The Week Ahead: Fed In The Spotlight Again In A Holiday-Shortened Week!
Stock Market: More Market Volatility Ahead!
The Game Plan: Economics, Employment Report, Fed to Drive Markets!
Wall Street: Catalysts To Control The Stock Market Direction!
by Ian Harvey
July 01, 2013
Choppy, thin trading will likely be the state of play in the week ahead as traders wait for the important June jobs report Friday and fret about what the Federal Reserve might do.
The S&P 500's 12.6-percent gain in the first half was the best since 1998 but the index lost 1.5 percent for the month of June amid a volatile bond market and soaring interest rates. This has set a tentative note for the second half of the year.
Manufacturing data and jobs-related reports are the highlights of the U.S. economic calendar in the week ahead and investors will be keeping a close eye on interest rates.
Panic selling on fears of an early exit of the U.S. Federal Reserve's stimulus efforts may be over for the time being, but the stock market may still face wild intraday swings as investors scramble to position themselves for Friday's payrolls report.
Trading volume is likely to be thin, with a half-day session on Wednesday and markets closed for the Independence Day holiday on Thursday. Both the Labor Department's weekly jobless claims and employment report for June will be released at 8:30 a.m. (1230 GMT).
• ‘The Past Week’
• ‘The Upcoming Week’
• ‘The Economy’
• ‘Volatility Continues!’
• ‘Earnings and Company News’
• ‘A List of Key Events’
• ‘The Spotlight on Certain Companies’
• ‘The Fed!’
• ‘Important Events’
• ‘The Jobs Report’
• ‘Catalysts to Drive the Market!’
• ‘Expectations for the Stock Market’
• ‘Sentiment Effect on Stocks’
• ‘Technical Outlook’
• ‘The NYSE Composite’
• ‘No Black Swans
The Fed in the Week Ahead
The S&P 500 on Friday posted the best first half of the year since 1998, rising more than 13 percent in the first six months of 2013, fueled by U.S. monetary stimulus.
Even though the market's pretty fairly valued, don’t be surprised if the same kind of rally experienced in the first half of the year is repeated in the second half of the year; there doesn't seem to be a catastrophic environment, and no major cliff situations on the horizon either.
For the quarter, the S&P 500 was up 2.3 percent but for the month, the S&P 500 fell 1.5 percent on concerns of an early exit by the Fed's supportive measures.
A Reuters survey of 53 investors across the United States, Europe and Japan released on Friday found that funds had already cut their average equity holdings in June to a nine-month low due to the recent volatility and had held more cash.
The equities market back-stepped the week before last after Fed Chairman Ben Bernanke signaled the central bank would begin to slow the pace of its bond buying later this year if the economy improves as forecast. Since then, a number of Fed speakers have sought to calm markets, giving assurances the stimulus efforts are going to be in place for awhile.
Federal Reserve Bank of New York President William Dudley, who said markets are "quite out of sync" with the Fed, will speak on economic conditions on Tuesday.
The panic selling from the Fed announcement is pretty much over. Now that the Fed officials are coming out and saying unanimously that 'we haven't changed at all, and we are possibly tapering in the fall depending on the data -- the market is apparently believing that now, and expectations from the Fed speakers in the week ahead will be little unchanged.
The roller-coaster ride is certain to continue in the week ahead. Markets in the second half could be driven by more volatility, though most strategists expect equities to ultimately end the year higher than their current levels.
The recent volatility in stocks and bonds will likely be with us for the foreseeable future -- at least a few months -- with continued pullbacks providing an opportunity to add to stocks in sectors sensitive to a continuation of the economic recovery – the recommendation is to put money to work now!
Strategists expect markets to continue zigzagging near-term, as investors struggle to adjust in the face of a rising yield environment and grapple with the reality that the Federal Reserve could begin to wind down its $85 billion a month bond-buying program before 2014.
It is even possible that the summer could be "range-bound" due to anemic volume as well as the catalyst that drove the market to the existing levels [the Fed] may not be there anymore.
Major averages have been on a roller-coaster ride since Federal Reserve Chairman Ben Bernanke told Congress in May that the central bank may reduce the pace of bond purchases in the next few meetings if policymakers see indications of sustained economic growth.
