

Jobless claims fell to only 262,000 last week, the lowest level since 2000, and it marked the eighth straight month that claims have remained below 300,000. This data sends a strong signal that the labor market is strengthening. There was also an increase in private sector wages and salaries in the first quarter as the Employment Cost Index rose 0.7%. Labor costs have now risen 2.6% in the twelve months ended in March.

For the week, the Dow Jones Industrial Average fell 0.3% to close at 18,024 while the S&P 500 Index slid 0.4% to close at 2,108. The Nasdaq Composite Index dropped 1.7% to close at 5,005. The Russell 2000 Index of small cap stocks posted the biggest loss as it declined 3.1%.

This Week

The only potential market-moving data on the calendar this week is the April employment report that will be released on Friday. The consensus estimate calls for 212,500 jobs to be created and for the unemployment rate to fall to 5.4% from 5.5%. Recent favorable data on initial claims for state unemployment benefits suggest that the jobs number should exceed at least 200,000. However, with only 126,000 jobs created in March, about half of the number that was expected, there promises to be some anxious moments ahead of the announcement.

Although the peak in the earnings season has come and gone, a number of prominent companies are still scheduled to report this week. Among the most notable are Allstate, MetLife, Dominion Resources, Sysco, Whole Foods Market, Berkshire Hathaway, Walt Disney, Devon Energy, Occidental Petroleum and Emerson Electric.

Portfolio Strategy

While it appears to be only a matter of time before the Federal Reserve begins to raise interest rates, other global central banks have just begun the stimulus process. Even though the Fed ended its bond-buying program last October and effectively ended quantitative easing, central banks in Europe and Japan began purchasing bonds and more than made up for the U.S. shortfall. Even China, the world’s second largest economy, got into the act last week with the announcement that its central bank would lower the reserve requirement ratio for banks in order to boost its slowing economic growth. The result of this global monetary easing has not been lost on global markets, either. Stock prices have climbed higher and bond yields have trended lower, not only in the U.S. but also in Japan and Europe. U.S. stocks have entered the seventh year of a bull market, with elevated valuations and the likelihood of lower expected returns in the foreseeable future. On the other hand, with the expectation that the European Central Bank (ECB) will continue easing into late 2016 and more stimulus measures likely from Japan, it is understandable why the European and Japanese markets have performed so well this year and are likely to continue to outperform. Along with lower valuations, rock bottom interest rates and favorable currency comparisons, these are the reasons why a well-diversified international fund with heavy exposure to Europe and Japan should be a part of every investor’s portfolio.