Stock Market: Barring Serious Negative News, This Resilient Market Could Break To New Highs!
Week Ahead: Fourth-Quarter Earnings Season Keeps On Happening!
Wall Street: Market Trend Points to Trading Range!
by Ian Harvey
October 20, 2012
The stock market got slammed last week by worse-than-expected quarterly results, but the damage may be limited because Wall Street was already expecting a nasty earnings season.
Expectations for the third quarter were dismal, with forecasts for a decline in profits from a year ago. But a recent flurry of high-profile reports has investors scowling at the weak revenue numbers, adding to worries about the state of the U.S. economy and the outlook for corporate America.
Based on results from 116 companies and estimates for the rest, earnings for S&P 500 companies are expected to decline 1.8 percent from a year ago - the first such decline in three years. Without Apple, that decline would be about 2.3 percent.
The big surprise so far has been the extent of the earnings hits felt by the technology sector, with its international exposure and the slowdown in PC sales.
International Business Machines (IBM), General Electric (GE), and Microsoft (MSFT) fell short of revenue expectations, creating a sour mood early in the third-quarter reporting period.
Sixty percent of the S&P companies that had reported as of Thursday saw earnings per share above estimates, Thomson Reuters says. But that is below the typical 62 percent and below the recent average of 67 percent.
Even more of a concern is that a substantial number of companies have bombed on revenues, with top line misses an unusually high 58.6 percent, above the recent trend of 45 percent and 10-year trend of 38 percent.
The third quarter is among the most important for investors and economists because it is when companies begin to give a better picture of what the following year may look like.
So far for the fourth quarter, there have been 17 negative outlooks from companies, no positive outlooks and one in line. That compares with 11 negative outlooks, two positive outlooks and two in line at a comparable period for third quarter guidance.
Taking some of the focus away from earnings in the week ahead will be the Federal Reserve's policy meeting on Tuesday and Wednesday. After last month's meeting, the Fed announced its third round of aggressive economic stimulus, causing the stock market to rally despite a slew of earnings warnings.
While investors welcomed the Fed's plan for more economic stimulus, known as "Quantitative Easing (QE3)", the move underscored worries that the U.S. economy may be in worse shape than feared.
Worsening macroeconomic conditions, namely sluggishness in the U.S. economy along with a dramatic slowdown in Europe and weakness in China, have been among the chief reasons cited by companies in their warnings about earnings and revenue.
U.S. economic indicators to watch in the week ahead will include new home sales for September on Wednesday and durable goods orders for September on Thursday, followed by the first look at third-quarter GDP on Friday, as well as the final reading for October on consumer sentiment from the Thomson Reuters/University of Michigan surveys.
But on a revenue basis, 82 percent of health care companies had negative surprises, while 83 percent of industrial companies had misses, and 67 percent of materials companies’ revenues came up short, according to the Thomson Reuters data.Friday also marked the 25th anniversary of Black Monday, when the U.S. stock market went into a free fall and the Dow lost 22.6 percent in a single trading session. The Black Monday stock market plunge on Oct. 19, 1987, stunned investors and rattled Wall Street.
• The Dow Jones Industrial Average (DJI) eked out a gain of 0.11 percent for the past week.
For the Dow, Friday's slide marked its biggest loss since June 21 - with the sell-off coming on the 25th anniversary of Black Monday, when the Dow plunged 22.6 percent in its worst single-day percentage drop ever.
• The Standard & Poor's 500 Index (SPX) rose 0.32 percent for the past week.
• The Nasdaq Composite Index (COMP) hit by tech’s selloff, lost 1.3 percent for the week to 3005.
For the year, the Dow is up 9.2%, with the S&P 500 up 14% and the Nasdaq up 15.4%.
Travelers (TRV) was the best performer on the Dow for the week, while IBM (IBM) led the laggards.
The S&P tech sector was down 2.4 percent, while materials were the best performers, up 2.1 percent.
Materials companies were expected to perform poorly this quarter but expectations for the technology sector had not come down as much and many investors were more heavily invested in tech than other sectors. Therefore, the selling by disappointed investors has been dramatic. Since the S&P’s Sept. 14, 2012 high, tech has by far been the biggest laggard, losing 7.8 percent. Materials stocks were the second worse sector since then, down 2.9 percent, and energy was third -- down 2. 8 percent.
