NEW YORK – Stocks may fail to extend their recent rally as a slowing growth outlook and higher interest rates offset strong second-quarter earnings.
Some investors said gains in stocks may be limited next week as equity prices already reflect prospects for the economy and corporate profits in the second half.
"The economic environment is becoming less friendly for many companies and the potential for considerable gains in earnings in the next quarters is lower," said David Joy, vice president for capital markets strategy at American Express Asset Management in Minneapolis, with $415 billion of assets.
"I would remain invested in stocks, but from now on I would focus mainly on large companies, with steady growth."
Better-than-expected earnings reports and economic data pushed the Standard & Poor's 500 index (search) up 3.6 percent in July and erased its year-to-date loss. The S&P 500 was up 1.8 percent for the year to date, through Friday's close. The Dow Jones industrial average (search) gained 3.4 percent during the month of July, but it was still down 1.3 percent for the year to date. In July, both the Dow and the S&P 500 had their best performance since December 2003.
The Nasdaq Composite Index (search) rallied 6.2 percent in July, nudging it up 0.4 percent for the year.
About 70 percent of the companies in the Standard & Poor's 500 have reported earnings for the last quarter, with most coming in better than expected. S&P currently projects profits for the quarter will grow 10.5 percent, higher than initial forecasts.
"It will be interesting to see if the earnings season will close on a positive note across the board or if the strong results will be concentrated among companies in the energy sector," Joy said.
Next week, energy companies reporting results will include Duke Energy Corp. (DUK) and Alliant Energy Corp.
Crude oil prices jumped 39 percent last quarter from a year earlier and touched an all-time high of more than $62 per barrel on the New York Mercantile Exchange (search) on July 7. NYMEX September crude settled on Friday at $60.57, up 63 cents.
Edward Keon, chief investment strategist at Prudential Equity Group in New York, is recommending that clients remain invested in shares of energy companies.
"Stocks in general remain a cheap alternative, compared with other investments," Keon said. "And despite the good run on energy stocks, they continue to be very attractive."
Keon said Prudential's portfolios hold more energy stocks than the amount recommended in most benchmark indexes and that he has been increasing holdings of technology shares.
At Friday's close, stocks were mixed for the week. The blue-chip Dow dipped 0.1 percent, while the broad S&P 500 index edged up just 0.04 percent, and the tech-laced Nasdaq advanced 0.2 percent. Both the S&P 500 and the Nasdaq hit four-year closing highs this week.
A week earlier, stocks had racked up four straight weeks of gains.
A key economic indicator for investors next week will be the U.S. non-farm payroll report (search) for July, set for release Friday.
The forecast calls for the addition of 182,500 jobs in July, up from 146,000 in June, according to economists polled Reuters data.
But considering steady economic growth and low inflation, job creation should be stronger, and in turn, that may limit demand for stocks, said Bill Strazzullo, chief market strategist at State Street Global Markets in Boston.
"That's one piece of the puzzle that hasn't really fallen in place," Strazzullo said. "These numbers with all the stimulus we've had should be over 250,000 every month. So there's definitely some weakness there."
The Commerce Department (search) said Friday the U.S. economy expanded at an annual rate of 3.4 percent in the second quarter, below the rate of 3.8 percent in the previous three months. It was the ninth straight quarter of GDP growth exceeding 3 percent.
Another widely watched economic report due next week includes the ISM index, a gauge of manufacturing activity, which is expected to rise to a reading of 54.5 in July from 53.8 in June. The Institute for Supply Management (search), or ISM, index will be released Monday.
Tuesday, a reading on inflation tracked by the Federal Reserve, the core Personal Consumer Expenditure index, is likely to slow to a gain of just 0.1 percent, down from an increase of 0.2 percent in the previous month.