The Stock Market in the Week Ahead

The Stock Market in the Week Ahead October 15, 2012

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by Ian Harvey

October 13, 2012

A tough earnings season and election politics could combine to make for a volatile stock market in the week ahead.

The second presidential debate takes place Tuesday night, and it has the potential to once more move the needle in a very tight race between President Barack Obama and former Mass. Gov. Mitt Romney.

It is interesting to note that Citigroup’s strategists have moved to “overweight” on U.S. equities.

Citigroup’s U.S. strategists expect the market to enter a ‘raging bull’ stock market next year, with 2013 year-end target on the S&P 500 of 1,615 -- that would take the index above the prior peak of 1,558 reached in 2007.

Investors are starting to realize that housing is turning – with a continuing expansion of technology through smart devices, there is a growth in the energy boom and also manufacturing competitiveness is returning!

The U.S. stock market is also not as dependent on Federal Reserve liquidity to continue higher as emerging equity markets are.

However, central bank-fueled gains took the stock market within reach of five-year highs in September, but now U.S. stock market participants are shifting their focus back to corporate outlooks, and the waters are becoming muddied.

Early earnings reports have underlined those concerns, which may be exacerbated when dozens of major companies - including Dow components General Electric, Microsoft Corp and International Business Machines Corp - report in the week ahead.

The questions on investors’ minds are:-

• “Is the stock market up solely because of QE?

• Or are earnings up?

• Is consumer spending at levels above those of 2007? and

• Are margins continuing to show impressive gains? “

The Fed liquidity has managed to put a floor under the market.

Besides earnings and the election, there is a series of important economic reports, including the Philadelphia Fed and Empire State surveys that will give a first look at how October is faring. Retail sales Monday should provide more insight into the consumer, after Friday’s consumer sentiment number saw a surprising jump to its highest level in five years.

China also releases data this week, starting with Monday’s inflation reports. Then on Thursday, China releases industrial production, retail sales and GDP.

It is obvious that the U.S. economy has been holding up while the global economy has really weakened over the last few months -- earnings are only telling us that and reinforcing it!

The Past Week in the Stock Market
The market's desultory performance came as the first week of earnings season ended.

Earnings season got underway this past week, although the few results that trickled in were less than inspiring. Alcoa, Costco, JP Morgan, and Wells Fargo all slumped after reporting, putting the onus on the week ahead and the lineup to come through.

The lousy start to earnings contributed to a down week for the stock market, as the major indices all slumped more than 2%. Gold continued to fall away from the $1,800 level, while oil firmed a bit to move above the $90 mark.

All in all, this was another week dominated by the election (including Thursday's VP pit bull debate) rather than any market-shaking news. However, those will likely change with the week ahead and the flood of major earnings reports.

Stocks moved lower in the past week, as the rally attempt on Thursday fizzled and the stock market closed mixed on Friday.

However, some good news emerged when the U.S. consumer sentiment unexpectedly rose to its highest level in five years in October in the latest in a string of encouraging signs for the economy that may boost President Obama's re-election hopes as voters go to the polls next month.

• The Dow Jones Industrial Average (DJI) closed out the week with a loss of 2.1%, marking its worst weekly close since the beginning of September.

• The Standard & Poor's 500 Index (SPX) fell 2.2 percent this past week, its biggest weekly percentage drop since June, on caution about the season after a number of bellwethers cautioned on their outlooks, including Chevron Corp and Alcoa Inc.
Profits are being dragged down by material and energy stocks. Material sector earnings are seen dropping 24 percent, and energy sector results are expected to slide 19 percent.

• The Nasdaq Composite Index (COMP) had a 2.9% weekly defeat -- its lowest weekly reading in two months.

For the year, the Dow is up 9.1%, with the S&P 500 up 13.6% and the Nasdaq up 16.9%.

AT&T (T) led the weekly blue-chip laggards, while McDonald's (MCD) finished higher.

The Stock Market Ending October 12, 2012

The CBOE Market Volatility Index (VIX), widely considered the best gauge of fear in the stock market, had a weekly return of 12.6%.