After the news, the S&P 500 index fell as much as 7 percent from its intraday record high in May. The Dow Jones Industrial Average has logged triple-digit moves in 15 of the 19 trading sessions in June, the most in a month since October 2011. And the 10-year bond yield climbed as high as 2.66 percent earlier this week.
The week ahead may see extra volatility as non-farm payrolls, which generally cause more volatility in the market, is combined with weekly claims coming out the same day on a shortened trading week.
In the options market, traders were active in the put weekly options on the Standard & Poor's 500 Index (SPX) in the past week. These short-term options have a week-long life span and expire on July 5. Put options are generally viewed as bearish bets against the market.
The most active weeklies options are the 1,600 puts on the SPX.
Important Events in the Week Ahead!
Friday's employment report is crucial to trading in the next couple of weeks, since it is a key metric the Fed watches. The consensus is for 170,000 nonfarm payrolls in June, and the unemployment rate is seen dipping a tenth of a percentage point to 7.5 percent. In May, the economy added 175,000 jobs.
New York Fed President William Dudley speaks on regional and national economic conditions in Stamford, Conn. Tuesday at 12:30 p.m.
Besides U.S. data, markets will be watching China's PMI data and Japan's Tankan Survey. On Thursday, U.S. markets are closed for the Fourth of July, but both the Bank of England and European Central Bank meet Thursday.
The Jobs Report for the Week Ahead
Investors will be looking for signs of sustained strength in U.S. labor markets in the week ahead when the government releases its June jobs report on Friday.
Additional economic data are scant in a week shortened by the July 4th holiday. All U.S. banks and securities markets will be closed on Thursday to mark the holiday.
The U.S. labor market has become an intense focal point for investors in recent months as the Federal Reserve has tied its monetary policies to the unemployment rate. Fed Chairman Ben Bernanke has said the Fed will consider scaling back its easy money policies only when the U.S. labor markets show signs of sustained growth.
That hasn’t happened yet.
In May U.S. employers added 175,000 jobs, a slight improvement over April, but not nearly enough to inspire confidence that hiring is gaining strong momentum. The headline unemployment rate ticked higher to 7.6% in May from 7.5% a month earlier.
Economists said the uptick in the rate was caused by more people returning to the workforce by attempting to find jobs, a good sign. People who are no longer looking for work aren’t counted among the workforce used to determine the unemployment rate.
Forecasts for June’s report reflect analysts’ belief that the job market remains sluggish. The economy is expected to have added 165,000 jobs and the unemployment rate is expected to drop slightly to 7.5%.
Earnings and Company News in the Week Ahead
Earnings will not be the major focus in the week ahead, with Constellation Brands (STZ) as the notable report coming out. But the earnings reporting cycle is about to take the spotlight with Alcoa’s (AA) release on July 8th. The Q2 earnings season has already gotten underway, with results from Nike (NKE), Accenture (ACN), Oracle (ORCL), FedEx (FDX) and others.
Accenture’s weak guidance reconfirms what we saw in the recent Oracle report about macro issues weighing on corporate spending outlook. Importantly, it puts us on notice about what to expect from IBM (IBM) and others in the coming days.
As has become customary at the start of recent quarterly earnings cycles, expectations for the Q2 earnings season remain quite low. A major driver of these low expectations is company guidance during the Q1 earnings season, which was overwhelmingly on the negative side. Total earnings for companies in the S&P 500 are expected to be down -0.3% from the same period last year on -0.5% lower revenues and almost flat margins. This is sharply down from +3.9% growth expected in the quarter in early April.
Nine of the 16 sectors are expected to show negative earnings growth in Q2. But the growth picture in Q2 is even more underwhelming when Finance is excluded from the data. Outside of Finance, total earnings for the S&P 500 would be down -4.3%. Total earnings were up +2.4% in Q1, but growth was expected to be in negative territory at this stage before that reporting season.
Finance at the Forefront Again!
Finance wasn’t a big driver of aggregate earnings growth for the S&P 500 in Q1, but takes back the lead role in Q2, with total earnings for the sector expected to be up +19.5% and estimates for the group are steadily going up. Earnings for the sector were up +7.7% in Q1, which came after many quarters of double-digit growth.
