David Joy: Treading water

Last week stocks suffered through their worst weekly performance since November, as the S&P 500 fell 2.1%, trimming its return on the year to 9.0%. After reaching a new high of 1593 on April 11, the S&P pulled back through last Thursday, and in the process closed below its 50 day moving average. But stocks did rebound last Friday, limiting the damage, and were higher well into afternoon trading on Monday as well. The extent of the pullback between April 11 and 18 was just 3.2%, and in terms of magnitude is reminiscent of the pullback between Feb. 18 and 25 when stocks fell 2.8% in response to an apparent misinterpretation of the Fed’s Open Market Committee meeting minutes.

The recent minor correction resulted from weaker economic data, reinforcing the notion that fundamentals do matter, that it is not all just about the Fed. Indeed, the latest round of data confirms this weakness. We have subsequently learned that manufacturing data from the Philadelphia Fed region softened in March, leading indicators actually fell, and existing home sales disappointed as they, too, declined from the prior reading. In response, as investors digest this economic softness, stocks have treaded water, trading at levels seen five weeks earlier. This pattern contrasts sharply with the robust ascent between year-end and mid-March, during which time stocks rose 9.4%. Since then they are basically flat.

Beyond questions about the strength of the economy, we are now in the middle of earnings season, and so far, here too, the news has been mixed. Actual results themselves have been decent. According to ISI, 20% of the S&P 500 companies have reported, and 67.3% have exceeded their expected earnings, slightly better than the long-term average of 66%. Regarding revenues, 64.5% of companies so far have exceeded expectations. But, as they point out, corporate guidance has been poor, and second quarter earnings expectations are being revised somewhat lower as a result. Of course, there is a long way yet to go before full first quarter results are complete, but the prevailing mood is undoubtedly less ebullient than it was just one month ago. It is certainly encouraging that the weakness in stocks has thus far been well contained. But the recent sideways trend in stocks is likely to continue until the economic data either improves or confirms the slowdown, and corporate guidance does the same. Until then, the battle for sentiment will be fought to a draw.

On the economic front, the best news of the week is likely to come on Friday when the advance estimate of first quarter GDP will be released. The consensus expectation calls for growth at an annualized pace of 3.0%. Unfortunately for investors, it is unlikely to do much to clarify the current uncertainty, as it will be viewed as yesterday’s news. More important will be the current reports for new home sales, durable goods orders, and initial jobless claims. Looking further ahead, it is next week that contains a host of potentially market-moving releases, including the results of the latest Fed meeting, both ISM reports, and April employment. On the earnings front, as this week rolls along we will hear from United Technologies, Apple, Ford, Coca-Cola, Exxon Mobil, 3M, UPS, Eli Lilly, Bristol-Myers Squibb, Dow Chemical and Chevron among others. And as with economic data, in addition to actual results, pay close attention to what corporations say about the months immediately ahead.

Lastly, while stocks are fractionally lower this month, bonds are higher. The Barclays Aggregate index is up 0.8% in April, and is higher on the year by 0.7%. The Barclays High Yield index is up 0.7% in April and 3.6% for the year. Just a few short weeks ago bonds were left for dead. Since then they have been resuscitated, as the economic data has softened and the deflation word has once again seeped into the conversation. Those who have maintained their asset class diversification are once again smiling.

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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill. 

The Barclays Capital U.S. Aggregate Bond Index is an unmanaged index composed of securities from the Barclays Capital Government/Corporate Bond Index, Mortgage-Backed Securities Index and the Asset-Backed Securities Index. Total return comprises price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization.

The Barclays Capital High Yield Municipal Bond Index is an unmanaged index made up of bonds that are non-investment grade, unrated, or rated below Ba1 by Moody's Investors Service with a remaining maturity of at least one year.

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