A Dovish Bernanke Soothes the Market

by Shawn Narancich, CFA Senior Vice President of Research

Bend it Like Bernanke

Concerned about the steep rise in 10 year U.S. Treasury interest rates that help set the price of mortgages, our fearless Fed Chairman went before Congress to give his semi-annual testimony to Congress this week. While he disclosed little to lawmakers that was new, one key takeaway was his emphasis on the idea that tapering the Fed’s program of buying U.S. mortgage backed securities (QE) has no pre-set schedule. Stocks, bonds, gold, and the dollar responded predictably (rally, rally, rally, decline) to the notion that the Fed will be slower to pull back the punchbowl of stimulus than traders first thought when it fired its first volley of commentary about “tapering" last month. At a time when the Fed’s forecast for 3-4 percent economic growth next year appears increasingly optimistic when juxtaposed against sub-2 percent GDP growth currently, investors are left to hope that a good old fashioned earnings season can sustain and perhaps enhance the heady returns US stocks have delivered so far this year.

Earnings Season Shifts into High Gear

On this topic, investors have now parsed their first full week of Q2 numbers. With over 15 percent of the S&P 500 having now reported, two-thirds of companies are beating earnings expectations, but only about 40 percent are exceeding the top-line forecasts promulgated by Wall Street. In broad brushstrokes then, not much has changed since last quarter, but as always, what makes this business so interesting is the detail beneath the averages.

Money in the Bank

Delving into sectors, we observe that banks have generally reported encouraging numbers, helped by higher levels of capital markets activity (IPO’s driving growth in investment banking, rising fees on managed assets, better trading revenues, etc) that have boosted earnings at the likes of Goldman Sachs, Morgan Stanley, and JP Morgan. Also at work for the financials is better credit quality, which has allowed key regional lenders like Wells Fargo and PNC to reduce their credit provisioning for bad loans. Looking ahead, higher levels of interest rates, if sustained, should help banks increase core earnings power on both their portfolios of marketable debt securities (maturities reinvesting at higher rates) and, more importantly, on new loans benchmarked to market rates. Anecdotally, several management teams have noted stabilization of net interest margins and the potential for rising net interest income if rate gains hold.

Like Falling off a Log

In tech land, no one can be too surprised by the weak numbers out of Intel and Microsoft, given the continued double-digit losses in sales of the PC, still their core market. And while Yahoo’s earnings beat expectations, this aging Internet player once again missed on the top line as its display ad business declined at double-digit rates despite the fact that the Internet continues to take ad share overall. Notwithstanding erosion in Yahoo’s core business under the leadership of new CEO Marissa Mayer, earnings expectations post-quarter actually increased because of Alibaba. This Chinese e-commerce giant reported 71 percent revenue growth and margin expansion as well, resulting in an earnings boost for Yahoo because of its 24 percent ownership interest. So as Wall Street begins to assess the effectiveness of Ms. Mayer’s leadership one year in, she has Alibaba to thank for a stock price that rocketed 10 percent higher post-earnings and now stands at nearly twice the level it was when she arrived last summer.

Next week, investors can look forward to an even heavier slate of second quarter earnings, with more consumer, industrial and energy names entering the fray.

Our Takeaways from the Week

  • Stocks, bonds, and gold melted up this week against the backdrop of further dovish jawboning by the Fed
  • Earnings season is off to the races, with puts and takes