The Week Ahead in the Stock Market
October 01, 2012
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 S&P 500 climbed 5.9 percent over the past three months as central banks geared up to boost liquidity to markets and kick-start their flagging economies. The move has lifted the benchmark index as much as 17 percent this year, recently pushing the S&P to its best level in five years.
Last Thursday’s rally interrupted the five-day slide, but the relief was short-lived as stocks were hit hard again on Friday. Most of the major averages closed lower, but above the worst levels.
Friday saw investors grappling with more disappointing U.S. economic data as business activity in the U.S. Midwest contracted for the first time since 2009. The news came on the heels of other weak regional manufacturing reports and a sharp drop in U.S. durable goods orders last month.
The Euro crisis again returned to the front burner for the first time since the ECB decision in early September. Stocks dropped sharply early Friday over concerns about Spanish banks' stress tests. The report was within expectations, so stocks did manage to rebound from the early-morning lows -- but could not make it back into positive territory.
• 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.
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TOP OPTIONS TRADES SINCE JULY 01, 2012 | |||||||
|---|---|---|---|---|---|---|---|
| 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% | ||||
| 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% | ||||
The stock market bulls are betting the Spanish budget proposals in the week ahead will be a preamble to a bailout request by Mariano Rajoy's government. The move would be seen as a first step to get the finances of the euro zone's fourth-largest economy in order and would clear some of the market uncertainty regarding the euro zone crisis.
Monetary policy is also on the list of market catalysts in the week ahead. Federal Reserve Chairman Ben Bernanke is scheduled to speak on Monday and the minutes of the latest FOMC meeting are set for release later in the week. The agenda for the week ahead includes meetings of the European Central Bank, the Bank of England and the Bank of Japan.
There could be a rebound in the week ahead if some of the reports are uplifting -- have Spain ask for a bailout, the ECB announcing favorable terms for that bailout, and if we see the Bank of Japan announce further monetary intervention.
If Spain and the ECB don't deliver, there could be further lateral move in the markets. A negative would be if Rajoy flat-out denies that they need a bailout.
The September jobs report is due in the week ahead and the numbers could play an important role in the upcoming presidential election.
The jobs data will come on the heels of the first of three U.S. presidential debates, scheduled for Wednesday night. Recent poll numbers point to a strengthening lead by President Barack Obama, but a weak payrolls reading could give some hope to Republican challenger Mitt Romney.
If Romney doesn't turn the ship with a very strong (debate) performance, the president is going to win!
The trend in the polls has taken away some of the market uncertainty regarding the presidential election. An ECB- or Spain-related headline out of Europe on Thursday could overcome almost anything that would happen Wednesday night during the debate.
It appears that the market is coming to terms with the fact the president is ahead, and unless something significant changes, Obama will prevail.
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.
The Stock Market and the “Fiscal Cliff” in the Week Ahead
The outcome of the election and the resulting handling of the so-called ”fiscal cliff” are seen as keys to the performance of markets in the fourth quarter, and to the economic outlook.
Fiscal cliff is used to describe the double whammy to the economy that could come from the dual expiration of Bush-era tax cuts and automatic spending cuts Jan. 1, if Congress does not act. The outcome on taxes and spending is expected to be different, depending on who wins the White House and Senate in November.
The number of times we’re going to see the candidates and hear about the candidates’ platforms does increase as you get closer and closer to the election so it does become more central to the market’s concerns. However, the election is only one of many macro issues affecting the stock market -- earnings are nearly upon us, and with the situations with Greece and Spain are also at the forefront.
The market is currently pricing in status quo with a Democratic White House and Senate, but that could change when President Barack Obama and Republican Mitt Romney are face-to-face Wednesday.
If the opinion on the results of the election changes because of the debate, it could be a market moving event. If there’s an upside surprise in Mitt Romney’s performance, expect to see the spreads in the pivotal states tick up a bit, this could mean a positive for the stock market.
The Republican ticket is widely favored on Wall Street, since Romney’s stand on taxes and spending are viewed as more favorable for the economy and markets. A Republican sweep, while not apparent in the polls, would also be expected to bring a swifter resolution to the fiscal cliff.
The Speculation on the November Election and Its Effect on the Stock Market
Since a month ago there has been little change -- but there has been a movement in the magnitude and trajectory of the trend that was prevailing at the time.
Speculators - those putting actual money on the line - are more convinced than ever the election is settled.
In August, the two major speculator markets on politics – Intrade.com and Iowa Electronic Markets – had one presidential candidate ahead of the other. The speculators were betting that the leading candidate's chance of victory was 57%.
Now, with only five weeks to go until November 6, speculators have raised the percentage. Intrade.com speculators say Barack Obama has a 75% chance of retaining the White House, while Iowa Electronic Markets speculators say he has an 80% chance.
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.
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Economic reports dominate the news flow in the week ahead, with the September non-farm payroll report coming out on Friday as the most significant. The tepid pace of jobs improvement has been a persistent source of frustration for investors. But the loss of momentum in the manufacturing sector in recent months has added to those worries. The two ISM surveys on deck this week will give a good sense of where the factory and service sectors stood.
These factors may provide plenty of excuses to take profits in the week ahead, beginning with Monday’s ISM manufacturing data, again expected to show weakness in the sector.
Manufacturing reports from China, over the weekend, and from Europe, also Monday, will provide a look at just how sluggish global activity has become.
Friday’s jobs report is expected to show the low level of job creation continued in September, after Augusts’ 96,000 nonfarm payrolls.
The U.S. election is also a focus in the week ahead, with the first presidential debate in the tight race Wednesday evening.
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%.
Only two sectors are expected to have double-digit earnings growth – Finance (up 15.5%) and Construction (up 42.3%). Construction doesn’t carry much weight in the aggregate picture as it contributes less than 0.5% of total S&P 500 earnings, but the Finance strength is making the aggregate growth rate look a lot better than it otherwise would be. Excluding Finance, total S&P 500 earnings in the third quarter would be down 6.6%.
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.
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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% unemploymentThe 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 energy3. 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!”
Maybe an even bigger stock market top is on the horizon -- S&P 1500?
Conclusion for the Week Ahead
There seems to be very little direct correlation between today's economy and today's stock prices. The market continues to look ahead. It doesn't appear to care about today's economic numbers in many instances. It doesn't even care about tomorrow's economic numbers. It cares about businesses' ability to generate future cash flow. And there's just no way around it: Businesses have done a magnificent job keeping profits intact, even while the economy slows. Corporate profits were at a new all-time high before unemployment had even peaked. There's a big disconnect between middle-class America and corporate America's profitability. And for better or worse, markets are driven by the latter.
The last three years have been great for buy-and-hold. You just had to stick with it. Stocks go up, and stocks go down. If you let yourself get washed out during bear markets, you'll invariably miss the ensuing rise. And that rise always happens before the economy gets better. Or, as Warren Buffett put it in 2008 -- "If you wait for the robins, spring will be over."
The largest gains may be behind us, but there again maybe not according to the information above. The S&P trades at around 15 times earnings -- not cheap, but not outrageous. Berkshire Hathaway (NYSE: BRK-B) still trades at a price-to-book ratio well below its historical average and only 10% above valuations. Other blue chips like Johnson & Johnson (NYSE: JNJ) offer historically stable dividends that yield double what's offered in Treasuries.
Stocks will almost certainly outperform bonds in the long run. You just have to give them a shot -- and keep your mind open to reality!
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
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Options traders win because they are successful.
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