Weak GDP growth, tech earnings send stocks lower

Commodities tend to zig, when the equity markets zag. – Jim Rogers

Both the S&P 500 Index and the Dow Jones Industrial Average ended the week on a sour note and closed lower by more than 1% as several factors seemed to unnerve investors. The technology-laden Nasdaq Composite Index dropped even more as disappointing earnings from Apple and other tech companies weighed heavily on the index. Among the reasons for the poor showing in stocks was weak economic data, particularly first quarter gross domestic product (GDP) growth of only 0.5%. This was the slowest rate of growth since the first quarter of 2014 as business investment recorded the weakest growth since the Great Recession. The weakness was magnified by the fact that even the Euro-zone posted stronger first quarter GDP growth, a better than expected 0.6%. The weak data left the Federal Reserve Open Market Committee (FOMC) no choice but to leave interest rates unchanged, citing economic activity that has slowed and consumer spending that has moderated. The Fed also stated that inflation was still running below its 2% target and that it was monitoring global economic and financial developments. Among the Fed’s chief concerns is slowing global growth as the International Monetary Fund (IMF) recently revised lower its estimate for growth. Positives in the U.S. economy such as steady job growth and an improving housing market were offset by a slowdown in business investment and exports. Investors were also disappointed by the decision of the Bank of Japan (BOJ) to make no changes to its monetary policy, including no change to the amount of its asset purchase program and no change to negative 1% interest rates on some deposits. Investors were clearly hoping for additional stimulus measures given Japan’s sluggish economy. Although Facebook and Amazon bucked the trend and shattered Wall Street earnings estimates last week, Apple’s quarterly revenue dropped 13%, the first decline since 2003, as earnings were also less than expected. Other technology stocks followed Apple’s stock lower as earnings generally failed to meet expectations, leaving their stock prices vulnerable given their loftier price earnings multiples and lack of dividend support.

Last Week

Housing data released last week was mixed as March new home sales declined by 1.5% but pending home sales for the month rose by the same percentage. The weakness in new home sales was confined mostly in the West region as sales rose in the Midwest and South, implying that the housing recovery is still intact buoyed by the strong labor market and low mortgage rates. Durable goods orders for March rose nearly 1%, less than expected, while the Chicago purchasing manager’s index (PMI) for April fell slightly and was also below expectations. The March personal consumption expenditures (PCE) price index, the Fed’s preferred inflation measure, edged up slightly and for the 12 months through March, the core (excluding food and energy) PCE index rose 1.6%, less than the Fed’s target inflation rate of 2%.

Exxon Mobil’s credit rating was downgraded to AA+ from AAA, leaving only Microsoft and Johnson & Johnson as the only two U.S. companies with a AAA rating.

For the week, the Dow Jones Industrial Average dropped 1.3% to close at 17,773 while the S&P 500 Index also lost 1.3% to close at 2,065. The Nasdaq Composite Index declined 2.7% to close at 4,775 as technology stocks were particularly weak.

This Week

Both March construction spending and factory orders should rebound and post modest increases after declining slightly in February. The April Institute of Supply Management (ISM) Manufacturing PMI is expected to be in line with the reading in March and show that the manufacturing sector is still expanding. The April employment report released on Friday is expected to show an increase of about 200,000 new jobs while the unemployment rate should remain at 5%.

So far first quarter earnings are down from the year ago period but nearly 75% of the companies that have reported earnings have beaten analysts’ reduced estimates. Among the most prominent companies on this week’s agenda are American International Group, MetLife, CBS, Time Warner, Archer Daniels Midland, Kellogg, Pfizer, Merck, CVS Health, Duke Energy, Devon Energy and Occidental Petroleum.

Portfolio Strategy

While the Federal Reserve has revised its forecast for the number of interest rate hikes this year from four to two, it’s conceivable that there might only be one rate hike and not until December. The Fed may be intentionally keeping the federal funds rate low in order to prevent the dollar from gaining strength and hurting profits of U.S. multi-national companies. This has been no easy task as both the European Central Bank (ECB) and the Bank of Japan (BOJ) have resorted to negative interest rates in an effort to revive their slumping economies. A weaker dollar has also helped stabilize the price of oil at higher levels, boosting the prospects for energy companies. The next FOMC meeting is scheduled for mid-June, just prior to the Brexit vote in Great Britain on whether or not they will decide to leave the European Union. The Fed might want to hold off given the uncertainty and consequences for financial markets if the decision is to leave. The next meeting after that occurs in late July and is sandwiched between the Republican convention and the Democratic convention, another possible excuse to postpone a rate hike. With FOMC meetings scheduled in late September and again in early November, the timing then might be too close to the presidential election. In light of the risks and uncertainties of raising interest rates at these critical times, the Fed might be forced to forego a rate hike until its December meeting, unless stronger economic growth or higher inflation force the Fed to act sooner.