Weekly Stock Recap

First Down Week In Nearly Two Months!

The broad market (S&P 500) had its first weekly loss in nearly two months. Market results were mixed though as the S&P 500 fell, but the NASDAQ posted yet another weekly gain on the strength of technology stocks. The S&P index dropped to a -4.1% return Year to Date. Trading was volatile as the market swung widely throughout the week. On a positive note, the market continues to hold the gains made over the past seven weeks. The NASDAQ has been the big winner so far this year in large part due to technology stocks. The NASDAQ has now reached a 7.4% Year To Date return, which is a big premium over the S&P Index return. Smaller cap stocks which make up more of the NASDAQ index have clearly performed better than the large cap stocks that dominate the S&P index. That is a good sign for our strategy as our stock screens tend to uncover more smaller cap stocks. Company size is not a criterion in our stock screen. However, small caps are more prevalent on our screens since our focus is on momentum, growth, and value, attributes where small cap stocks often excel relative to their larger counterparts. The facts suggest it is a lot easier for a $200 million company to grow 25% than a $20 billion company. We continue to be optimistic on the stock market as the recent trend continues to show significant strength. First quarter earnings season is now in full swing, and will continue to be the primary driver on market direction over the near term.

Earnings Down, Revenue Lower Than Expected!

Earnings reports were the primary driver last week and will likely be the focal point next week as well. So far, most companies are reporting significant drops in earnings which news reports suggest are down overall on average 40%. However, the majority of companies did beat analyst expectations relative to their earnings performance. Beating expectations is a positive, although we would caution that expectation levels were in general very low. However, we do think companies overall have been aggressive and successful with reducing expenses quickly, and that has help sustain higher earnings levels. In our mind the bigger concern is the behavior of top line growth, revenue. News reports suggest that overall revenue is down nearly 11%. That is a smaller decline that earnings, but what is interesting is that the majority of companies are posting revenue numbers that are worst than expected, the opposite of the earnings situation. Our concern is that it is easier for companies to manipulate earnings over the short term than it is to manipulate revenue. Revenue growth is usually a very good barometer for the long term health of a company. The fact that most companies are missing revenue expectations suggest that market and economic factors are indeed having a significant impact, one that will likely continue for some time. Declining revenue will certainly pressure companies over the near term, declines that could have a more significant impact as companies exhaust their cost cutting measures. The Treasury stress test is also causing volatility in the financial sector, although preliminary reports suggest that most banks are carrying more than enough capital. Existing home sales were down again in March, while new home sales were up slightly from very low levels. The Housing sector has just not responded yet to low mortgage rates, lower house prices, and government efforts to increase available credit. We view that as a sign that a recovery in housing is not going to happen overnight as job fears and higher inventories depress sales. In fact, we see a long term housing trend that will demand adjustments to what we would call the re-pricing of American real estate. That means a downward bias in long term real estate price trends, including smaller and cheaper homes.

Market Beating Foresight

Despite the small loss on the S&P last week, the market continues to show strength and a positive bias. However, volatility did rise early last week as the market swung sharply through the week. Earning season is in full swing and both earnings and revenue are down. Companies have been doing better at beating earning expectations than revenue expectations. The revenue concerns suggest to us that recovery may be slower than expected. Next week will be another large slate of companies reporting quarterly earnings. These reports will again be the primary driver on market direction. More news may also come from the Treasury on the Bank Stress tests, and that too will influence the behavior of the financial sector. We continue to believe that the likely scenario is that most companies will meet or exceed what are low earnings expectations. We plan to gradually increase our stock allocations and will likely go all in once this earnings season is complete assuming that there has not been a meltdown. We could go all in now, but we think it is more prudent to wait a little longer. We still have 7 months left this year to make up for any potential gains we give up by sitting in cash. While we do expect to survive the quarterly earnings season without a meltdown, we would still caution that the economy and future outlooks will show only slow recovery at best. In our minds, a slow recovery is not a bad thing, it just means that the stock market will rise more slowly that it has over the past 2 months. Of course, as optimism grows, we recognize there is a great deal of pent up investor demand now sitting on the sidelines that could drive stock prices higher than fundamentals would otherwise warrant. Either way, if corporate earnings and future outlooks hold up, we will likely see a rising stock market. Our stock selection strategy will provide winners regardless of whether the market rises slowly or fast.