**For a more in-depth look at the past week…..CLICK HERE…..**

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TRADE	GAIN	TRADE	GAIN
DLTR Aug 110 Calls	32%	UIS Oct 17 Calls	79%
HSY Aug 70 Calls	56%	TSO Nov 25 Calls	54%
NKE Oct 92.50 Calls	49%	HLF July 47.50 Calls (again)	38%
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GLD Nov 165.00 Calls	72%	LVS Dec 45.00 Calls	67%
GLD Oct 170.00 Calls	52%	MON Jan 2013 87.50 Calls	26%

The Week Ahead
The Elections and the Influence on the Stock Market

Analysts are also watching to see how Romney fares in the debate after he was viewed as the clear winner in the first one. Since then, his poll numbers have matched and even in some cases surpassed President Obama, and stocks and sectors that would perform better with Republicans in the White House have also done better.

If Romney puts in a good showing, it’s definitely going to help the market. It appears that an Obama re-election is the base case right now, but definitely a Romney victory would affect how corporates might feel -- if Romney wins, people have to become more invested. People seem to be cautiously positioned at the present time.

The Trading Environment in the Week Ahead

Companies, so far, have been signaling that a weaker global economy is stealing their earnings thunder. Based on actual earnings for companies that have already reported and estimates for those expected to report, third-quarter earnings will be down 2.6 percent, according to FactSet. Five of the 10 S&P industry sectors are expected to report a decline in earnings growth, led by materials and energy, while eight of the 10 sectors are expected to report revenue growth.

This quarter should be the first quarter in five in which the mega-caps underperform the index, so that will be tested in the week ahead. It’s a very big mega-cap week with many big names reporting. Without the support of the mega-caps, the earning season could be even more negative than expected. If there are a couple of big misses it is possible that a much worse season may emerge.

Investors will be relying on stocks that generate earnings domestically. Many investors have been overweight in the consumer sector as well as the health care sector. By playing the domestic theme provides the benefit from domestic growth.

Housing and the Impact on Consumer Sentiment

There are also a number of U.S. housing-related reports, including builder sentiment Tuesday; housing starts Wednesday and existing-home sales Friday. Housing has been the one data series that has shown improvement.

Housing-related stocks are one of the favorite plays of investors because it is focused on domestic stocks -- obviously the home builders are the first group that comes to mind and those are fairly volatile and pricey options. There are other peripherals to play housing -- such as consumer durables. Some of the specialty retailers have exposure to housing. Usually autos tend to trade in line with housing, but for most of this year the auto sector has done poorly, and a lot of the consumer space tends to benefit when housing benefits.

Consumers are feeling better because of the improvement in housing, but also the stock market, with the S&P 500 up 14 percent year-to-date. JP Morgan provided numbers and determined the gains in housing prices in 2012 amount to $1.7 trillion and the gain in stocks is $3.6 trillion, for a total $5.3 trillion, the biggest gain in household wealth ever. The increase in housing prices does not nearly match the steep decline, but it is the first increase since 2006.

This gives an insight as to why consumer confidence keeps going up. Consumer sentiment hit a new high Friday. This is not because jobs are picking up but consumers spend more when they see asset values rise. Historically five percent is spent in the following 12 months … The spending effect would be about $260 billion on incremental spending.

The improvement in consumer confidence may actually be something that helps President Obama. The economic numbers were hurting the president until recently, and the race is now too close to call. The surprise decline in the unemployment rate to 7.8 percent was helpful to Obama because based on history; the president needs 7.6 percent unemployment to get 50 percent of the vote.

The University of Michigan consumer sentiment is a great predictor of presidents getting re-elected. Sentiment jumped to 83.1 Friday, close to the 83.5 level which is predicted as the need for the president to be re-elected. It’s been sitting at the 72 level all year, which occurred when Jimmy Carter and George Herbert Walker Bush lost.

European Influence on the Stock Market and Company Earnings

Europe will also stay in the headlines in the week ahead. There is an EU summit Thursday and Friday, at which leaders are expected to discuss budgets and tighter financial integration. Europe is making progress and beginning to stabilize, and that should help the stock market.

This means that the bad news is in front of us, and can be now put out of the way and then the stock market can focus on what’s going to drive forward growth -- earnings revisions are probably going to turn positive soon as Europe is stabilizing and the U.S. demand story is better.

The Major ETFs in the Week Ahead

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The Key Events in the Week Ahead
Third-quarter earnings season kicks into high gear in the week ahead with earnings reports from several financial and technology bellwethers. Also due are economic reports from across a spectrum of important sectors.

Many multinationals with exposure to the slowing global economy are among the dozen Dow components and 80 S&P 500 companies reporting earnings. General Electric, IBM, Microsoft, Intel, Citigroup, McDonald’s and Coca-Cola are among them.

