S&P 500 Index rebounds despite mixed earnings results

We want these assets to be productive. We buy them. We own them. To say we care only about the short term is wrong. What I care about is seeing these assets in the best hands. – Carl Icahn

Despite weak earnings results from some bellwether companies last week, the S&P 500 Index managed to recover as investors sought to buy stocks on weakness after the previous week’s slide. To be sure, overall second quarter earnings results so far have generally exceeded lowered expectations. Revenue growth, however, has been somewhat disappointing as only about half of the companies have beaten estimates on the top line. Early in the week, strong profit reports from Ford, UPS and Pfizer set a positive tone for the stock market and Pfizer added to the bullishness by raising its guidance going forward. By week’s end, though, two of the largest integrated oil companies in the world, Exxon Mobil and Chevron, reported much weaker than expected earnings due to low oil prices. Procter & Gamble also reported lackluster earnings on weak sales caused by the strong dollar. Economic data also confused and confounded investors last week and failed to give a clear picture of the economy. Non-defense capital goods orders rose, suggesting that business spending was improving. But durable goods orders excluding the transportation sector rose only modestly, implying that manufacturers are still struggling with a strong dollar and slow economic growth. Second quarter gross domestic product (GDP) was up 2.3% on strong consumer spending, but this trailed most economists’ forecasts of about 3% growth. First quarter GDP was revised higher to show a slight gain from a previously reported slight contraction. Results from the Federal Open Market Committee (FOMC) meeting were also inconclusive. The Fed left interest rates unchanged, which was no surprise, and commented that economic growth was moderate and jobs gains were solid. But inflation has been running below the Fed’s target and both business investment and net exports have been soft. Given these mixed signals, the jury is still out as to whether or not the economy is strong enough to justify an interest rate hike by the Fed in September.

Last Week

Mixed data from the housing sector saw U.S. home prices rise about 5% in May according to the S&P/Case-Shiller Index while pending home sales fell almost 2% in June. Weekly jobless claims fell to 267,000 and now have stayed below 300,000 since May, the longest run below this threshold in 15 years. If this strength in the labor market is reflected in the July employment report, it certainly would give the Fed a reason to hike rates in September.

The Employment Cost Index, a measure of labor costs, registered the smallest increase in the second quarter in 33 years. In the 12 months ended in June, labor costs rose only 2%. U.S. consumer sentiment also fell to the lowest level since May, most likely due to the disappointing pace of economic growth.

For the week, the Dow Jones Industrial Average added 0.7% to close at 17,690 while the S&P 500 Index climbed 1.2% to close at 2,103. The Nasdaq Composite Index gained 0.8% to close at 5,128. 

This Week

The most important piece of economic data this week will come on Friday when the July employment report is released. U.S. nonfarm payrolls are expected to increase by 225,000 and the unemployment rate should remain unchanged at 5.3%. Other data this week include the ISM manufacturing index, which is expected to be slightly higher with a reading comfortably above 50, indicating continued expansion. June factory orders and construction spending also should report healthy increases.

In overseas news, the financial markets in Greece will reopen with some trading restrictions after being closed while the terms of its bailout agreement were being hammered out. The Bank of England will likely keep its interest rates the same while no change is seen in the Bank of Japan’s interest rate policy, either.

Among the most notable companies scheduled to report second quarter earnings this week are Allstate, Walt Disney, Kellogg, Archer Daniels Midland, Devon Energy, Duke Energy, Time Warner, Emerson Electric and CVS Health.

Portfolio Strategy

When the government announced last week that second quarter GDP rose 2.3%, it also said that consumer spending was strong, rising almost 3%. To measure the effects of inflation on consumer spending, the price index for personal-consumption expenditures, or PCE, is also published. In the second quarter, the PCE price index rose at an annualized rate of 2.2%. According to most economists, this is the inflation measure that the Fed primarily uses to determine how close inflation is to its 2% target. The Federal Reserve also has specific goals for the labor market and, in its remarks last week, commented that job gains were solid and that the unemployment rate declined slightly. In effect, both the inflation number and the statement about the labor market would seem to indicate that both conditions have been met for the Fed to raise the federal funds rate. Although 2^nd quarter GDP was weaker than expected, the fact that 1^st quarter GDP was revised upward could also influence the Fed’s decision. With no meeting scheduled in August, the Federal Open Market Committee (FOMC) will not convene again until September 16th and 17th. Based on this inflation and jobs data, a case could be made that the Fed will hike rates in September, especially if the price and employment data between now and then confirm these numbers.

The next Weekly Market Commentary will be sent out on Monday August 17^th as I will be on vacation this week and the first part of the following week.