U.S. Stocks’ Boom Raises the Stakes as 2nd Quarter Gets Under Way
Calling the first quarter a surprise for Wall Street would be putting it mildly. And that has raised the stakes as the second quarter kicks off today.
Defying the majority view at the end of 1994, the U.S. economy appeared to slow in the first three months of this year, bond yields fell and stocks boomed--even though the dollar crumbled against the Japanese yen and German mark.
Yet if U.S. investors feel good about their gains this year, they’re also likely to feel jittery about what comes next.
After all, the first quarter’s 9% price gain in the Standard & Poor’s 500 index of blue-chip stocks, to record highs, is the kind of return many investors would expect to make in a year.
And while most barometers of the economy suggest that a slowdown occurred in the first quarter, there’s no guarantee that consumer spending won’t resurge this spring--which could resurrect worries of higher inflation and higher interest rates.
Moreover, trouble in foreign markets played to Wall Street’s advantage in the first quarter, but a continuing meltdown of overseas shares could begin to signal a much slower world economy than investors would want. Early today Tokyo shares plummeted 4.4% as the dollar sank again.
For most U.S. investors, however, the primary focus in the near-term may be on three key issues:
* Can corporate earnings stay hot in a cooling economy? With many stocks at or near record highs after the first quarter, investors will need assurance that underlying corporate earnings growth remains robust enough to support share prices.
So far this year, Wall Street seems to have concentrated on the benefits of an economic “soft landing”--lower interest rates and modest inflation--without asking much about the potential down side of slower earnings growth.
“Some people may have idealized what a soft landing is,” says Eric Miller, investment strategist at DLJ Securities in New York. “It’s not good for everyone.”
Yet analysts remain surprisingly upbeat about first-quarter profits, which companies will begin to report in earnest starting next week. Earnings-tracker Zacks Investment Research in Chicago say analysts’ estimates call for corporate profits overall to be up nearly 21% in the first quarter vs. a year ago, excluding special charges.
That would be slower than the 25% overall growth of the fourth quarter of last year, but still a strong pace, says Zacks’ chief Ben Zacks.
Are analysts too optimistic? Zacks doesn’t think so. The economy may be cooling, but “things don’t stop on a dime,” he says. Nor have many American companies shown any signs of altering their zealous cost-cutting mentality, which puts the maintenance of earnings growth ahead of other goals, Zacks notes.
Moreover, some money managers note that the industries most vulnerable to disappointing earnings in a weaker economy--auto and steel firms, for example, have already seen their stocks trashed.
“I think a lot of the earnings worries have been discounted,” says Jerry Dodson, manager of the Parnassus Fund in San Francisco. Shares of Inland Steel, for instance, have slumped 25% from their 1994 peak, to $27.50 now, he says. Even in a less-robust economy, Dodson says, “Inland is a better fundamental story than a year ago.”
So if the long-awaited pullback in the stock market overall hits in April, Dodson and other bulls say, it could provide a good buying opportunity for investors who stay focused on companies with still-strong earnings growth.
* Can inflation stay low? Despite the U.S. economy’s hot pace last year, inflation remained tamed. Last Friday, when the government revised annualized fourth-quarter gross domestic product growth up to 5.1% from the previous estimate of 4.6%, it didn’t change the estimated 2.6% annualized rise in a key inflation index for the quarter.
The message seemed to be: Thanks in part to continued productivity gains, the U.S. economy can grow briskly without pushing prices up much. First-quarter inflation data said much the same.
Yet Wall Street’s nagging fear is that there’s pent-up inflation in the pipeline, and that it will spill out in the second quarter, even if economic growth continues to moderate. That would assuredly force the Federal Reserve Board to raise short-term interest rates again, and probably push long-term rates up as well.
Some economists believe that the biggest inflation threat is in wage growth. If businesses continue to hire at the strong pace of the last several months, labor could get scarcer (relatively speaking) and wages could rise faster than the Fed would like to see.
That’s why this Friday’s government report on March employment may be crucial for stock and bond markets. “For inflation truly to remain tranquil, the labor market must cool down,” says John R. Williams, economist at Bankers Trust in New York. He expects a weak March jobs report, which in theory could provide stocks and bonds with another reason to rally.
* Will the dollar begin to matter? Wall Street decided in the first quarter that the sliding dollar is a crisis for everyone else--but not for America.
Yet on Friday, the dollar went into another free fall against the German mark and Japanese yen, ostensibly because the Bank of Japan refused to cut its official bank lending rate (now a mere 1.75%) to lessen the attraction of yen-denominated securities.
While few Wall Streeters would welcome a true dollar panic, some say it’s important to remember that the dollar’s weakness is largely a mark and yen issue. Sung Won Sohn, economist at Norwest Corp. in Minneapolis, says that when measured against a basket of currencies from 100 nations with which the United States trades, the dollar has actually trended modestly higher since 1990--even though it has tumbled vs. the mark and yen.
The dollar may come to matter more to markets, some pros say, when and if it begins to strengthen again. And if that happens, the bulls believe it would be great news--bringing foreign investors rushing into U.S. stocks and bonds.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
An Eclectic Quarter
Here are the best-and worst-performing stock industry groups in the first quarter, out of about 90 groups total. Some stocks that are sensitive to swings in the economy (such as steel issues) were trounced, while others (such as airlines) soared. The market overall, as measured by the Standard & Poor’s 500 index, rose 9% in price.
* Best Groups
Industry group 1st qtr. change Airlines +20.8% Manufactured housing +20.3% Electronic instruments +19.4% Hotels/motels +19.3% Financial (misc.) +18.0% Railroads +17.7% Medical products/supplies +17.1% Life insurance +17.1% Retail: general merchandise +17.0% Toymakers +17.0%
* Worst Groups
Industry group 1st qtr. change Truckers -10.3% Steel -4.3% Shoemakers -2.7% Metals (misc.) -2.3% Retail: specialty -1.2% Auto makers -0.7% Publishers +0.1% Broadcasters +0.8% Aluminum +1.4% Electric utilities +2.6%
Data through March 30.
Source: Standard & Poor’s Corp.
