Week Ahead: Stocks Eye Spain and China!
Stock Market: Bernanke and Jobs – Scare Factor for October!
Wall Street: Economic Keys Driving Stocks to New Highs!
by Ian Harvey
September 29, 2012
Wall Street will open October with a busy week ahead, highlighted by low expectations for global manufacturing data and the U.S. jobs report, but that could set the stage for positive surprises that help lift the market.
Traders expect October to give the markets a scare, starting with news on the economy and jobs in the week ahead.
After a surprisingly good performance in the third quarter, the thinking is the stock market is ready to pull back, especially after a few choppy sessions and a new batch of data that should continue to show a slow-moving economy.
Counterbalancing the disappointing economic news has been the willingness of global central banks to take action, and the Fed’s quantitative easing program is expected to provide a floor for the market if it does start to correct.
Of interest will be Fed Chairman Ben Bernanke’s comments Monday, in the week ahead, on the economy before the Economic Club of Indiana. The European Central Bank also holds a rates meeting Thursday, and while it is not expected to act, ECB President Mario Draghi will hold a briefing afterwards.
While the data has been disappointing, some of it has not, including housing and some consumer-related readings. University of Michigan consumer sentiment, for instance, was revised down from 79.2 to 78.3 in the final September report, but interestingly, the expectations of consumers rose, and consumer confidence, reported in the past week, also improved.
Stocks logged the best third quarter performance since 2010!
• The Dow Jones Industrial Average (DJI) buckled more than 1% on the week to finish at 13437.13. However, the Dow enjoyed a 2.6% rally during September, and for the third quarter, the index surged 4.3%.
• The Standard & Poor's 500 Index (SPX) sawed off 1.3% for the week to end at 1440.67, However, the SPX jumped 2.4% for the month, and for the third-quarter returned 5.8%.
• The Nasdaq Composite Index (COMP) declined 2% to 3116.23 for the past week. But, the COMP tacked on 1.6% in September. Its quarterly total arrived at a gain of 6.2%, which is the best of its fellow benchmarks.
All in all, the stock market is doing pretty well. It took some shots this past week, but in looking at the SPX chart below, the uptrend remains intact. A lot probably hinges on the upcoming debate, but for now, the bulls are still in charge.
Home Depot (HD) was the biggest gainer on the blue-chip index for the quarter, while H-P (HPQ) was the worst performer. Most key S&P sectors posted gains for the quarter, led by energy, while utilities sagged.
The CBOE Market Volatility Index (VIX), widely considered the best gauge of fear in the stock market, battled its way back atop the 15 mark on Friday of the past week, adding 0.9 point, or 6%. The stock market's fear gauge lifted 12.5% on the week, but saw a monthly loss of nearly 10%. For the third quarter, the VIX was down 7.9%.
**For a more in-depth look at the past week…..CLICK HERE…..**
The Major ETFs in the Past Week
As expected, early in the past week, the selling continued. By Wednesday, many of the major Exchange-Traded Funds -- ETFs -- reached more important support. The sharp rally took the major averages well off the lows, and despite the heavy selling early Friday, Wednesday’s lows did hold in all except the Dow Industrials.
It is still clearly a mixed market, as while the technical studies on the NYSE Composite and Russell 2000 still suggest that this is just a correction, the S&P 500 and Nasdaq 100 look much weaker.
The sentiment picture is also mixed, as individual investors are still not enthusiastic about the stock market—only 36.4% are bullish.
TOP OPTIONS TRADES SINCE JULY 01, 2012
|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%|
|FB Aug 25.00 Puts||500%||DISH Sept 30.00 Calls||100%|
|APPL Jan 13 650.00 Calls||71%||CSTR Oct 42.50 Puts||400%|
|LNKD Aug 92.50 Puts||30%||LNKD Aug 100.00 Calls||250%|
|SLV Nov 30.00 Calls||114%||JCP Nov 25.00 Calls||67%|
|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%|
Speculators in both markets also remain convinced the Republicans will hold sway over the House of Representatives. The Senate remains undecided, with one party or the other holding only a slight margin.
In other words, it appears more likely that not much will materially change.
