Stocks drop on global growth concerns, disappointing earnings

Know what you own, and know why you own it. – Peter Lynch

Unlike the prior week that produced mostly positive earnings surprises, disappointing earnings this past week led to losses of between 2% and 3% for the major stock averages. While the S&P 500 Index lost just over 2%, the Dow Jones Industrial Average slid 3% as United Technologies, IBM and Apple, stocks in the Dow all priced above $100 a share, reported lower than expected revenues. Even though its profit rose 38% and it eclipsed analyst earnings estimates by four cents a share, Apple was a victim of its own success as the Street had expected even better results. It was the smallest earnings beat by the world’s largest company by market capitalization in two years. Other high profile companies that reported disappointing earnings included Caterpillar, American Express and Microsoft. Weaker than expected revenue and earnings can be tolerated if future economic growth is assured of accelerating, but investors last week began to question the likelihood of this happening. Economic data in the U.S. recently has been mixed and even though preliminary manufacturing data released on Friday was slightly better, the same data in China produced far worse results. The weakness in commodity prices also has been disconcerting and could lead to macro concerns that the global economy is slowing down. The price of gold closed at a 5-year low last week, hurt by a stronger dollar, negative sentiment and the prospects of higher interest rates down the road. The month of September is fast approaching, when many observers expect the Federal Reserve to begin raising interest rates in an effort to normalize monetary policy. With persistent worries about a Fed rate hike and the strength of the global economy, the S&P 500 Index is likely to remain stuck in its recent trading range of between 2050 and 2130, having failed once again to break through last week and set new highs.

Last Week

The housing sector produced mixed results last week as U.S. existing home sales in June rose more than 3%, the highest level since February 2007. However, June new home sales fell almost 7% to a seven-month low. The labor market continues to remain solid as weekly jobless claims fell to 255,000, much better than expected and the lowest level since 1973. Leading economic indicators for June were up modestly.

Of approximately 175 S&P 500 companies that have reported second quarter earnings so far, 77% have beaten earnings estimates while only about 50% have beaten revenue estimates. Clearly, top-line growth is a concern and could be problematic for the stock market as it attempts to break out of its recent trading range.

For the week, the Dow Jones Industrial Average retreated 3% to close at 17,568 while the S&P 500 Index dropped 2.2% to close at 2,079. The Nasdaq Composite Index fell 2.3% to close at 5,088. 

This Week

There will be several key pieces of economic data released this week, including durable goods for June, which are expected to jump over 3%, much better than the previous month. Second quarter gross domestic product (GDP) will also be reported and the preliminary indication is for growth of 2.8%. The Chicago Purchasing Managers Index (PMI) is expected to be slightly above 50, a level that equates to continued expansion.

The Federal Reserve meets for two days to review monetary policy and discuss interest rates. While investors will again be looking for clues about the timing of a Fed interest rate hike, it is likely that Fed Chair Janet Yellen will say that any decision will be dependent on the release of future economic data.

It promises to be another busy week for second quarter earnings reports as blue chip companies such as Merck, Pfizer, Amgen, Ford Motor, DuPont, Chevron, Exxon Mobil, Berkshire Hathaway and Procter & Gamble are all scheduled to report.

Portfolio Strategy

News last week that China wasn’t holding as much gold as everyone first thought was just another reason for investors to dump the precious metal. With the price of gold now trading at below $1,100 an ounce, investors seem to have thrown in the towel and are selling their gold-related holdings regardless of the price. Under normal circumstances, gold and other commodities act like an insurance policy as these investments are not correlated with equities and tend to behave differently than stocks. In periods of high inflation or during uncertain times that involve geopolitical risk or financial crises, gold tends to do well while stocks tend to perform poorly. With inflation running at less than 2%, the dollar getting stronger and no impending global geopolitical risks, it’s no wonder that gold’s luster has become tarnished. Interest rates have also been at historically low levels since the U.S. financial crisis of 2008 and are forecast to go higher when the Federal Reserve begins to raise the federal funds rate. Whether it happens in September, December or beginning in 2016, it will most definitely happen sooner or later. When rates do rise, investors will be inclined to purchase fixed income investments or high dividend-paying stocks since gold doesn’t pay any interest or dividends. If the dollar strengthens further and interest rates begin to rise sooner, it’s possible that gold could trend even lower. As a rule of thumb, gold and other commodity investments should comprise only about 2% or 3% of an investor’s portfolio and definitely no more than 5%.