The election seems to come and go in terms of its impact. The tendency of the market is to trade with earnings – which are still the driver of stocks despite the fact that investors get distracted by all the policy measures. While the election on any given day will be a focus, it’s really all about earnings. There obviously is a connection between the election and earnings because the winner can affect policy. For now, the investor is going with what the companies are telling us.

Earnings in the Week Ahead

It’s all about corporate earnings at this stage. And on that count, it’s not so much about how companies do relative to third quarter expectations, but rather what kind of guidance they provide for the fourth quarter and beyond. The earnings-related anxiety so much on display in recent days primarily reflects how the earnings picture will evolve as a result of this earnings season.

We don’t have any discernible trend emerging as yet at this admittedly early stage, but do the stronger-looking earnings reports from banking bellwethers J.P. Morgan (JPM) and Wells Fargo (WFC) tell us anything about the broader third quarter earnings season? Of the two results, J.P. Morgan clearly came out ahead of expectations and has strong results, but we can’t say the same about Wells Fargo. The funny thing is that of the two banking giants, it is Wells that resembles more a traditional banking entity and not J.P. Morgan. As the London Whale episode of the recent past shows, J.P. Morgan is too complex of a banking institution for investors to properly size up. As such, while a solid earnings beat from J.P. Morgan is welcome, it doesn’t tell us much about how the earnings season will unfold.

We should also keep in mind that the Finance sector as a whole is expected to produce strong earnings growth in the third quarter, as it did in the previous one. Total Finance sector earnings in the third quarter are expected to be up 14.2% from the same period last year, the second highest growth expected of any of the 16 sectors; Construction is expected to have the highest earnings growth rate at almost 45%, but Construction is too small a slice of the total earnings pie at less than 0.5% of the total, whereas Finance is the second largest earnings contributor after Tech at almost 18% of the total. Excluding the strong growth contribution from Finance, the roughly 3% decline in total Third quarter earnings drops even further to a roughly 7% decline.

The stock market ramps into high gear in the week ahead, with 200 companies reporting results, including 80 from the S&P 500. It will be in much easier to comment on this reporting season by the end of the week, as by then we will have seen results from more than one-fifth of the S&P 500 members.

Third-quarter earnings season kicks into high gear in the week ahead with earnings reports from several financial and technology bellwethers. Also due are economic reports from across a spectrum of important sectors.

Citigroup (C) gets things rolling on Monday with Goldman Sachs Group (GS), Bank of America (BAC), American Express (AXP), and Morgan Stanley (MS) following.

Technology companies reporting in the week ahead include Google (GOOG), Intel (INTC), International Business Machines (IBM), Microsoft (MSFT) and eBay (EBAY).

Also on tap in the week ahead are Johnson and Johnson (JNJ), Coca Cola (KO), and Halliburton (HAL).

Economy in the Week Ahead

There is a full economic calendar in the week ahead, with retail sales, the Empire State Manufacturing Survey, and business inventories out on Monday. Then on Tuesday, we get the Consumer Price Index, which may be interesting, as the Producer Price Index last Friday was higher than expected at 1.1%.

Also out Tuesday are industrial production numbers and the Housing Sentiment Index. The charts on the homebuilding stocks do look overextended, so this report may be quite interesting. This report provides a reading not only on the demand for housing, but also the homebuilders' view of economic momentum, and therefore may impact the markets.

More data from this sector follows on Wednesday with housing starts, and then Friday brings existing home sales. Of course, on Thursday we get the jobless claims, which dropped sharply last week, but the report was discounted due to a lack of quarterly data from one state. On Thursday, we also get the Philadelphia Fed Survey on manufacturing, as well as the Leading Indicators.

For more information and a list of key events and earnings in the week ahead………CLICK HERE…..

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Conclusion for the Week Ahead

Another Friday with a mixed close...which may reflect an indecisive outlook going into the week ahead debate. Many funds close their book at the end of October, so if they need to do new buying, they should be starting by the end of the week ahead.

Still, the major averages need several consecutive higher closes with good market internals to indicate that the correction is over. As this is a correction, a good opportunity has been presented to buy some of the diversified sector ETFs and stocks that have drawn back but are potentially sound as they test good support.

Confirmation that the correction is over before becoming a more aggressive buyer is essential at this stage. Be sure to have your stops in place and your buy orders in the market.

Further Articles Relating to the Week Ahead

1. The Economy and Earnings in the Week Ahead – October 15, 2012

2. The Past Week Stock Market Results – October 15, 2012

3. The Major ETFs in the Week Ahead – October 15, 2012

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