D.C. Histrionics Take the Shine off Stocks

by Shawn Narancich, CFA Senior Vice President of Research

The Circus is Back in Town

With stocks pulling back from new all-time highs reached last week, politicians become an easy target. “Blame it on the clowns in Washington!” Yet the fact that benchmark blue chip stocks stand within 2 percent of their recent highs is a testament to what we foresaw at the end of last year, which is that investor focus would turn away from the D.C. budget battles and more closely focus on company and economic fundamentals. Fed policy remains in the limelight as traders focus on the ultimate timing of “tapering,” but for Bernanke & Co., call it mission accomplished, as last week’s delay in removing a degree of monetary accommodation has stalled the upward march in benchmark Treasury yields. Although the Fed’s decision was widely panned, the recent choppiness in housing-related data speaks to the concern that policymakers ascribed to the steep rise in mortgage rates. Post-Fed decision, mortgage rates have moderated, which should help sustain the rebound in this key driver of the economy.

Window Dressing

Third quarter end is rapidly approaching, and with it, another earnings season is coming into focus. Earnings pre-announcements have been few and far between so far, but that could change in the next couple weeks as corporate finance departments close their books and reconcile numbers to investor expectations. Although the trade-weighted dollar has weakened this quarter, the much anticipated economic acceleration has yet to materialize. With the Commerce Department’s final read of second quarter GDP in the books at 2.5 percent, don’t be surprised if this ends up being the best rate of growth we see in 2013. Over the last month, economists have been busy cutting their estimates of third quarter GDP, with consensus expectations falling to roughly 2 percent. It's forward progress, but certainly not the type of gangbuster growth that would lead us to predict a big upside for corporate America’s third quarter earnings reports.

 Just Did It

For now, investors whet their earnings appetite by feasting on Nike’s surprisingly strong fiscal first quarter earnings—up 36.5 percent on 4.5 percent sales growth. Not only did key metrics exceed expectations, but the all-important futures order number rose by 10 percent on a currency neutral basis. Not bad for a company expected to book over $27 billion in sales for the current fiscal year! Despite Nike’s premium valuation, the stock sprinted ahead 5 percent on the announcement, outperforming on a down day for equities in general. 

While the dynamics of Nike’s growth owe much to its latest innovations like Flyknit shoe technology, we can’t help but notice the parallel between Nike’s geographical business performance and that of the global economy in general. Instead of key emerging markets leading the way, Nike’s China business actually contracted, underpinning a mere 1 percent growth rate in the company’s overall emerging market sales. Contrast that pedestrian performance with North America and Western Europe, where sales rose 9 percent and 11 percent, respectively, and these numbers mirror what’s happening globally, as growth at the margin is better in developed markets than it is in the emerging markets. While we don’t anticipate this being the case longer term, it’s today’s reality. 

 Our Takeaways from the Week

  •  D.C. politics and slower-than-previously-expected economic growth have put a damper on stock prices
  •  As the third quarter concludes, another earnings season awaits