All the industries within the Finance sector like the major banks, regional banks, brokers and insurers are expected to have positive growth. But the growth picture is particularly notable for the brokerage and investment management industry players like Goldman Sachs (GS) and Morgan Stanley (MS), with total earnings for the group expected to be up +38.7% in Q2 after the +2.6% gain in Q1.
Technology to Remain Weak!
Unlike Finance, the earnings picture for the Technology sector remains fairly weak. Total earnings for the sector are expected to be down -11.8% from the same period last year, which follows the -4.4% earnings decline in Q1. Earnings estimates for the sector have been steadily coming down as the quarter progressed, with the current -11.8% decline down from the expected decline of -3.1% in mid-April.
The weakest group within the Technology sector is the PC makers, with total earnings for the Computers and Office Equipment industry expected to be down -16.1% in Q2 after the -14.1% decline in Q1. Semiconductors and electronics are other Tech industries with negative earnings growth in the quarter, while the software group is expected to show modest positive growth.
The Spotlight on Certain Companies in the Week Ahead
Constellation Brands, the maker of alcoholic beverages, is expected to report fiscal first quarter earnings on Tuesday, July 2. Analysts expect the company to report earnings per share of $0.40, down slightly from the $0.41 earned per share in the first quarter of last year while revenue is expected to rise slightly to $674.25 million from $673.65 million.
The analysts at J.P. Morgan are rather cautious on the stock heading into earnings. They have a price target of $55 on the stock and neutral rating.
“[Constellation Brands] is scheduled to report 1Q14 (3M to May 31) results on Tuesday, July 2. We look for 1Q EPS of $0.38, down 4% YoY, dampened by 1) +$10m in interest expense YoY related to the Crown purchase; 2) +60bps rise in tax rate to 37.0% 3) a stronger US dollar vs. the Canadian dollar and 4) +2.3% increase in diluted shares outstanding.”
“We anticipate reported wine sales to rise by 4.5% to $663.2mn, with wine volumes +4%, wine revenue/case +1% and FX -0.5%. Equity income is expected to rise 6.3% YoY to $64.7m, including a 4% increase in beer revenue. We look for reported beer volumes to rise 2.5% (including -100bps from the loss of St. Pauli Girl) and +1.5% in beer price/mix.”
“STZ has the potential to generate growth, margins, returns and free cash flow that could put it among the top-tier consumer staples companies. Our Neutral rating is based on our view that most of the benefits are still ~2 years away.”
Goldman Sachs is also cautious on the stock ahead of earnings. They too have a neutral rating on the stock but have a slightly higher price target at $60.
“STZ reports 1Q FY14 results Tuesday, July 2, and we forecast EPS of $0.39 (consensus $0.40). We are, however, above STZ guidance for the full year at $2.93 vs. $2.55-$2.85 and expect STZ to take the bottom end of guidance up by about $0.05. We revise our EPS estimates modestly to incorporate more favorable FX and adjusting for the timing of the Crown deal closing.”
“We do not expect much surprise in 1Q results, as we forecast EPS of $0.39 (consensus $0.40) on 4% wine/ spirits volume growth and +8% wine/spirits EBIT. 1Q wine/spirits EBIT growth is likely to be boosted as STZ laps de-load and heavy marketing spend in 1Q13. For the full year, we still expect EBIT to come in below sales as grape costs increase and wine pricing remains muted.”
“We expect guidance to come up as the year progresses on a likely lower tax rate and since the wide guidance range reflects conservatism on the part of management until more details around the beer transactions become clearer in the coming months.”
A List of Key Events for the Week Ahead
All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.
• Earnings: MSC Industrial Direct (NYSE: MSM) and Shulman Inc. (NASDAQ: SHLM).
• 10:00 am Construction spending
• 10:00 am ISM Manufacturing
• Earnings: Acuity Brands (NYSE: AYI), and Constellation Brands (NYSE: STZ).
• 10:00 am Factory orders for May
Earnings: International Speedway (NASDAQ: ISCA).
