The Market is Swinging from Sick to Healthy

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Companies and stock analysts again played the earnings expectations game well, and that’s pushed stock prices higher. Only a few months ago, investors worried about a hard landing in China, continued weakness in Europe and Japan and a recession in the United States. That led analysts to slash their earnings estimates for the quarter and the year. Companies also bad-mouthed their future prospects. Stocks declined sharply in January and the first half of February.

As the first quarter closed, expectations were low. Bloomberg.com said this was going to be the worst earnings season since 2009. It showed a chart that indicated earnings were expected to decline 9.8% for the quarter, the biggest drop since 2009. Much of that decline was due to problems in energy and commodity businesses, but analysts also expected declines or weak increases in other industries.

As usual, analysts overreacted. They set expectations so low that stocks rose well before the end of the quarter. As the first earnings were announced, many stocks rose after companies announced relatively poor earnings. The key was that the reports weren’t as bad as expected. For example, most major banks reported last week. The reports were bad, but either not as bad as expected or were accompanied by fairly optimistic views of the future. The result is that the SPDR Bank ETF rose 7% last week.

The question is: Where does the broader stock market go from here? Indexes are very close to their record highs, and valuations also are high. But several headwinds for companies are diminishing. The dollar no longer is rising. Energy and commodity prices might have found bottoms. There are signs of renewed growth in some emerging economies. Of course, the plan for steady interest rate increases from the Fed has been modified.

I expect the major indexes will be in a trading range in 2016. This probably will be a good year for active stock fund managers who are able to avoid the year’s losers. It also is a good time to buy and hold stocks or stock funds. Don’t worry about the ups and downs of the trading range or the extremes of optimism and pessimism in the headlines. I’d hold less than your maximum comfortable stock allocation, but I wouldn’t be out of stocks.

The Data

There are new signs of a bottom forming in manufacturing, though the reports still are mixed.

On the negative side, Industrial Production was down across the board. The report is a bit exaggerated because it includes utility production, which can rise or fall with the weather. Also, this is more of a backward-looking report than the regional manufacturing surveys. So, there are good reasons to believe manufacturing isn’t as weak as this report indicates.

One of those reasons is the Empire State Manufacturing Survey. It increased from just barely positive last month (after months of negative reports) to a strongly positive report that solidly beat expectations. The components of the report were mostly positive. This indicates we could have a sustainable bottom in manufacturing, at least in the Empire State region.

The Philadelphia Fed Business Outlook Survey (previously the Philadelphia Fed Manufacturing Index) reported a small negative reading following a substantial increase last month. It’s hard to reconcile this report with last month’s and with the Empire State report. These regional Fed bank reports are based on anecdotal surveys and can be influenced by subjective factors, as well as differences in the businesses sample from month to month.

Housing data dominated this week. The Housing Market Index from the National Association of Home Builders (NAHB) remained unchanged for the third month. The report indicates that new home builders are optimistic, but the weakness remains low traffic of potential buyers.

Housing starts declined by 8.8% and were below expectations. But the report needs some careful reading. Multifamily housing has led the way in the recovery, but the country is finally becoming saturated with apartments. Most of the decline in the report is due to few apartment building starts. The 12-month increases in both categories remain strong.

Existing home sales increased 5.1% for the month and are up 1.5% for 12 months. They increased 4.8% for the first quarter. The largest increase was in single-family home sales. In addition to higher sales, prices increased by 5% for the month and 5.7% for 12 months. The higher home prices also are due to increased inventory of homes for sale, though the inventory still is considered low.

Home prices rise in line with expectations, according to the Federal Housing Finance Agency (FHFA) House Price Index. It is the lowest monthly gain since August and puts the 12-month price change at 5.6%.

The labor market continues to look healthy. New unemployment claims declined by 6,000 to bring the number to only 247,000. That’s the lowest number of weekly claims since 1973, and the work force was much smaller then.

Leading Economic Indicators, as compiled by The Conference Board, rose a modest 0.2%, but last month’s reading was revised to a negative 0.1%.

Consumer Sentiment as measured by the University of Michigan had a meaningful decline to 89.7. Consumers are mostly positive about current conditions but became less optimistic about expectations for jobs and income.

The Markets

It was another positive week for stocks. As of around mid-day Thursday, the S&P 500 was up 1.01% for the last five days. The Dow Jones Industrial Average increased 1.10%. The Russell 2000 rose 1.11%. The All-Country World Index gained 1.56%. Emerging market equities lagged with a gain of only 0.46%.

Long-term treasury bonds didn’t have a good week, losing 1.47%. Investment-grade bonds gained 0.37%. Treasury Inflation-Protected Securities (TIPS) lost 0.14%. High-yield bonds gained 0.99%.

The dollar lost about 0.2%.

Energy-based commodities had another good week, gaining 3.06%. Broad-based commodities did better, gaining 3.91%. Gold was flat for the week.

Recommended Reading for You

This study found that investors worry too much about stock crashes, expecting them to happen more often than they do.

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Here’s Alan Greenspan’s take on why monetary policy isn’t very effective and why fiscal policymakers need to take action.

I comment and link to these and other items on my public blog at http://www.bobcarlson.net.

Sincerely,