Friday the 13th Comes Early

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Friday the 13th of 2010 actually came this past Wednesday, when the stock market began to panic over a possible double-dip recession when the Federal Reserve issued another warning about our nation’s weak economic conditions. The major stock indexes all dropped by nearly 3% on that dismal Wednesday and continued to sputter throughout the rest of the week. Talk is now centered around the possibility of a second leg down in the recession and the discouraging fact that the central bank really doesn’t have much arsenal left in what they can do now right to ‘steady the ship.’ Clearly the economy is slowing, and higher unemployment claims along with the continued woes in the housing market are clearly wearing on investor’s psyche. Uncertainty about jobs, consumer confidence, corporate margins and tax changes will more than likely cap any stock market rally in the immediate future. But the downside damage should be limited too, not the least because stocks now look reasonably priced compared to bonds. Right now the jury continues to remain out on whether any meaningful conclusions can be drawn from the recent erratic market behavior, at least until the majority of investors come back from summer vacation.

The Dow Jones Industrial Average ended its three-week winning streak this past week and fell by some 30 points, or 3.3%, to a level of 10,303. This much watch blue-chip index is now down 1.20% for the year. The Standard & Poor’s 500 gave up 42 points, or 3.8%, to 1,079, and has now retreated during six of the last seven sessions and finds itself lower in 2010 by 3.21%. Meanwhile the Nasdaq Composite Index lost 115 points, or 5%, to 2,173 and the Russell 2000 of smaller-cap stocks fell by an atrocious 6.3%, to 609. As it now stands, the Nasdaq and the Russell 2000 are lower by 4.22% and 2.54% respectively for the year. Just because we may be facing slower economic growth both here and abroad, doesn’t necessarily mean that we’ll also have lousy corporate profits. Investors need to remember that corporate growth is based on their respective earnings, which are not usually dependent on the U.S. dollar or government deficits. Thus far we have heard from over 450 (90%) of the companies representing the Standard & Poor’s 500. Second-quarter earnings are up some 28% on a year-over-year basis, for the sixth straight quarter of net positive earnings surprises. What’s more, the average profit margin for these reporting companies is 9.4%, almost a full point above analysts’ expectations of 8.5%. Bottom line, earnings keep rising strongly while stocks prices either have ironically remained flat or have headed ‘south.’ According to Yardeni Research, rising earnings have now pushed the average S&P price-earnings ratios down to 13.2 for growth stocks and 11.4 for value stocks.

Due to the existing economic uncertainty, most of these companies are not hiring much, but they do have plenty of room to continue delivering productivity growth with their existing manpower. And although we haven’t seen a V-shaped economic recovery thus far, we’ve already seen a sharp V-shaped recover in earnings, so perhaps investors need to concentrate on the fact that the stock market reflects companies’ outlooks and not currencies. The Treasury market continued its bullish trend as the Federal Reserve announced its plan last week to buy more Treasuries. Thanks to a slowing economic outlook, it appears that the Fed will purchase some $300 billion of long-term Treasuries from its maturing mortgage debt. This should help keep yields lower for the foreseeable future, and that’s good news, since that means mortgage rates and other borrowing rates for consumers will follow. The 10-year Treasury yield is now at 2.68%, which is a 16-month low and the five-year Treasury is at a paltry 1.46%.

On the shorter end of the maturity curve, the two-yield yield slipped to 0.513%, the lowest level ever. Thus, in addition to keeping a lid on yields, the Fed’s move to buy more bonds should reassure investors that the central bank will do whatever it takes to promote growth and keep inflationary/deflationary pressures in check. As much as this past week was painful and interesting to say the least, there’s not much to look forward to this week when it comes to economic data. About the only reports of any real significance this week would be Tuesday’s July housing starts report, and July’s producer price index. Housing starts should come in with around a 2% jump while producer prices should rise 0.2%. Other than those two reports, most eyes will continue to peruse the corporate earnings’ calendar as several more important companies will be reporting their second quarter results.

Let’s just hope that these earnings come in with better-than-expected results and that we begin to see some stability in the overall market. Until than, please be patient and keep your wits about yourself!

Sources:  Barron’s, The Wall Street Journal, The Kirk Report, Kiplinger’s, The New York Times, Associated Press, Reuters, Morningstar

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