April 15, 2012

The Big Picture

The stock market is driven by two factors: interest rates and earnings.  Low interest rates and rising earnings support stock prices.  But what happens when rates are as low as they can go?  And what happens when earnings results differ from expectations? 

After a stellar first quarter in which the Dow Jones Industrial Average gained 8.1%, the NASDAQ soared nearly 19% and the S&P 500 added 12% for its best first quarter since 1998, the major stock market averages hit an air pocket last week and posted the worst weekly performance of the year.   

Conventional wisdom puts some of the blame on China, which reported weaker than expected economic growth.  If China slows, can the global recovery be sustained?   Others fault the Federal Reserve Banks inability to stimulate the economy despite several rounds of quantitative easing.  And then there are the skeptics that believe the recent stock market gains were all “blue smoke and mirrors”, those who “buy the rumors and sell the facts”. 

To paraphrase Shakespeare, the investor doth protest too much, methinks.  First, the U.S. economy is three times as large as China’s and while we may be a mature economy, we are far from moribund. China’s leap from poverty to a market-based economy has exaggerated its impact on the global stage and masked the fact that it still is not a democracy.  The move this weekend to widen the Yuan’s trading band versus the dollar is just one step toward allowing market forces to rebalance the Chinese economy instead of political forces, but its by no means a done deal. 

Secondly, the news that the Federal Open Market Committee minutes suggested no more quantitative easing seemed to disappoint those who felt that QE1 and QE2 were ineffective.  That was before the most recent unemployment figures were released.  For those passive-aggressive investors addicted to liquidity, the weaker-than-expected labor market increased the calls for more monetary stimulus.  But the economy still shows signs of strength, if auto sales are any indication, reducing the odds of more easing. 

Lastly, the expectations for first quarter earnings are so low that it won’t be difficult for results to beat consensus.   The nation’s largest bank, JP Morgan Chase, and the nation’s largest mortgage lender, Wells Fargo, both beat market earnings-per-share expectations and reflect a financial sector that has recovered from the meltdown of 2008.  However, the financial sector was the best performing sector in the first quarter, hence the selloff on the news. 

But the underlying trend is hard to deny.  Both banking giants showed improved credit card activity and a drop in delinquent mortgage loans.  An improving economic outlook will continue to support operations and earnings in the financial and other economically sensitive sectors. 

I, Investor 

With the bulk of first-quarter earnings reports due out over the next few weeks, expectations trump economic releases.  But with the bar set so low, data may garner some attention.    March retail sales activity kicks off this week, coupled with February business sales and inventory data on Monday.  Tuesday sees March housing starts and permits figures along with industrial production and capacity utilization rates.

Thursday’s weekly jobless claims share the spotlight with March existing home sales and leading economic indicators as well as the Philadelphia Fed’s April business survey. 

The week of March 23-27 is dominated by a two-day Federal Open Market Committee meeting, policy statement and Chairman Bernanke’s press briefing afterwards.  March new home sales and durable goods orders are also on the docket, as is consumer confidence and sentiment readings for April.  The week wraps up with the advanced look at first-quarter GDP and employment cost index. 

As the market grapples with its expectations, look for more sideways consolidation.  Financial giants American Express and Goldman Sachs are due to release earnings as are tech bellwethers Intel, IBM, E-Bay and Yahoo.  Whether they and other S&P 500 companies miss or beat expectations will most likely determine the next near-term move.

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