Stocks rebound on economic data, earnings

Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and mutual funds altogether. – Peter Lynch

All of the major stock averages rallied more than 2% last week as economic data continued to show signs of improvement and first quarter earnings reports have not been as bad as expected. More and more, it appears that extreme weather-related factors were definitely the culprit in slowing the economy during the first quarter. This was clearly evident in the economic data released by the government last week. Retail sales in March registered their largest increase since September 2012 while industrial production rose more than anticipated. The Federal Reserve also said that capacity utilization increased and is now just below 80%, a level that usually signals the need for additional hiring and investment by companies and a sign that the economy is poised to accelerate. The Fed Beige Book even confirmed this trend by stating that the economy is gathering momentum throughout the U.S. And if that was not enough, Fed Chair Janet Yellen chimed in with dovish remarks indicating that interest rates will likely remain low for a “considerable time” as the economy mends and while inflation remains below its target of 2%. Corporate earnings reports for the first quarter also contributed to the rebound in stock prices as blue chips such as Coca Cola, Johnson & Johnson, Goldman Sachs and Morgan Stanley all beat their earnings estimates. While the earnings season still has a long way to go, there might be life in this old bull yet as the economy improves and earnings begin to re-accelerate.

Last Week

As indicated above, March retail sales were strong across the board as they posted a gain of 1.1%, a sign that the economy is emerging from its long winter hibernation. Only gasoline stations and electronics stores reported declines during the month. The consumer price index (CPI) rose 0.2% in March, slightly higher than expected but still low as wage growth remains modest and retail competition keeps prices in check. While housing starts improved during the month, they were below estimates. Expectations are for the housing sector recovery to speed up in the coming months.

China’s GDP growth slowed to 7.4% in the first quarter, which was the slowest level in 18 months and slower than the previous quarter. To ensure sufficient employment for its labor force, China needs to grow at least 7.2%.

For the week, the Dow Jones Industrial Average gained 2.4% to close at 16,408 while the S&P 500 Index rose 2.7% to close at 1,864. The technology-laden Nasdaq Composite Index climbed 2.0% to close at 4,095. With the exception of the Nasdaq, the markets regained everything they had lost during the previous week.

This Week

In a sparse week for economic data, both existing home sales and new home sales for March should lend support for continued improvement in the housing sector. Durable goods orders for February should also increase about 2% while the April Michigan consumer sentiment index should show continued confidence among consumers with a higher reading than last month.

Earnings reports for the first quarter will continue to dominate the headlines as a slew of companies are slated to make their announcements. Among some of the most prominent include 3M, Boeing and Caterpillar in the capital goods sector, McDonalds and Procter & Gamble in the consumer sector, Microsoft and Apple in the technology sector, Verizon and AT&T in the telephone utilities sector and Eli Lilly and Amgen in the health care sector.

Portfolio Strategy

In order for stocks to trade higher and for equity valuations to be justified, earnings growth must improve in a sustainable fashion. The consensus of Wall Street analysts is for earnings growth of just 1% for the first quarter, a low hurdle rate that most companies have beaten so far. With a few notable exceptions, such as JP Morgan Chase, Google and IBM, earnings results have been encouraging despite these low expectations. Historically, the month of April has been a good one for stocks and earnings season also has generally been favorable for stock market performance. Based on last week’s upbeat economic data, investors have turned optimistic about the prospects for growth in the coming quarters. While everyone agrees that the harsh winter impacted the economy, what is less clear is what effect more normal weather has had on sales and production. One can expect a certain amount of business to be lost due to the weather but delayed economic activity or pent-up demand could also positively affect second quarter results. As important as the quarterly earnings results are, equally important is the positive outlook by corporations about future earnings growth and their assessment of the economy going forward. The stock market is a forward-looking mechanism and only better earnings growth will enable this bull to run awhile longer.