Stocks close lower on growth concerns, profit-taking

Chains of habits are too light to be felt until they are too heavy to be broken. – Warren Buffett

The stock market posted its worst week since February as investors once again fretted about global growth concerns and decided to take some profits after stocks rose 2% the previous week. First quarter earnings season also begins next week and investors might have concluded that the risk off trade might be the most prudent way to deal with what promises to be another quarter of weak earnings. To be sure, mixed economic data last week also confounded investors. The biggest surprise was the projection of the Atlanta Federal Reserve that first quarter U.S. gross domestic product (GDP) growth would only be 0.1%, much lower than had been previously expected. Minutes from the March Federal Reserve meeting also didn’t instill much confidence in investors. Most of the Fed policymakers seemed to be against raising interest rates at their meeting later this month. There also was disagreement about the level of inflation, with some arguing that inflation was firming while others thought that recent price increases were not sustainable. If nothing else, the Fed believed that a cautious approach to monetary policy was warranted in light of sluggish global growth. This continued dovish behavior, though, has raised questions about the effectiveness of Fed monetary policy in boosting growth and raised new concerns that the Fed may be rapidly running out of bullets to jump start the economy. As anxiety increased over the possibility of tepid economic growth, investors sought refuge in Treasury notes and bonds. The yield on the 10-year Treasury ended the week at 1.72%. Although stocks slipped last week, oil rose 8% to nearly $40 a barrel, a hopeful sign that oil prices might finally be stabilizing. The Energy Information Administration (EIA) reported a drop in oil inventories, oil imports declined and the number of U.S. oil rigs in service fell. For the time being, the strong correlation between stock prices and the price of oil seems to have been broken while stocks appear to be in a trading range, at least until revenue and earnings growth resume.

Last Week

What little there was in terms of economic data last week yielded mixed results and failed to give a clear picture on the state of the economy. Factory orders fell in February, in line with estimates, and the U.S. trade deficit widened more than expected in the month. On the other hand, the March ISM non-manufacturing index rose to 54.5 from 53.4 in February, a reading that shows solid expansion. Weekly jobless claims were at only 267,000, an indication of few layoffs and a labor market that continues to be strong and resilient.

For the week, the Dow Jones Industrial Average fell 1.2% to close at 17,576 while the S&P 500 Index lost 1.2% to close at 2,047. The Nasdaq Composite Index declined 1.3% to close at 4,850.

This Week

The March producer price index (PPI) and consumer price index (CPI) are expected to increase 0.3% and 0.2%, respectively, as inflation should be slightly higher than in previous months. March retail sales are also forecast to edge up slightly after being down modestly last month. March industrial production is expected to be flat and the April Michigan sentiment index should show that consumer confidence has increased as the job market remains strong and the stock market has erased all of its losses suffered back in January and February.

The Federal Reserve issues its beige book of economic conditions across regions of the country and China reports first quarter GDP as well as March retail sales and industrial production.

The unofficial start of the first quarter earnings season begins on Monday when Alcoa reports earnings. Financials will dominate the week after that report with JP Morgan Chase, Bank America, Wells Fargo, PNC Financial Services, Charles Schwab and CitiGroup all due to report.

Portfolio Strategy

Investors that are hoping for a rebound in first quarter earnings growth may be in for a rude awakening as earnings season begins this week. Profits for S&P 500 companies are expected to drop about 8% from the same period a year ago, making this the fourth consecutive quarterly earnings decline. While weak earnings are widely anticipated, analysts’ estimates of those earnings have also been reduced, providing an opportunity for companies to exceed lowered expectations. The correction in stock prices in January and February caused many analysts to recalibrate their earnings forecasts, but topping estimates in the quarter may not be enough to propel stocks higher. Part of the problem now is that the recent stock market rally has caused valuations to rise, leaving stocks vulnerable for a pullback on any earnings disappointments. Over the last ten years, the S&P 500 Index has traded at an average price earnings ratio of about 16, compared to a current valuation of about 18 times trailing earnings and 17 times expected earnings for 2016. Projected earnings for this year are predicated on profit growth resuming in the second half based on a weakening dollar, higher and stable oil prices, better GDP growth and stronger consumer and business spending. But all of these variables are wild cards that may or may not happen. The dollar could strengthen if the Federal Reserve raises interest rates prematurely and there is no guarantee that oil prices will stabilize at these levels, given the uncertainty of an oil output freeze or cut in actual production. Increased consumer and business spending in the second half of the year is dependent on better economic conditions, the price of gasoline remaining cheap and a continued strong labor market, all of which are question marks at the moment.