Bob’s Journal

Earnings season for the second quarter is over, so you should be ready for stock prices to decline.

I know that sounds counterintuitive, since the economy is strong and growth might be increasing. This earnings season was a positive one with about two-thirds of companies reporting results exceeding estimates for earnings and revenue.

Also, more companies raised their guidance for the rest of the year than lowered it. So, why should stock prices decline?

It is not widely known but there has been a clear pattern in the market indexes. Since 2013, as earnings are being reported, the indexes rise. Once earnings season is over, stocks either lose value or stagnate. The only exception has been in early 2018 when the earnings were being reported for the last quarter of 2017. During that earnings season, stock prices declined.

The result is that about 80% of stock returns since 2013 have occurred during earnings seasons. Perhaps this is because in the aftermath of the financial crisis investors are more conservative. They’re happy to see forecasts that earnings are going to rise sharply. But they won’t put their money on the line until they actually see the higher earnings reported.

That’s a reversal of the market’s usual role of anticipating events. The old adage was, “Buy on the rumor, sell on the news.” Since 2013, investors have been waiting for the news.

Another development is that stock prices aren’t responding fully to positive earnings reports. Stock prices have been rising less sharply than earnings the last few quarters. The result is that market valuations have been declining. Stocks are less overvalued than they were a year ago.

There’s another interesting perspective on recent earnings seasons.

When companies beat their earnings estimates, their stock prices usually rose, but by fairly modest amounts. This earnings season, the average stock that beat its estimate increased 1.8% on the first trading day following the announcement. The reaction varied by sector, with telecommunications and consumer staples companies each rising more than 5% following positive earnings. But prices of real estate and utility sector companies barely budged.

Yet, when companies issued disappointing earnings, their stocks were punished. On average, a stock lost 3.6% after the company announced earnings below expectations. Health care company stocks were hurt the most, losing almost 8% after issuing disappointing earnings.

One more bit of data about earnings is that for the second consecutive quarter, the percentage of companies beating their estimates was less than the previous quarter. My take is that investors and financial assets are responding to tighter monetary policy. That policy has been partly offset by looser fiscal policy.

But investors have been uncertain how the two policies, monetary and fiscal, would balance out, so they’re cautious. They wait for good news to be reported before investing and sell quickly on bad news.

The Data

The Small Business Optimism Index from NFIB increased to 107.9 from 107.2. That’s the second-highest level ever for the index. The highest level was in September 1983. Business owners expect sales to increase. Finding quality labor remains the biggest problem by far for most small businesses.

There was mixed news in retail sales. Sales for the latest month increased a strong 0.5%, and they increased 0.6% after excluding autos. But last month’s sales increase was revised down to 0.2% from 0.5%, and sales after excluding autos were revised down to 0.2% from 0.4%.

Manufacturing put out some mixed reports this week.

The Empire State Manufacturing Survey increased to 25.6 from 22.6. Expectations were for a decline. New order growth was very strong. Unfilled orders and delivery times continue to increase, indicating the sector is stretched beyond capacity.

But the Philadelphia Fed Business Outlook Survey declined to 11.9 from 25.7. Analysts expected a decline but not one this severe. This is the lowest level for the index in almost two years. The current level still indicates growth, and the six-month outlook component of the survey was very positive.

There was more mixed news from the Industrial Production report. The headline production number increased only 0.1%. But the manufacturing component increased 0.3%, following last month’s 0.8% increase. The headline number was distorted by a couple of factors. Mining volume declined, which is unusual. Also, utility production declined, which probably was due to weather.

The quarterly productivity reports delivered some positive news. Productivity increased by 2.9%, well above last quarter’s 0.4%, which was revised down to 0.3%. In addition, nominal compensation declined. So, unit labor costs declined 0.9%. That’s all good news for businesses.

Home builders continue to be optimistic, but with some reservations. The Housing Market Index from NAHB declined to 67 from 68. Though a strong number, it’s the lowest since September 2017. The index peaked in December and has been declining fairly steadily. Builders worry about higher construction costs leading to affordability problems. The higher costs are due to both tariffs and shortages of skilled labor.

Those concerns likely are why housing starts were disappointing. Last month’s number was revised significantly lower from the initial report. This month’s starts were 0.9% above last month’s revised level but still were well below expectations. Over 12 months, starts are down 1.4%. But permits for new housing increased 1.5% in the latest month and are up 4.2% over 12 months. That indicates starts are disappointing because of shortages of labor and materials. Higher materials costs, especially for lumber, also are holding back starts.

There’s not much new in inflation. The Consumer Price Index rose 0.2% for the latest month, giving it a 2.9% increase over 12 months. Excluding food and energy, the increases were 0.2% and 2.4%, respectively.

New unemployment claims declined another 2,000 to 212,000. Both the weekly number and four-week average are very close to their historic lows reached earlier this year.

The Markets

The S&P 500 declined 1.29% for the week ended with Wednesday’s close. The Dow Jones Industrial Average fell 1.51%. The Russell 2000 lost 0.88%. The All-Country World Index dropped 2.74%. Emerging market equities plummeted 6.21%.

Long-term treasuries returned 1.73% for the week. Investment-grade bonds rose 0.56%. Treasury Inflation-Protected Securities (TIPS) added 0.61%. High-yield bonds lost 0.31%.

On the currency font, the dollar rose 1.75%.

Energy-based commodities fell 2.65% for the week. Broader-based commodities lost 4.01%. Gold declined 3.10%.

Bob’s News & Updates

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