Markets, Earnings and the Economy Behind Risk Aversion

by: AAII

Many AAII members expressed an aversion to higher risk in response to a special question in the weekly Sentiment Survey.

Certainly, the market is not helping your mood. Since rebounding off of the March 2009 bear market bottom, the Dow sustained a pattern of higher lows and higher highs. (For those of you who do not look at charts, this is a bullish pattern.) The trend was interrupted earlier this month when the Dow revisited its February 2010 lows.

The initial group of second-quarter earnings reports is not exactly giving a warm and fuzzy feeling, either. Best Buy (NYSE:BBY), Walgreens (WAG), FedEx (NYSE:FDX), Darden Restaurants (NYSE:DRI), Bed, Bath & Beyond (NASDAQ:BBBY) and ConAgra Foods (NYSE:CAG) either had disappointing sales numbers, missed earnings expectations or provided lower than expected guidance. (The fact that restaurant chain operator Darden Restaurants and consumer food provider ConAgra both missed has me wondering what exactly people are eating...)

Then there is the economy. New home sales--based on when the contract is signed--plunged last month, a statistic significantly impacted by the expiration of the homebuyer's tax credit. Existing home sales--based on the date of closing--were also disappointing. The Federal Reserve sounded less optimistic following the completion of its two-day meeting. The Federal Open Market Committee (FOMC) opined in its statement that "financial conditions have become less supportive of economic growth."

Combined, the economic and earnings data are adding to the reasons behind the market's pause on its ascent up the proverbial wall of worry. Many people are looking at the data and asking "when?" When will companies start spending their cash? When will companies start aggressively hiring workers? When will credit finally loosen up?

Despite these concerns, there remains reason for hope. The Fed still expects economic growth to continue. The Conference Board's leading indicator index rose last month and still signals expansion. The four-week average of initial jobless claims fell. Corporations are sitting on record levels of cash.

There was an expectation by some economists that the economic recovery would be uneven, and many think this is what we are seeing right now. We're not in an environment that can be sugar-coated, but growth is still occurring. The most important thing is that there is nothing that warrants a change in the rules governing how successful portfolios are run. Rather, strategies such as seeking fundamentally sound companies that are trading at attractive valuations continue to apply.


Only a handful of S&P 500 members are scheduled to report quarterly results next week. The small group is comprised of Micron Technology (MU - Monday), General Mills (GIS - Tuesday), Apollo Group (APOL - Wednesday), Monsanto (MON - Wednesday), and Constellation Brands (STZ - Thursday).

The big economic report of the week will be the June jobs numbers, published on Friday morning. The change in nonfarm payrolls will be significantly impacted by the termination of temporary census jobs and, thus, economists are currently forecasting a drop of 70,000. The unemployment rate is projected to hold steady at 9.7%. Both projections could change depending on what the ADP Employment Survey (Wednesday) and the Monster Employment Index (Thursday) say.

Several other economic reports are also on the calendar, including May personal income and spending (Monday), the Conference Board's June consumer confidence survey (Tuesday), the April Case-Shiller home price index (Tuesday), the ISM's June manufacturing survey (Thursday), May pending home sales (Thursday) and May factory orders (Friday).

Atlanta Federal Reserve Bank President Dennis Lockhart is scheduled to speak on Wednesday.

Friday, July 2, will be a full trading day for the U.S. stock exchanges. The U.S. financial markets will be closed on Monday, July 5, in observance of Independence Day.

Charles Rotblut, CFA is a Vice President with AAII and editor of the AAII Journal.