• 07:00 am Mortgage Applications
• 08:15 am ADP, June
• 08:30 am Jobless Claims
• 08:30 am Trade Balance
• 10:00 am ISM nonmanufacturing
Markets closed for Independence Day
• Earnings: Finish Line (NASDAQ: FINL) and Blackberry (NASDAQ: BBRY).
• 8:30 am Employment report
International Economic Reports in the Week Ahead
• Monday - Manufacturing PMIs from China, the eurozone, Germany, France, Italy and Spain.
• Wednesday - Services PMIs from China, the Eurozone, Germany, France, Italy and Spain.
• Thursday - Interest rate decision from the Bank of England and the European Central Bank.
• Friday - German factory orders, the Canadian employment report, and the Canadian Ivey PMI.
Expectations in the Week Ahead!
Expect the market to continue trading in a bumpy fashion in the week ahead due to several fear factors -- the Fed exit, weaker bank lending and problems in Europe are all factors that could have an impact.
The market is dealing with the Fed's expected tapering of bond buying, which some investors fear will hurt market liquidity. There are also concerns that corporate earnings estimates, now reflecting gains of 10 to 11 percent for the second half, are too high and will have to come down.
Also, another problem is the slowdown in China and other emerging markets, and it's not clear how much impact they will have on companies and the world economy.
A lot of investors are moving to cyclical sectors -- domestics and international cycles. If you bought domestic cyclical, any sector, they've all rallied hard – however, in regard to global cyclicals, confidence towards Europe, China, Brazil and Turkey progression, is needed.
Some strategists expressed caution about the second half, suggesting that gains for the year have mostly been made and that investors should prepare for an upside at the beginning of 2014.
Catalysts to Drive the Market in the Week Ahead!
Following are the economic releases and other potentially market moving catalysts in the week ahead.
• On Monday Asia's economic health will be examined with manufacturing PMI from China. The focus on China is important because that country seems to be slowing down at a pace that has to make the government extremely uncomfortable. If the numbers are below 50 then expect more pressure on the mineral stocks and the commodities in general.
• Also, the Tanken All Industry Capital Expenditure Index from Japan needs consideration. Japan had fallen so far that some pundits were convinced it would remain in the grips of a bear market for the rest of the year. But recently there have been signs of life and it will be interesting to see if the Tanken report confirms that those signs of life will endure.
• The health of the auto industry comes into play on Tuesday with the light vehicle sales report. Some softness is expected because of the sudden surge in interest rates due to the damage the Fed wrought with its confused comments about potentially ending its accommodative stance.
• Also the state of industry with U.S. factory orders needs monitoring. Industrials are the stocks to buy if rates are heading higher. We've had two similar bursts in rates, in 1994 and in 2004, and at those times most of the gains were concentrated in the cyclicals.
• Europe takes center stage on Wednesday with Eurozone retail sales. One of the reasons Europe seemed to find some footing this past week was that German retail sales were better than expected, even as the Spanish have had to endure three straight years of declining retail numbers. This aggregate figure could buttress the thinking that Europe's bottoming and can actually begin to get some pep back.
• Of all the economic numbers out in the week ahead, none will matter more than the report released Friday -- the non-farm payroll report. Trading will be thin due to the holiday so the important thing to consider is that the reaction will be wildly disproportional versus other non-farm payroll reports. The consensus holds that 165,000 jobs were created this month.
Technical Outlook for the Week Ahead
As was apparent in the week before last, the daily technical studies were negative. But the market was getting quite oversold, which made a rebound likely this past week. The rally was quite impressive, and though prices just reached the expected upside targets, the internals did act better.
The daily studies improved to slightly positive after Thursday's close, but the market was ready for a pullback, or at least a pause, as experienced Friday afternoon.
It is now looking more likely that the lows from June 25 will hold for the week ahead. It will take a sharp down day with very negative market internals to reverse the improvement.
The seasonal pattern is a bit more positive for July and August, but then September is generally a problem.
The market did get oversold enough on the recent drop to support the resumption of the uptrend, as the number of NYSE stocks above their 50-day MAs dropped below 28 last week and has now risen to 40. In November 2012 it dropped below 22, and the June lows were at 13 (see arrows below).
