May 20: Growth Debate Driving Stocks – Economic Highlights

Stocks will likely struggle to sustain the positive momentum of the last two sessions given the absence of any major economic reports on the docket today. And while we do have a handful of earnings reports that are of interest, the reporting season is effectively coming to close.

First quarter earnings turned out to be much stronger than expected, belying pre-season concerns about margins and growth. Granted we did see margin pressures in some key sectors, such as in consumer staples, but the aggregate trend remained in the positive. We also saw across board top-line gains in most of the industries, which was very impressive given the U.S. economy’s tepid growth pace in the quarter.

This goes on to show that the S&P 500 is not solely dependent on the U.S. economy, given that more than a third of its earnings come from beyond the U.S. shores. But the flip side of that argument is the still-substantial domestic exposure of the corporate sector.

And this is the backdrop for the ongoing market debate about the economy’s growth outlook. The argument that the first quarter economic softness was due to transitory factors that will reverse in the current and coming quarters is fairly convincing. But we can’t deny the spate of recent soft readings either.

And I am not referring to what seems to be the onset of a double dip in the housing market. Consumer spending remains under pressure due to high fuel costs. And this week’s soft Empire State and Philly Fed surveys raise question marks about the the manufacturing sector, a stand-out performer in this recovery thus far. We will have to see whether the upcoming Chicgo PMI and then the ISM manufacturing reports bear these trends out in the coming days.

These soft readings no doubt add to the skeptical narrative about the economic outlook. But there is no shortage of positives either. In addition to the solid picture of coporate profitability, we still have a fairly supportive interest rate environment, notwithstanding the end of QE2 next month. The trend on the labor market front remains positive as well, confirmed by the resumption of the downtrend in the jobless claims data. The labor market recovery, if sustained over the coming weeks, will go some way in offsetting the soft readings elsewhere.

Of the handful of earnings reports in focus today, the picture remians mixed. We had a very weak report from Gap (GPS) after the close on Thursday, while Salesforce.com (CRM) handily beat expectations. Kirkland’s (KIRK), the home decor retailer, beat EPS and came inline on revenue, but guided lower. We also had a solid report from AnnTaylor (ANN).

But more than earnings reports, it is the ongoing economic debate referred to above that is driving the market at this stage. I am afraid that we will spend the entire summer going back and forth on this issue.