How the Federal Reserve Reacted to Disappointing Earnings and Other Market Events

Posted: Oct 25, 2014 12:01 AM

During the past month, the S&P 500 fell more than 198 points from its peak, and it appears to have hit a potential bottom around 1,820. The index bounced 66 points late last week to close at 1,886.76. While some observers may split hairs and say that 9.8% drop from the Sept. 19 high to the low on Oct. 15 falls just short of a correction, I’m inclined to round up and say, “Yes, we had a correction.” Trust me, I double majored in mathematics and economics, so I may have an idea of what we’re talking about when it comes to rounding.

What helped pacify the market this past week?

Was it a detected turn in the economies of the euro zone or China?

Nope. In fact, earlier this week, we learned growth in China was the weakest in years, and sifting through the flash PMI report reveals the picture ahead is not very encouraging.

Was there a reversal in the view that the euro zone may be headed for a triple-dip recession? No, there was not, and if anything, there is more data pointing to deflation concerns, given that prices were increasingly being cut in order to help boost sales. So much for profits…

Was it earnings results that across the board and across industries were better than expected?

Afraid not. Those results continue to be mixed, with solid results at General Electric (GE), Honeywell (HON), CSX (CSX) and other industrial/manufacturing companies compared to weaker-than-expected performance at Wal-Mart (WMT), Gap (GPS) and Urban Outfitters (URBN). While some of the drop at Wal-Mart can be attributed to the fall-off in gas prices, the stronger dollar and lower food stamp receipts, the weakness at Gap and Urban Outfitters is clearly a flare across the consumer-spending bow of the boat.

Even though we continue to see at-the-pump gas prices move lower – I’ve personally seen $2.80 per gallon in New Jersey — odds are that we will see them continue to move even lower in the near term. My perspective was confirmed during the last few days thanks to Wal-Mart (WMT), Gap (GPS), Urban Outfitters (URBN) and others. Each of those companies issued disappointing quarterly results in one form or another – reported results or a softer-than-expected outlook – following disappointing September retail sales, per the Commerce Department.

Citing a tougher-than-expected sales environment, a stronger U.S. dollar and lower food-stamp payments, Wal-Mart cut its forecasted sales growth for 2014 to 2-3% from the prior guidance of 3-5%. In looking at its September results, Gap shared that its same-store sales at the namesake brand stores fell 3% during the month. Other companies that posted misses relative to same-store sales expectations included Fred’s (FRED), Costco (COST) and, once again, Urban Outfitters (URBN). Once a high flyer, Urban Outfitters has been plagued by challenges, which led the company in a filing dated Sept. 9 to share that its then-quarter-to-date retail segment’s comparable sales posted a low-single-digit percentage decline. Recently, Urban shared that the negative trend has continued in the balance of the quarter.

The hits kept coming this week, as Hasbro Inc. (HAS) posted third-quarter 2014 results that missed consensus estimates on both the top and bottom lines due to softer preschool sales, VF Corp. (VFC) delivered weaker-than-expected quarterly results and McDonald’s (MCD) saw its third-quarter comparable sales in the United States drop 3.3% driven by negative guest traffic. Even Chipotle Mexican Grille (CMG), which delivered better-than-expected September quarter results, offered a slower-than-expected view on what’s ahead. Chipotle now expects comparable restaurant sales increases in the mid-teens for 2014 – compared to 17% for the first nine months of 2014 – and forecasts comparisons to dip to low-to-mid-single-digit percentage increases for 2015.

It’s my take that the National Retail Federation’s (NRF) view of holiday spending rising 4.5% year over year is a bit aggressive. Keep in mind this is the same group that expects consumers to spend $350 million on Halloween costumes for their pets this year. Even as I poke fun at the NRF, the more I read about the upcoming holiday shopping season, the more I hear about an accelerated shift to online shopping.

So what did sway the market mentality?

The notion the Federal Reserve may hold off finishing its quantitative easing (QE) tapering efforts. Last week, Federal Reserve Bank of St. Louis President James Bullard and Federal Reserve Bank of San Francisco President John Williams hinted that the Fed may suspend its QE tapering in the near term until the impacts of a weak euro-zone economy, slowing growth in China and, of course, Ebola and its ripple effects pass.

The bottom line is that the ultra-low-interest-rate sugar from the Fed is going to flow at least at modest levels through the end of 2014. This also means the likelihood of the Fed starting its interest rate increases has been pushed back from the first half of 2015 to somewhere in the second half of the year. I continue to see the first hike in late 3Q 2015.

The markets remain highly dependent on both the actions of and lip service coming from the Federal Reserve, and I’ll be keeping that in mind as I look to assess changes in my PowerTrend Profits investment newsletter recommendations.

In case you missed it, I encourage you to read my e-letter column from last week about the economic ripple effects of the Ebola virus.