So does that mean nothing will materially change in regard to the dreaded “fiscal cliff” – media shorthand for the combination of federal tax increases and spending cuts that are scheduled to go into effect January 1, 2013? In other words, should we look forward to more gridlock? (See the solution offered below in “Economic Keys Driving the Stock Market to New Highs”)
The Major ETFs in the Week Ahead
As was expected in the past week, more Eurozone news put pressure on the stock market. It does not appear to be over, and if stocks fail to rally above last Thursday’s highs early in the week ahead, a deeper correction looks more likely.
Clearly, the short-term outlook favors a cautious approach for now, and be sure you have your stops in place.
October is a seasonally strong period, which suggests a better buying opportunity is likely in the weeks ahead.
Earnings in the Week Ahead
There is a total of 16 companies reporting results in the week ahead, including five S&P 500 companies. Expectations for the third quarter remain quite low, with total earnings expected to drop 3% from the same period last year. This growth expectation reflects a 2.4% drop in total revenues and a 10-basis point expansion in net margins.
The actual growth rates will most likely be better than these pre-season expectations, given how company managements have refined the art of under-promising and over-delivering quarter after quarter. Just to give you an idea of how good they are at anchoring expectations, roughly two-thirds of the companies in the S&P 500 would typically beat earnings expectations in any given quarter – it was 62% in the second quarter and 65% in the first quarter.
If we do get negative earnings growth this quarter as currently expected, that will be the first decline in quarterly earnings since the earnings recovery got underway after the end of the Great Recession in 2009. The earnings weakness is quite broad-based, with half of the sectors expected to have negative earnings growth.
As was the case in the second quarter, the Energy and Basic Material sectors are the weakest, with earnings declines of 24.9% and 22.3%, respectively. Energy and Basic Materials earnings were down 16% and 20.5% respectively in the second quarter, when total earnings for the S&P 500 as a whole were up 4%.
Economy in the Week Ahead
The week ahead economic news may shed more light on the economy. The PMI Manufacturing Index and ISM Manufacturing Index are both out on Monday, along with construction spending.
Wednesday we get a preliminary reading on the jobs outlook with the ADP Employment report, as well as the ISM Non-Manufacturing report. Thursday brings jobless claims and factory orders, followed Friday by the monthly jobs report.
The September jobs report is due in the week ahead and the numbers could play an important role in the upcoming presidential election.
Jobs are undoubtedly the central theme of this campaign. President Barack Obama, if he expects to win re-election, has to convince voters that his policies are addressing the causes of a stubbornly high unemployment rate (8.1% in August). A lousy jobs report just a month before the Nov. 6 election won’t be helpful.
Former Massachusetts Gov. Mitt Romney, the Republican candidate, has argued that Obama’s economic policies have failed and that the recovery should be much farther along nearly four years removed from the financial crisis brought on by the collapse of the U.S. housing market.
Both campaigns will certainly attempt to spin the job numbers in their favor when they are released on Friday.
Also, the ECB and BOJ are set to meet on Thursday, with the Bank of Japan's meeting extending until Friday.
The S&P 500 in the Week Ahead
The benchmark S&P 500 earlier this month reached its highest level since late 2007. Yet uncertainty remains over whether stocks can hold their gains against the headwinds of a struggling economy. That explains, in part, the retreat over the last several days.
The S&P 500 hit a high of 1,474.51 in mid-September before pulling back by a bit more than 2 percent. A run at 1,500 seems possible, but the flurry of economic and world events ahead probably will prevent a major advance in the week ahead.
However, all-in-all, the stock market is doing pretty well. It took some shots this past week, but in looking at the SPX chart below, the uptrend remains intact. A lot probably hinges on the upcoming debate, but for now, the bulls are still in charge.
Economic Keys Driving the Stock Market to New Highs
Since the May correction, the market has scaled a big wall of worry that kept many investors on the sidelines and put lots of bears in the critical listings.
Central bank words from both sides of the Atlantic helped propel the S&P 500 from 1300 to 1400 in June through August. And then central bank actions and short-covering launched us to 1,475 in mid-September.
But last week, the technical case for new highs this year according to the charts said big investors must actually like the fundamentals too - not just unlimited QE.
