Investors Say “Meh” to Earnings; Stocks Close Mixed

Don’t say I didn’t warn you. First-quarter earnings expectations are exceedingly high. The mere hint of imperfection in a company’s operating results can send its shares tumbling.

The main stock indices ended a choppy trading session today on a mixed note, as Wall Street punished ostensibly solid earnings results. The Dow Jones Industrial Average closed in the red; the S&P 500 and Nasdaq edged into the green.

Before the opening bell today, Morgan Stanley (NYSE: MS) posted a huge first-quarter earnings beat. The bank reported earnings per share (EPS) of $1.45, a 45% year-over-year increase and well ahead of analyst expectations of $1.28. Revenue came in at $11.1 billion, up 14% from last year and a record. That said, MS shares today only rose 0.06%.

International Business Machines (NYSE: IBM) posted first-quarter results that beat estimates on earnings and revenue. EPS came in at $2.45 per share, versus $2.42 expected by analysts. Revenue came in at $19.1 billion, versus expectations of $18.84 billion.

However, IBM’s management reaffirmed previous full-year guidance of about $13.80 in EPS, compared to expectations of $13.83. That’s all it took to make IBM one of today’s big decliners, for a loss of 7.61%.

Dow component Johnson & Johnson (NYSE: JNJ) also weighed on the index Wednesday, even though the health services behemoth beat on earnings and revenue yesterday. The culprit: a dip in net income. JNJ shares fell 0.93% yesterday and another 2.10% today.

Despite IBM’s continuing difficulties in reinventing itself, the technology sector looks promising this year.

According to the analyst consensus, total first-quarter earnings for the tech sector are expected to increase 20.7% on a year-over-year basis, on the strength of an 11.4% jump in revenue. On a full year basis, technology is projected to rack up 17.3% earnings growth in 2018, higher than the earnings growth of 15.8% posted in 2017.

These numbers outpace the S&P 500, which is nonetheless expected to turn in a stellar first quarter. The estimated earnings growth rate for the S&P 500 in the first quarter is 17.3%. But you shouldn’t ignore mounting risks, notably inflation.

Igniting the fires of inflation…

The economy is running hot. Wages are rising. Tax cuts are providing stimulus. The federal budget is on track for an enormous deficit. These conditions are conspiring to ignite inflation.

Historical data show that inflation dampens the returns of equities. From 1928 to 2017, when inflation was below 3% in any given year, the S&P 500 generated a median return of 16%. However, when inflation exceeded 3%, the median return for stocks was only 6.5% a year.

There are several reasons why inflation hurts stocks as a whole. Simply put, a stock’s price is the risk-adjusted present value of the company’s future cash flows. An increase in inflation erodes that value.

The consumer price index (CPI) is still relatively low at an annualized pace of 2.4%, but it’s on an upward trajectory. Many investors have either forgotten or were too young to remember the ravages of past inflation. During the late 1970s, inflation hit double-digits and peaked at 14.8% in March 1980.

The Federal Reserve under chairman Paul Volcker finally conquered inflation by hiking interest rates. Rates under Volcker reached a peak in June 1981 of 20%. That’s the sort of rate you’d expect Tony Soprano to charge, but the harsh medicine did the trick.

Keep an eye on the jobless claims report that’s due tomorrow. The economy is close to full employment. As the labor market tightens, wage growth could throw gasoline on inflationary fires.

Another inflationary trend is the brewing trade war. Tariffs boost the costs of goods. It’s also worrisome that massive tax cuts and federal deficit spending are occurring during the late stage of an economic boom. We’re overdue for a recession. If an economic slowdown hits while inflation rises, we’ll be confronted with a doomsday scenario for stocks: stagflation.

The Federal Reserve’s “Beige Book,” released today, also soured investor moods. The central bank’s survey of economists and business leaders found widespread concern over tariffs. Recent protectionist measures from the White House and China were seen as costly for consumers and a killer of high-skilled jobs in the U.S. Not surprisingly, gold futures today scored their highest finish in a week.

The verdict: Elevate cash levels in your portfolio. Consider inflation-linked hedges such as commodities and hard assets. Pare your exposure to momentum stocks. It’s entirely likely that you’ll look back on the gains of 2017 with nostalgia.

Wednesday Market Wrap

  • DJIA: -0.16% or -38.56 points to close at 24,748.07
  • S&P 500: +0.08% or +2.25 points to close at 2,708.64
  • Nasdaq: +0.19% or +14.14 points to close at 7,295.24

Wednesday’s Big Gainers

  • W&T Offshore (NYSE: WTI) +14.37%

Rising energy prices lift natural gas liquids firm.

  • Denbury Resources (NYSE: DNR) +10.56%

Energy producer projected to excel on earnings.

  • Sanchez Energy (NYSE: SN) +7.65%

Indebted energy producer’s cash flow strengthens.

Wednesday’s Big Decliners

  • Sinovac Biotech (NSDQ: SVA) -9.34%

Analysts turn bearish on drug maker.

  • Fred’s (NSDQ: FRED) -9.26%

Retailer postpones earnings to sell specialty pharmacy business.

  • International Business Machines (NYSE: IBM) -7.61%

Big Blue’s earnings disappoint Wall Street.

Letters to the Editor

“How does Latin America look as an investment destination?” — David P.

Throughout Latin America, leaders are plowing considerable sums into infrastructure spending, including Internet development, and pursuing policies designed to shift their economies from a heavy dependence on exports toward domestic demand.

Governments also are implementing reforms such as individual and corporate tax relief, minimum wage hikes and business deregulation, all designed to boost indigenous consumption.

Mexico stands out. Our southern neighbor is the fourth-largest auto exporter and the world’s eighth-largest producer of oil. Mexico manufactures and exports the same amount of goods as the rest of Latin America combined.

When the North American Free Trade Agreement is finally renegotiated among the U.S., Mexico and Canada, all three countries are expected to reach mutually agreeable terms.

Got questions about overseas investing? Send me a letter:

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.