Yesterday was the close of the first quarter, and so today we are taking stock of what last quarter delivered. The Dow Jones Industrial Average closed the quarter with a modest loss, the S&P 500 was basically flat, and the Nasdaq Composite Index and Russell 2000 had slight gains of 3.5% and 4% respectively. It was the weakest quarter for the S&P 500 since the fourth quarter of 2012, when the S&P 500 fell 1.27%.
From a sector performance perspective, health care took the lead thanks in part to the $95.3 billion in mergers and acquisitions announced during the quarter. The Health Care Select Sector SPDR (XLV) rose 6.03%. Consumer discretionary came in second with Consumer Discretionary Select Sector SPDR (XLY) up 4.44%.
Despite the arctic chill that gripped much of the country, the worst performers included utilities, an industry that in many ways is a proxy for bonds. It delivered the biggest loss, with Utilities Select Sector SPDR (XLU) down 5.91%. Financials were also down as the Financial Select Sector SPDR (XLF) fell 2.51%. Energy unsurprisingly took a beating, as well, with Energy Select Sector SPDR (XLE) down 2%. With the continued weaknesses in capital spending, we aren't surprised to see that Industrial Select Sector SPDR (XLI) fell 1.43%. Overall, only health care, consumer discretionary and real estate had any meaningful gains, with the remaining sectors relatively flat to negative.
Last quarter's sector performance is a major shift from the fourth quarter of 2014, when all sectors delivered strong positive performance, with the exceptions of Materials Select Sector SPDR (XLB), which fell 2.04%, and Energy Select Sector SPDR, which fell 12.6%. Utilities Select Sector SPDR was the highest performer in the fourth quarter, delivering a return of 12.19%, while in the first quarter, it was the worst performer, down almost 6%. In both the fourth and first quarters, consumer discretionary, real estate and health care delivered strong performances.
In comparison, stock markets outside the U.S. performed much better in the first quarter, with the German DAX delivering a whopping 22.5% and the French CAC 40 not far behind at 17.8%. Only the U.K. was near the U.S. with a meager 3.15% return. That was an impressive turnaround from the previous quarter when most all of these were in the red, with the exception of the German DAX, which was up a mere 3.5%, and the Nikkei 225, which was up 7.9%.
Looking forward to the rest of 2015, we are concerned with the trend in earnings expectations as revisions to estimates for S&P 500 earnings have been increasingly negative during the last three quarters, driven largely by the impact that the drop in oil prices has had on energy companies and the impact of a rising dollar on exporters. Exacerbating the situation is the current market valuation, which as we pointed out before is rather high when viewed against net income growth. Note we said net income growth not earnings-per-share growth, which is receiving a helping hand from the massive buybacks we've highlighted to you here. The chart below shows how expectations for 2015 earnings have gone from slightly positive -- with the exception of the fourth quarter of 2015 -- to strongly negative in each quarter starting in June of last year. By now, earnings for all four quarters of 2015 are expected to be below the previous period's earnings, which is consistent with the continued stream of weaker-than-expected economic news. That brings us to another reason to be more alert than usual this Friday. We wouldn't be surprised to see a few public companies quietly slipping in unflattering earnings warnings for the first quarter with most of Wall Street away.
On Monday, we learned that the Chicago Purchasing Manager Index for March came in at 46.3, almost as bad as the horrible number in February and well below expectations for 51.7 from last month's glum 45.8. With two straight lower readings, there is cause for concern. According to a report by research firm Bespoke, there have been 17 prior streaks where the Chicago PMI was below 50 for at least two months in a row, and all but four started or ended within a year before or after a recession.
In contrast, this morning we learned that the Markit Eurozone Manufacturing PMI hit a 10-month high of 52.2 in March, up from 51 in February with growth accelerating in Germany, Spain, Italy and the Netherland and companies raising employment at the fastest pace in over three-and-a-half years. The European economy and stock markets are benefiting from lower oil prices, the effects of a weaker euro versus the dollar and the "whatever it takes" policies from the European Central Bank.
By comparison, the latest and not so greatest PMI data for China reversed gears in March after a modest improvement in February. That reinforces the notion of stringing several months of data together so as not to get head-faked by any one data point. New order growth tumbled, and we see that as meaningful for the short-term direction of the economy, particularly because the "Chinese New Year" excuse can't be used in March. We continue to think China will eventually ratchet up its own stimulative efforts, and so we like iShares FTSE/Xinhua China 25 Index (FXI).
Putting it all together, we think that European stocks will likely outperform U.S. stocks and that the dollar has further room to strengthen with the Fed's promised rate rise and the ECB's commitment to quantitative easing. We can see why investors rushed into exchange-traded funds such as iShares Currency Hedged MSCI EMU (HEZU), and we continue to favor iShares Europe (IEV). For those investors preferring to stick with U.S. stocks, our recommendation is to be cautious in the near term and favor companies that have momentum such as Mobileye (MBLY), Skyworks Solutions (SWKS) and Facebook (FB).
With current U.S. valuations, global tensions from Ukraine to Greece and likely earnings disappointments, investors might consider putting on a little protection with an ETF such as iPath S&P 500 VIX Short-Term Future ETN (VXX) or ProShares Short S&P 500 (SH). If you instead see the glass half full, build that stock shopping list so that you're prepared should any of your favorites go on "on sale" in the next few weeks.