The CBOE Market Volatility Index (VIX – 17.06) ), widely considered the best gauge of fear in the stock market, rose 13.5 percent to close at 17.06, conquering its 80-day moving average for just the second time since late June, but off its session high at 17.60. Options expiration added a bit of volatility to Friday's trading.
**For a more in-depth look at the past week…..CLICK HERE…..**
The Major ETFs in the Past Week
1) Obviously more earnings
3) Fed meeting
In addition to the above influences, there are several moving parts that make calling the stock market in the next few months complicated:
1) the outcome of the election – many investors think a Romney win would be positive for the stock market, a sweep of the Presidency, the House and the Senate by the Republicans would be VERY positive, and status quo would be a mild negative.
2) the ”fiscal cliff” -- it has appeared on the radar of stock market traders. This is a divided argument as to whether this will be resolved in the next few months.
3) economic data -- which has shown some resilience, particularly for the consumer (housing, retail)
Floor under the Stock Market
Even with the bumpy earnings season, strategists say there are plenty of underpinnings for the stock market, including the already baked-in expectations that earnings would be weak. It is obvious that the institutional clients know the estimates are too high, so the missing of estimates is not going to be disruptive in the aggregate. Individual companies could still have some strong volatility. Individual stocks will still get whipsawed at times.
Some strategists see a trough in the third- or fourth-quarter profit reports, and the current reports are only revealing what the market already knows about a slowdown in the global economy. The global data’s been really, really sluggish, and so that’s the reason why industrial and tech earnings are as weak as they are -- there are signs that investors have been buying stocks on dips that sold off on earnings news. That is a sign the earnings misses are already factored in to share prices.
The fact that so many managers are lagging the indexes this year could also give a boost to the market this quarter -- they’re trying to close this gap and have roughly 10 weeks to fix that. This presents a great opportunity for investors to buy on pullbacks.
The election could be a factor for the market, but a re-election of President Barack Obama is already priced in. However, a Mitt Romney victory could ignite a bigger rally.
There are two different kinds of views at the moment:-
1. Some people are saying: ‘I’ve made some money, let’s lock in the gains.’
2. Others are saying, ‘I see a big fourth quarter rally. Let’s gear up!’
However, the bias is a little more bullish than it is cautious.
More investors, recently, are starting to trust that there is a continuing stock market rally. There has been an improvement in economic indicators:-
• in the last couple of weeks, the ISM had a move above the boom-bust line
• auto sales above 14 million
• retail sales better than expected, and
• an improvement in the housing recovery.
• As well as an improvement in some of China’s data this past week.
The Fed in the Week Ahead
The Fed’s easy policies are another reason traders say stock prices are supported. The Fed is continuing its ”Operation Twist”, where it buys long-dated Treasury securities and sells the short end. It is also conducting "an open-ended QE3 mortgage-purchase program ", announced at its last meeting.
Fed watchers are not expecting any action at this week’s meeting --it’s likely to be an inconsequential meeting, a transition meeting.
The December meeting is the one with the greater likelihood of Fed action and results because there are decisions that have to be made. The key decision to be made is whether to continue the purchase of longer term securities, after Operation Twist ends. Second is whether to change the forward guidance (on rates) and move it away from calendar guidance, which many members do not like.
The Major ETFs in the Week Ahead
Earnings in the Week Ahead
The third quarter earnings season has been quite weak thus far, but we have plenty of reports still to come and things may change. The week ahead is particularly busy on the reporting front, with a total of 668 companies coming out with third quarter results, including eight Dow components and 155 S&P 500 members. With results from 115 S&P 500 companies already available (as of Friday, October 19), we will be past the half-way mark by the end of the week ahead.
Total earnings for the companies that have already reported results are down 2.9% from the same period last year and only 54.8% of the companies have beat earnings expectations, with a median surprise of 1.8%. The performance on the revenue side is a bit better, with total revenues up 1.3%, but only 33.9% of them are able to beat revenue expectations. This is weaker than what these 115 companies have been reporting in recent quarters.