Now that the first significant pullback since July is in progress, it's time to look at the fundamental drivers that will motivate money managers to buy the dips.
1. Europe Recovering
Europe is definitely in a recession and no doubt will remain so for all of next year. But the heavy lifting required to backstop their sovereign debt crisis is finally occurring. Against the wishes of the old guard inflation hawks of Germany's Bundesbank, the ECB is slowly evolving to become a lender of last resort.
When Mario Draghi took office one year ago, he ridiculed those who suggested this was the destiny of Europe's central bank. But he and more moderate members of the ECB have recognized that the "irreversibility" of the euro is paramount and they will now do whatever it takes to save their grand experiment.
2. US Economic Resiliency
The big mistake that big investors made in 2010 and 2011 was in believing that an economy approaching stall speed was one headed toward recession. But after two years of sending stocks into steep corrections near 20%, they finally realized that corporate earnings were still growing despite a slew of problems:
• 1% GDP,
• Debt-ceiling debacle,
• Euro meltdown,
• China slowdown, and
• 8% unemployment
The fundamental case for a US economy to continue to see corporate earnings grow -- some themes are very persistent, and some are just being realized:
• Record low interest rates and corporate cash, which make stocks the place to be,
• Housing bottoming and brewing with animal spirits, which predicts job creation,
• While 45% of S&P profits come from abroad, the impact of Euro-China has been small and the worst was priced-in at S&P 1,300,
• S&P earnings estimates for 2013 are slowly inching down from above $110 toward $105, and that makes S&P 1,450 trade under 14X. Still very attractive!
• Energy sector is in a "sweet spot" feedback loop where booming domestic exploration and production raises supply, keeps prices stable and creates jobs, and
• US innovation creates the future - and tomorrow's profits - from technology, biotech and high-tech manufacturing industries to financials, retailing and energy
3. Fiscal Cliff Navigable
The question gaining a great deal of attention, particularly in regard to stock market investors, is the question – “ What are the chances that Congress comes together and works out the tax and spending compromises necessary to reduce the deficit but not derail the economy?” Some of the worst estimates are a 5% blow to GDP if all the tax cuts expire and all the automatic spending cuts go into effect.
This brick of uncertainty in the wall of worry, when it became apparent, was too heavy and unpredictable to ignore. But the market began shaking it off this summer, almost as if investors could imagine the worst impact and then begin seeing all the ways it could be avoided. Either that or they are waiting for more visibility on the election before the "fiscal cliff" hand-wringing returns.
Though we are seeing some impact on business spending and confidence in the second half of this year, this is not affecting investors who are discounting fundamentals out into the first half of next year. I think the market has got this right and that our Congress men and women will not jeopardize the economy again for political gain.
4. China Not So Bad
This scenario is a continuing saga – but it is also an over-blown situation in regard to the U.S.’s biggest trading partner. However, there's some substance behind the nervousness, with Caterpillar and FedEx feeling the global slowdown and rumors of Chinese economic stimulus coming this year being sorely over-exaggerated.
But the truth is that China has engineered a soft landing. It's still in progress because they are still concerned about over-heated property markets. And a big stimulus package seems inevitable for a country with hundreds of millions of citizens migrating to new cities for jobs and housing.
China cannot afford to slip much below 7% growth and word is that this package is already in the pipeline – just waiting for the new regime to take office and hit the go button with a chunk of their $3 trillion plus in foreign exchange reserves.
5. Central Banks Commitments
Finally, part of the summer rally was fueled by expectations for central bank actions on both sides of the pond – however, these did not unfold into "sell the news" events.
This was due to the fact that market players needed to know that central banks were all-in on the war against deflation in the U.S. and banking weakness in the Eurozone. There was doubt over whether the Fed and the ECB could both overcome political entanglements and criticism to win the long-term economic war.
The most important banks in the world have spoken and acted. The investors can now only hope their work has enough momentum to get some inflation under control.
“The Stock Market Will Continue to Climb a Wall of Worry!”
Further Articles Relating to the Week Ahead
1. The Economy and Earnings in the Week Ahead – October 01, 2012
2. The Past Week Stock Market Results – October 01, 2012
3. The Major ETFs in the Week Ahead – October 01, 2012