Blog : Winter Isn't Over Yet

by Ed Zwirn on April 11th, 2014

As bad as last winter was, the advent of spring has left many stock market investors in a mood to wax nostalgic over the Arctic inversion. Along with the returning robins, the warmer weather seems to have flushed a horde of hungry bears out of hibernation.

But we are probably not through with winter just yet. First quarter earnings season is set to go full speed in the coming week, with 54 Standard & Poor's 500 companies set to report this coming four-day week. High-profile companies expected to impact the broader market with earnings over the next several days include GE, Johnson & Johnson, Goldman Sachs, Google and IBM.

And the overwhelming consensus in this skittish market is that these headline earnings reports will show much slower growth, with profit growth for S&P 500 companies now expected to have increased just 0.9% in Q1, down from a Jan. 1 forecast of 6.5% growth, according to Thomson Reuters data.

This gloomy outlook has fed into the pressure hitting an overblown stock market, a market which since late last year has been hitting, and then retreating from, record levels. The latter part of the past week definitely belongs in the retreat category, with all major market indexes marching backwards on Thursday and Friday.

The start of the rollback has been characterized as a "tech selloff." And the tech-heavy NASDAQ was the center of this devastation. The NASDAQ composite index suffered its worst loss since 2011 on Thursday and continued downward on Friday to close below 4,000 for the first time since December.

But this devastation was widespread. Over the two trading days, the NASDAQ lost 4.4%. At the same time, the 30 blue chip Dow Jones Industrial Average sank 2.5%, while, at the lower price end of the market, penny stocks took a beating, with the small-cap Russell 2000 index falling an overall 4.2% on Thursday and Friday.

The beating being taken by many speculative tech stocks is certainly part of the story here, but, as the broad nature of the latest stock market rout indicates, there is a lot more going on.

The gloomy earnings outlook, for one thing, is not confined to the tech sector, and many people think, especially with the coming trading week truncated by Easter and Passover celebrations, that traders may have been positioning themselves for the coming earnings barrage by dumping shares ahead of the announcements, leaving themselves free to argue with their families and abuse their digestive systems with matzos and, later in the week, peeps.

This in turn begs the question of whether the disappointing announcements will disappoint, if in fact investors have already reacted to them negatively in anticipation. Upside and/or downside surprises are likely to be headline events as this news comes out.

In addition, a consensus seems to have emerged over the past couple of days that a correction has arrived, and that we are going to see further stock market declines before things recover. One article I read today quotes analysts quibbling over whether the pullback for the S&P 500 will come to between 5%-7% or 6%-8%, but you get the idea, with any pullback likely to extend through the summer, a season in which stock markets tend to underperform anyway.

On the other hand, these analysts both expect the year to end on a positive note for stocks, small comfort as that may be at this point. Chad Morganlander, portfolio manager at Stifel's Washington Crossing Advisor, sees a total S&P 500 return of 6-8% for 2014, based on 3% GDP growth and 6.5% earnings growth.

There is reason to believe in this longer-term optimism. As I pointed out in my investment blog, the most recent economic releases have generally come out showing 1) a more pronounced winter slowdown than had been initially reported, and 2) better-than-expected results for March, when things started to thaw out. Extending this trend, we have the possibility of a U.S. economic recovery continuing to proceed, however grudgingly, through the coming months.

At the same time, there are (as usual) many wild cards. For one thing, there is a healthy chance that developments in the international situation could harm financial markets. Late last summer, the buzz had been over possible U.S. military action in Syria, an eventuality that was thankfully averted. Now a possibly more dangerous situation is playing out in Ukraine, as Russian troops mass on the border of that country and NATO allies beat the drums.

The upshot for penny stock investors: Developments like possible major wars are so potentially catastrophic that their full consequences may prove impossible to hedge against in any case. But it will be very possible to manage the manageable risks over the coming months, and maybe even come out ahead while others are losing by carefully picking through otherwise sound stocks that are taking a beating solely due to market conditions.