While the weakness is quite broad-based, the Tech sector is standing out for its sub-par performance, as we have seen in reports from Intel (INTC), IBM (IBM) and Google (GOOG). The roughly one quarter of Tech sector companies that have already reported results account for more than 40% of the sector’s total third quarter earnings. Total earnings for these Tech companies are down 10.9% from the same period last year, which is a sharp departure from what these companies have done consistently in recent quarters.
Of the 385 S&P 500 companies still to report results, roughly 40% will come out this week, including Apple (AAPL), Amazon (AMZN), Facebook (FB), just to mention the very prominent names. Total earnings for these 385 companies are expected to drop 2.3% from the same period last year. The still-to-come Tech sector earnings (includes Apple) are expected to be up 6.6%, which compares to growth rates of 12% in the second quarter and 26% in the first quarter of 2012 for these same companies.
The composite earnings growth rate, combining the reports that have come out with those still to come, for the third quarter is for a decline of 2.2% for the S&P 500 as a whole and a decline of 6.5%, excluding Finance. The composite Tech sector earnings growth rate is for a decline of 1.2% from the same period last year, a major reversal of the persistent strong growth for a long time. Excluding Apple, which accounts for about 20% of the sector’s earnings, total Tech sector earnings would be down 6.3% vs. positive 2.1% growth in the second quarter.
Earnings Trend for the Stock Market
The earnings trend is that the:-
a) Banks have been beating
b) Techs are reporting poor revenue growth on weak PC sales and business software. Longer term, there is a disruption going on in tech land. The WinTel model is dissolving.
Wintel is a portmanteau of Windows and Intel, referring to personal computers using Intel x86 compatible processors running Microsoft Windows. It is mostly used to describe the monopolistic actions undertaken by both companies when attempting to dominate the market.
Microsoft (MSFT) and Intel (INTC) are an old story, but the slower business software story from MSFT is another headwind in addition to slower PC sales. Hewlett Packard (HPQ) and Dell (DELL) aren't working. Photos are not being as printed as much, so anyone in the printer business is having a tough time.
Even digital brands are having a tougher time, with Google (GOOG) seeing disruption as it moves to mobile.
c) Its still early but Industrials and Materials are reporting weak revenues, with guidance cautious on weaker global demand
Right now, Q3 earnings are FLAT, with revenues expected up just 1.3 percent. Earnings for Q4 are expected to be up 9.8 percent, with revenues up 4.1 percent.
The bottom line is at there is a lot of moving parts to the stock market earning story.
Economy in the Week Ahead
In the week ahead, the 'Federal Open Market Committee - FOMC' starts its meeting on Tuesday, with their announcement following on Wednesday afternoon. Given the improvement in the economic data, the real surprise would be if the Fed’s outlook for the economy improved.
On Wednesday, we also get new home sales and a flash reading on the PMI Manufacturing Index. On Thursday, in addition to the jobless claims, we get the durable goods orders as well as the Pending Home Sales Index. Friday brings the preliminary reading on third–quarter GDP and the University of Michigan Consumer Sentiment Survey.
Conclusion for the Week Ahead
Last week’s action was the most negative we have seen in some time, as most of the major averages closed near the day's lows. This will likely trigger more selling in Asian markets early Monday, which may make for a wild opening that day in the US markets.
To turn the short–term outlook around, we need to see a higher close this week. Otherwise, the risk of a sharper decline in the other sectors will increase.
They could catch up with the tech sector. If Apple’s earnings do disappoint, it could trigger a selling climax. On the other hand, a strong close in Apple this week could easily stabilize the tech sector.
Even though the energy and materials sectors gave up some of their gains on Friday, the charts still indicate that they have completed their corrections. The drug sector also still looks pretty good, as it has a seasonal tendency to bottom at the end of the month.
Be sure you take a look at all your positions and have a plan in place, including stops, for each position.
1. The Economy and Earnings in the Week Ahead – October 22, 2012
2. The Past Week Stock Market Results – October 22, 2012
3. The Major ETFs in the Week Ahead – October 22, 2012