The major market indices finished the week modestly lower as concerns over the state of the economic recovery outweighed the strong start to second-quarter earnings season.
Last week several bellwether companies beat earnings expectations and issued upbeat forward guidance. Such positive news would usually be a catalyst for market outperformance; however, the data seems to conflict with recent economic reports that suggest the economic recovery may have hit a wall.
While we continue to believe that earnings season could be a segue to a period of near-term market stabilization, the growing confusion between what corporations are telling us and what the economy is saying could lead to some choppy trading in the near term.
Q2 earnings: So far, so good. As of Friday, 49 members of the S&P 500 have reported quarterly results, with overall earnings up 131% on a year-over-year basis. Approximately 80% of the companies have beaten analyst expectations while 18% have fallen short. While still early in the reporting season, the beat rate is significantly better than the historical 61% average. The strong results have been fuelled by the technology, materials and consumer discretionary sectors. When all is said and done, second quarter earnings for the S&P 500, according to Bloomberg data, are expected to rise 36%.
Fed pares back growth expectations. The minutes from the June 22/23 Federal Open Market Committee (FOMC) meeting were released last week. While the Committee acknowledged that the risk to the economic outlook had "shifted to the downside," it was far from convinced that further stimulus was needed. The Committee did reiterate its concerns over the high level of unemployment and expressed concerns over the rising risk of deflation.
As part of the FOMC minutes, the Committee also released its updated assessment on the economy. The FOMC said it now expect softer than originally forecast economic growth and a decline in pricing pressure. It also warned the unemployment rate would fall at a slower-than-expected rate in the coming years. For 2010 it sees GDP growth within a range of 3% to 3.5% versus its prior estimated range of 3.2% to 3.7%. Inflation is expected to remain subdued and fall within a range of 1% to 1.1%. Looking ahead, policymakers are forecasting 2011 GDP growth of 3.5% to 4.2% and between 3.5% and 4.5% in 2012.
While the reductions were not surprising in light of the recent softness in economic data, what is surprising is that, unlike almost all private forecasters, the Federal Reserve is forecasting a continuation of positive sequential growth. Using the average of the Fed's range, they are forecasting GDP growth of 3.25%, 3.85% and 4.0% in 2010, 2011 and 2012, respectively. Private forecasters on the other hand are forecasting growth of 3.1% this year and then a decline in the growth rate to 2.9% in 2011.
| Index | Closing Price 7/16/2010 |
Week Ending 7/16/2010 |
Year to date through 7/16/2010 |
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| Dow Jones Industrial Average | 10097.90 | -0.98% | -3.17% | ||
| Wilshire 5000 Total Market | 10965.29 | -1.38% | -4.00% | ||
| S&P 500 | 1064.88 | -1.21% | -4.50% | ||
| NASDAQ Composite | 2179.05 | -0.79% | -3.97% | ||
| S&P/TSX Composite | 11569.65 | -0.01% | -2.45% | ||
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Financial reform. The U.S. Senate, by a 60 to 39 vote, passed the Financial Reform Bill last Thursday. While the regulatory bill (all 2,300 pages of it) sets the stage for a major overhaul of the financial services industry, the full impact will likely take years to be felt. The bill is structured to put more power in the hands of regulators, who in turn will be responsible for writing the underlying rules and regulations. The bill moves to the President's desk and is expected to be signed into law by the end of this week.
More stimulus on the way? The recent softness in the data is once again raising the chorus for another round of stimulus to try and help revive the sagging economy. If this weren't an election year (mid-term) one could say that the likelihood of additional stimulus would be very low, but with the current administration floundering in the polls, the full court press could be coming. Stay tuned.
China's economic soft patch? Not only is U.S. data shifting into low gear, but a report last week showed China's GDP falling to 10.3% in the second quarter from 11.9% in Q1. While a 10%-plus rate of growth is nothing to sneeze at, the rate did fall short of the 10.5% rate forecast by economists. The Chinese government has been intentionally trying to slow growth for several quarters in an attempt to prevent bubbles from developing in certain segments of its economy. So, while the pace of slowing growth in China was surprising, the fact that growth is actually slowing should not be.
Eurozone. In a sign that the eurozone continues to be on the mend, Spain, Greece and Portugal all held very successful debt auctions last week. While the interest rates that these countries were forced to pay was elevated, the strong demand is likely a signal that investors are becoming more confident that a fiscal crisis has been averted. As mentioned last week, if a country's currency represents a proxy for its economic health and fiscal policies, then the fact that the euro continues to strengthen underscores the progress being made in Europe.
Looking ahead - Stress tests. The results from the stress tests on European financial institutions are due out this Friday. While there has been strategic telegraphing that most banks will breeze through the test, I believe many investors are still waiting to see if any skeletons emerge from out of the closet. This week's economic calendar will be heavy on housing data, with housing starts, building permits, mortgage applications and existing home sales on the docket. The earnings calendar will get top billing over the next two weeks as approximately 290 members of the S&P 500 are scheduled to report results.
