Economy Stumbling Again But Stocks Will Prevail

Economic growth as measured by GDP is contracting from a strong spurt in the second half of 2014. The housing market remains sluggish seven years after the financial crisis. The energy sector has been battered by cheap oil prices.

The only bright spot in recent months in an increasingly dismal economic landscape was the labor market, which was generating jobs at a rate not seen since the late 1990s. But that all changed in March, according to surprisingly weak numbers released last week by the Labor Department.

So investors turn their lonely eyes to first-quarter earnings for some sign that the stubbornly resistant recovery isn’t stalling yet again.

Overall, the experts say things may get rough for a while, but that most long-term indicators suggest the economy is headed in the right direction and that stocks will fall in line with the broader trend.

Peter Kenny, chief market strategist at New York-based trading firm Clearpool Group, noted that the major stock indexes are “largely unchanged” through the first three months of 2015, with the Dow Jones Industrial average up just over 1% and the broad-based S&P 500 up about 1.7%.

Stocks on a Roll

Kenny sees that as something of a victory for investors given the stream of lousy data released during the first quarter.

“The equity markets have withstood a great deal this year and in some respects the fact they are positive is in and of itself a major accomplishment. However, markets, not unlike the last two trading session, seem to be in pause mode. Volume with few exceptions has been rather unexceptional and investor enthusiasm seems to reflect that,” Kenny observed.

U.S. equity markets have been on a roll since the end of the 2008-2009 recession, regaining all of the losses incurred during the worst of the financial crisis. Unprecedented economic stimulus initiated by the Federal Reserve in the form of bond-purchasing programs and years of historically low interest rates have helped fuel a bull market that has pushed the Dow and S&P to all-time highs.

Since hitting a recession-induced bottom on March 9, 2009, the S&P 500 has soared more than 175%, according to FactSet Research Systems Inc. In fact, stocks have climbed so high so fast that some (mostly critics of the Fed’s easy-money policies) have warned that stocks could be approaching bubble territory.

The question now is whether a string of lousy earnings reports in the early days of the earnings season now upon us could send stock markets into a tailspin.

That threat is very real given analysts’ predictions that corporate earnings were hit hard during the first quarter by the low energy prices and an increasingly strong dollar, which made U.S. exports more expensive and foreign imports cheaper.

The season didn’t get off to a rousing start on Wednesday, with Alcoa (NYSE: AA) and Bed Bath & Beyond (NASDAQ: BBBY) missing analysts’ expectations. Alcoa’s shares fell 3% Thursday after quarterly sales missed projections and the big aluminum producer forecast a global supply glut for the metal in 2015. Retail giant Bed Bath & Beyond’s shares fell more than 5% after reporting lower-than-estimated earnings and outlook a day earlier.

Expectations are Low

David Kelly, chief global strategist for J.P. Morgan Funds, said “expectations are low” for first quarter earnings “as they should be, since the earnings drag from low oil prices and a high dollar were significantly stronger in the first quarter of this year than in the fourth quarter of 2014.”

Kelly said analysts’ current projections of a 2.1% decline year-over-year for S&P 500 companies might be “a little too optimistic.”

But in spite of what is looking increasingly more like another stumble on the long road to a full economic recovery, Kelly believes corporate earnings aren’t threatened by a long-term downturn.

“The reality is that if the dollar and oil prices stay at current levels this will be a one-year drag on earnings growth with the 2016 numbers looking better,” he said. “If the dollar begins to edge down and oil prices begin to edge up, the earnings outlook should brighten.  And in an environment where valuations are not particularly stretched and both bond yields and cash yields remain very low, this should be sufficient to justify a continued overweight to U.S. equities.”

Furthermore, most economists and analysts believe the weak March labor report was an anomaly, a once-off that shouldn’t be given too much weight as investors mull strategy moving forward in 2015.