Sentiment Effect in the Week Ahead
As expected, sentiment numbers did turn a bit less bullish last week. Only 30% of individual investors are bullish according to the American Association of Individual Investors (AAII), down from 37.4%. Still, only 35% are bearish, and it would be good to see these numbers at more extreme levels.
The number of bullish financial newsletter writers also dropped from 46.8% to 41.7%, but at 25%, the number of bears is still quite low.
The NYSE Composite in the Week Ahead
The number of new NYSE 52-week lows spiked to 546, which was a new high for the correction. The number of stocks making new highs still shows a pattern of lower highs for the week ahead.
The daily chart of the NYSE Composite shows that the former uptrend (line a) was tested on last week's rally, and it was not able to move above the 20-day ’Exponential Moving Average’ (EMA) at 9,188. First support is in the 8,900 to 9,000 area, and the correction has held above the 38.2% 'Fibonacci Retracement’ support at 8,757.
”The McClellan Oscillator” does show a pattern of higher highs (line b) and moved above the zero line late last week -- this bullish divergence is consistent with a market low, but it needs to be confirmed by the A/D line in the week ahead.
The daily NYSE Advance/Decline (A/D) line has moved back above its downtrend (line c) and its WMA. A pullback and then a move above last week's high would complete the bottom formation in the week ahead. For July, the monthly pivot is at 9,143, with stronger resistance at 9,255 and then 9,412.
There doesn’t appear to be any “BLACK SWANS” apparent!! The rapid move up in interest rates and the recent 800-point two-day drop in the Dow Jones industrial average (INDU) has more than a few investors worried we might be seeing the beginning stages of a new economic crisis.
Adding to the anxiety is the fact that all this seems to be triggered by Ben Bernanke's suggestion that the Fed may soon curtail its bond buying stimulus program, which some have been warning would spell doom.
The best advice in regard to this is “calm down and chill out”. The investor says the effect of the Fed on the market has been exaggerated. The recent combined rout of stocks and bonds seems to be over for now and there is absolutely no reason for this to continue -- there is no liquidity crisis or big unwind – not like 2008.
Some have said that the market is suffering from excess leverage or the fact that Wall Street dealers, because of new rules, are no longer willing to support the bond market. However, there is no real evidence of that occurring. Some bond markets are less liquid than usual, but there are no signs of the type of market turmoil that was brewing back in 2008 -- markets are functioning well.
The main reasons for the stock market turmoil in the past couple of weeks are that:-
• interest rates are rising at a time when inflation is flat,
• expectations for corporate cash flows haven't dramatically improved,
• commodity prices are falling, and
• this is all coming at a time when China is slowing as well.
All sounds quite dramatic!
However, this negativity is not sustainable -- either interest rates have to head back down, or growth has to pick up. Either way, investors should benefit. A more normal market is more likely to prevail.
Conclusion for the Week Ahead
The improvement in the technical studies last week does suggest that July may be a better month for stocks.
The major averages closed the week higher, though the averages closed on the day's lows, as the selling was heavy in the last few minutes. The four market-tracking ETFs were all up for the week, closing out their best half-year performances since 1999.
History shows that strong market momentum in the beginning of the year bodes well for a robust annual performance.
We have momentum from a strong start to the year—there have been 26 times since World War II that the market was up both January and February, and in all cases, the market posted an average total full-year return of about 24 percent.
The pullback does not appear to be over, and some further selling early in the week would not be surprising. However, it would take a very sharp down day with very negative market internals to cancel out last week's improvement.
Quite a few stocks and industry groups are starting to lead the market higher already, breaking out of their trading ranges last week.
Some strategists are recommending that investors take advantage of the recent sell-off in commodities, such as gold, silver, and other commodities which have felt the brunt of the selling. It's not a bad time to be looking to add these to your positions, unless we head into a huge deflationary spiral.
In addition, investors should consider adding options to their portfolios.
The nice thing about options over stocks is that whereas you need movement to make money in stocks, you can still make money in ”options” in a sideways, range-bound market. It's a nice blend in an overall portfolio.