Stocks post modest losses on concern over earnings

To be an investor you must be a believer in a better tomorrow. – Benjamin Graham

Stocks posted modest losses for the second consecutive week as uncertainty over the third quarter earnings season, the upcoming presidential election and the timing of the next Federal Reserve interest rate hike seemed to rattle investors. The S&P 500 Index posted a loss of 1% for the week as economic data was also generally mixed. Alcoa began the start of earnings season by missing analysts’ estimates badly and lowered its revenue forecast for the balance of the year. By week’s end, though, JP Morgan Chase, CitiGroup and Wells Fargo all announced better than expected quarterly revenue and earnings, but that was not enough to calm investors’ jittery nerves over the deluge of upcoming profit reports. Of concern is the fact that the stock prices of these banks barely budged on their positive news. The outcome of the U.S. presidential election on November 8^th also was a concern as fears increased that the Democrats could take control of the Senate and possibly the House, although the latter is definitely a long shot. Minutes from the most recent Federal Open Market Committee (FOMC) meeting only added to the uncertainty as Fed officials seem to be divided on their views of the economy and monetary policy. Hawks worry that a delay in raising interest rates might necessitate more aggressive hikes later on, which could send the economy into a recession. Doves, on the other hand, point to the fact that GDP growth in the first half of the year was only about 1% and that inflation remains subdued. All Fed officials felt that the economy was improving but continue to worry about business investment. Even Fed Chair Janet Yellen weighed in last week in a speech in Boston by saying that it might be useful for policymakers to consider the benefits of a “high pressure economy” to increase inflation. Her argument was that weak demand and abundant supply in the economy were responsible for muted inflation and sluggish growth. Other factors that weighed on stocks last week were weak data out of China and a stronger dollar. China’s exports plunged 10% in September and were symptomatic of weak global growth while a stronger dollar makes U.S. products more expensive in foreign markets and leads to lower profits. But the focus for the stock market over the next few weeks will be squarely on quarterly earnings as both the election, the Federal Reserve and economic data will likely take a back seat.

Last Week

U.S. retail sales rebounded strongly in September, rising 0.6% and matching estimates, as automobile sales were strong as were sales at restaurants and gas stations. Weekly jobless claims also fell to 246,000, a level not seen since 1973, as there is no sign of rising layoffs in the economy. On the inflation front, import prices rose less than expected in September and the producer price index (PPI) rose 0.3% after being unchanged in August. The Index of Consumer Sentiment in October dropped as uncertainty over the presidential election probably was a factor.

For the week, the Dow Jones Industrial Average dropped 0.6% to close at 18,138 while the S&P 500 Index declined 1.0% to close at 2,132. The Nasdaq Composite Index lost 1.5% to close at 5,214.

This Week

Both September housing starts and existing home sales are expected to increase modestly over the numbers that were reported in August. The consumer price index (CPI) for September is forecast to increase 0.3% while leading economic indicators for September are also expected to rise slightly after a small decline in August. Finally, industrial production should edge higher after falling in August.

In overseas news, the European Central Bank (ECB) meets to discuss monetary policy and the direction of interest rates while China reports third quarter gross domestic product (GDP), which is expected to increase 6.7 %.

This promises to be a busy week for earnings as prominent companies scheduled to report include IBM, Intel, Microsoft, Bank of America, Goldman Sachs, Morgan Stanley, American Express, Johnson & Johnson, Abbott Labs, Verizon, GE, Honeywell, Illinois Tool Works, Union Pacific, McDonald’s, Walgreen, Schlumberger and Halliburton.

Portfolio Strategy

Investors are justified in worrying about the upcoming earnings season as profits are expected to drop by about 0.7%, making this the sixth consecutive quarterly decline in earnings. Much of the recent weakness in corporate earnings, though, can be attributed directly to the energy sector as profits have plunged as the price of oil has fallen. Excluding the energy sector, corporate earnings have actually risen in three of the past four quarters and have been fairly good. Stock valuations may be stretched at 17 times estimated forward earnings forecasts but these valuations should take into account more than just earnings growth. The fact that interest rates are at historic lows and companies are returning cash to shareholders in the form of increased dividends and stock buybacks should also be taken into consideration. When this occurs, stocks are not as pricey as one might think, especially when one considers that the 25-year average forward price earnings ratio for stocks is only about 16. Although third quarter earnings may be disappointing on an absolute basis, relative to analysts’ lowered estimates, earnings are likely to come in higher and be supportive of current stock prices.