Earnings Take Center Stage This Week – 4/26/13

Corporate earnings took center stage this week as financial markets digested a multitude of 1st quarter results.  Over half of the S&P 500 companies have reported results this season and 74 percent have exceeded analyst expectations, causing analyst to turn more bullish on forward earnings.  Profits at S&P 500 companies also gained 1.1 percent year-over-year, a slight increase over initial estimates.

The U.S. economy grew at an annualized rate of 2.5 percent in the first quarter, which was lower than forecast.  However, consumer spending, which accounts for the largest portion of GDP, grew by the most since 2010.  This is a positive catalyst for financial markets and shows that consumers appear to be less effected by the payroll tax cut reversal and increase in taxes than initially estimated. 

Federal Reserve Policy will be the next big Catalyst

The Federal Reserve’s upcoming policy meeting likely will grapple with the question: How long should the Fed stick with its easy monetary policy, including the ongoing purchase of billions of dollars of bonds and mortgage-backed securities? While some Fed officials recently have suggested scaling back the program, this week’s reports may give the central bank some flexibility to continue stimulating the sluggish U.S. economy by keeping interest rates low. The Fed’s policymaking body, the Federal Open Market Committee, will begin its two-day meeting on April 30.

Consumer prices helping keep inflation down

The cost of consumer goods dipped 0.2% in March, as a 4.4% drop in gasoline prices offset a slight gain in service costs. The decline of the Consumer Price Index followed February’s 0.7% increase. Core CPI, excluding food and energy, ticked up 0.1%. Analysts said the 1.9% increase in core prices from March 2012 indicates the Federal Reserve’s policy is not creating inflationary pressures that might force monetary tightening—at least not yet. The Fed’s annual target rate of inflation is 2%, but has set 2.5% as an acceptable threshold to maintain its’ current course to keep the economy out of recession and comfortably above deflationary conditions.  In addition to their inflation target, the Fed has linked the program to conditions in the labor market, which has not shown any substantial improvements thus far.

Housing recovery is convincing even skeptics:

Construction of multifamily homes drove housing starts up 7% in March to its highest level since June, 2008. The seasonally adjusted annual rate was just under 1.04 million, as construction of homes with at least five units rose 31%. February’s figures were revised sharply upward to 968,000.  There were a few warning signs for the industry. Construction of single-family homes dropped 4.8% and the number of new building permits fell almost 4%, which could indicate slower construction in the coming months. This may just be a seasonal adjustment.

Home builder’s earnings rose nicely in the first quarter of 2013.  Pulte Homes CEO stated that “the stronger demand which the housing industry saw throughout 2012 has carried into the spring selling season of 2013. We experienced higher traffic in our communities with buyers feeling a greater sense of urgency given the combination of limited product inventory and rising prices found in many markets throughout the country,”  Pulte reported home sale revenues for the first quarter increased 35% to $1.1 billion, compared with $814 million last year. Higher revenues for the quarter resulted from a 23% increase in closings to 3,833 homes combined with a 10%, or $26,000, increase in average selling price to $287,000. Many analysts are correlating growth in the housing market with the overall economy’s direction.

Economic Growth is critical to correct the U.S. Budget deficit:

The earnings reports are once again showing us that many of the pieces necessary for stronger economic growth are in place—it just comes down to putting the puzzle together. While political bickering continues to impede recovery, the U.S. economy is healing – despite Washington. Across-the-board government spending cuts kicked in on March 1. While not as dramatic as the potential fiscal cliff in January, which threatened both tax hikes and spending cuts, reduced government spending could weigh on growth. However, we continue to expect deal-making in Congress, as reflected in the recent extension of the continuing resolution, which will keep the government funded through September 30. Based on their recent track record, lawmakers are likely to serve up more postponements and partial solutions. This would not necessarily be a bad thing: with each new delay and Band-Aid solution, business reaction has become less dramatic.

Asset Class divergence:

Emerging markets and commodities both have trailed the S&P 500 thus far in 2013.  This together with bond prices staying flat will produce some short term deviations from the performance of a properly diversified portfolio compared to the S&P 500.  Emerging market stocks and commodities both rose this week and may be near a turning point.  Longer term investors will benefit from owning both of these asset classes as the global growth picture continues to improve.  We could see these asset classes push higher if the political uncertainty improves along with the macroeconomic picture, which we feel should be more evident in the third and fourth quarter of this year.