Commentary for the week ending 7-16-10

Earnings week started out with a bang, only to fall sharply on Friday. At the close, the Dow lost 0.98%, the S&P dropped 1.20%, and the Nasdaq fell 0.79%. Gold dropped to the lowest levels in two months, while oil was relatively unchanged.

Source: MSN Moneycentral

This week started out strong with early corporate earnings reports showing solid growth. The market shot upwards and expectations for the remaining reports were high. There was even talk of how the worst was behind us and markets will only be higher from here.

Unfortunately the rally did not last. Later reports showed a rise in earnings, yet their revenue was flat or lower (As we discussed last week, revenue is what is actually received from the products or services sold). The reduction in costs looks to be the main source of earnings growth, not the demand for these products or services.

Adding to the negative mood, economic reports continued to paint a bleak picture of the U.S. economy. Consumer sentiment dropped to the lowest level in a year. Retail sales have dropped and manufacturing is lower. Mortgage applications are at the lowest level in a decade and unemployment remains weak.

Theses negative stories and the poor corporate revenue growth were too much for the market on Friday as it fell 2.5%.

To a lesser degree, we believe the final passage of the financial regulation bill contributed to the Friday drop, also. The Wall Street Journal had an article on Brian Moynihan, the new CEO at Bank America, as he addressed the impact it will have on his bank. He cited a cost of over $4 billion a year, plus a one-time charge of nearly $10 billion. With this sour outlook for the future, the financial sector was hit the hardest on Friday. Bank of America was down 9%.

As we have said in the past, bank customers will bear the brunt of this new regulation. The banks will simply pass these costs on to their customers in the form of more and higher fees. This bill adds many more regulations and costs to these businesses, but really solves nothing.

Next Week

We continue with earnings season next week. A third of the Dow stocks and one-fifth of the S&P 500 stocks will be reporting, so it will be a very busy week. Like before, we will be watching for revenue growth, not just earnings growth.

Thankfully there will be few economic reports to worry over in addition to all the earnings reports. We will get info on housing and leading economic indicators, and that’s about it. Both reports are expected to be lower.

Where are we investing now?

Despite the relatively decent corporate earnings, we remain cautious due to the negative overall economic picture. We have noticed the companies with a large overseas presence (especially Asia) have shown impressive growth. Companies who are predominantly domestic have been underperforming. It shows the weakness of the U.S. economy, but also shows that there is strength in other parts of the world.

With all the cost cutting, companies will be well positioned when growth does return. Until then, it will be a tough road. Some values can be found, but we are not in any rush to buy them at this point.

Our big-picture outlook still remains the same, as we are optimistic through the end of the year. Low interest rates and the remaining stimulus will push the markets higher. The higher interest rates down the road, higher taxes, increasing government involvement in the private sector, and a still-high unemployment rate have us worried for the longer term.

In equities, we are focused on higher-quality and multi-national stocks, but some smaller stocks look promising, as well. We continue to avoid banking and insurance sector stocks. TIPs are important as we expect inflation to increase in the future, while U.S. treasuries are a sector we are very bearish (pessimistic) on as yields will increase over time. Commodities remain a longer term favorite, as inflation will also impact prices to the upside. Government policies will weaken the dollar over time, and we are beginning to see the weakness now. Municipal bonds will play a more important role in our portfolios over the coming months and years as higher tax rates take effect. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.