The Week Ahead in the Stock Market October 08, 2012
Stock Market Rally to Continue!
Week Ahead: Politics to Dominate Market as Economy Takes Backseat!
Wall Street: Big-Name Profit Warnings To Consider!
by Ian Harvey
October 06, 2012
Trading volume is expected to be thin with Columbus Day on Monday (banks and the bond market will be closed, while the stock market will be open) and light economic data throughout the week.
Third-quarter earnings season kicks off the week ahead with Dow component Alcoa (AA) on Tuesday, for further market direction. Financial giants J.P. Morgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC) are also expected to report earnings next week.
However, even though the stock market rally is expected to continue, Wall Street should be on the alert for a pullback as U.S. earnings season begins in the week ahead - if the clouds of profit warnings from bellwethers ranging from FedEx to Hewlett-Packard lead to a downpour of lower profits - or even losses.
Investors will scour reports on inflation, housing and consumer sentiment next week.
Stocks rallied for the past week but retreated Friday after the government said the unemployment rate fell to 7.8%, lowest since 2009. Apple, Zynga and Facebook also led a pullback. Crude oil fell below $90.
The Eurozone markets were also higher for the week despite more negative data regarding their economies. The concern over the crisis seemed to cool in the past week, but new protests are likely in the week ahead and they could trouble the markets.
The rest of the economic data last week was positive. Early in the week, manufacturing data beat expectations. Orders in the non-manufacturing sector also showed an unexpected surge. Factory orders were weak overall, but if you exclude transportation equipment, they were actually up.
The market got a nice surprise Friday, as after revisions the unemployment rate dropped below 8% for the first time in three years. The market acted well all week, and by Wednesday's close, the technical action suggested that the correction was over.
Even though the close was mixed-most of the averages closed Friday well below the day's highs-the overall action was constructive.
Stocks gave up most of a rally on Friday, but buying very late in the session pushed the Dow Jones Industrial Average (DJI) to their best close in nearly five years.
The initial buying was set off when the Labor Department said the U.S. unemployment rate had dropped to 7.8% in September, its lowest level since 2009. September payrolls grew by 114,000, the department said, a touch below the consensus estimate of 120,000 jobs. But estimates for payroll growth in July and August grew by 86,000, suggesting that the summer slowdown wasn't as bad as thought.
The news of the falling unemployment rate cheered the White House, reeling from President Obama's performance in Wednesday's debate against Mitt Romney. It dismayed Republicans. "This is not what a real recovery looks like," Romney said in a statement. Former General Electric (GE) CEO Jack Welch went so far as to accuse the Labor Department of cooking the numbers. Labor Secretary Hilda Solis said she was "insulted" by the idea.
The pullback began when big technology stocks, such as Apple (AAPL), Amazon.com (AMZN), Facebook (FB) and Zynga (ZNGA), stumbled and accelerated on declines in energy and financial stocks. It was a ‘sell-on-the-news’ type of a situation – the stock market had the big jobs numbers in the morning, but traders and investors didn’t want to keep their positions going into the weekend and next week!
On the negative side, the speed with which the market will get overbought on continued strength may pose a problem -- the market hasn’t had a truly ugly day since the highs registered on September 14th.
Most of the market's gains this year have been prompted by easy monetary policies. The improvement in U.S. hiring last month is one bright spot as manufacturing around the world has been showing signs of softness in recent months.
• The Dow Jones Industrial Average (DJI) rallied 1.29 percent for the week, finding a foothold above 13,600 for the first time since December 2007.
For the year, the Dow is up 11.4%
Bank of America (BAC) was the biggest gainer on the Dow, while H-P (HPQ) tumbled more than 13 percent.
• The Standard & Poor's 500 Index (SPX) saw a 1.41% rise for the week.
For the year, the S&P 500 up 16.2%.
Most key S&P sectors ended in positive territory for the week, led by financials. Techs were the only decliners.
• The Nasdaq Composite Index (COMP) enjoyed a weekly return of 0.6%.
For the year, the Nasdaq up 20.4%.
The CBOE Market Volatility Index (VIX), widely considered the best gauge of fear in the stock market, stayed below its 20-day moving average, and notched its lowest close since Sept. 24 on Friday. The VIX inched 0.2 point, or 1.5%, lower for the day, and backpedaled 8.9% for the past week.
**For a more in-depth look at the past week…..CLICK HERE…..**
The Major ETFs in the Past Week
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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% | ||||
Politics are likely to remain in the spotlight for investors in the week ahead, as the stock market becomes more focused on the presidential election than economic figures.
Against the backdrop of the Federal Reserve’s open-ended quantitative easing program launched a few weeks ago, some traders are discounting much of the economic fundamentals. They believe much of the upcoming data won't yet capture the liquidity the Fed just began to pump into markets.
It doesn’t matter what the numbers are because the Fed has tipped their hand -- the rest of the real economy doesn’t matter much anymore. At the end of the day housing can go through the roof: if the unemployment remains elevated the Fed will continue easing.
Presidential Elections and Their Influence on the Stock Market
The presidential elections are having an increased impact on markets. The outcome is seen as key to resolving the ”fiscal cliff” that hangs over the investment climate.
The Trading Environment in the Week Ahead
Any revelations from economic data will come mid-week, when the Fed’s Beige Book—the central banks closely monitored view of economic conditions—is released on Wednesday. Also of interest will be initial jobless claims, mortgage figures and consumer confidence later in the week ahead.
In this environment, traders expect gold (XAU) to continue a run that saw the precious metal stall out near the psychologically-important $1,800 barrier. Over in Europe, the 'will they or won't they' debate about Spain taking a bailout should whipsaw the euro (EUR).
The calendar could prompt investors to book profits, particularly with the impressive run-up in the Dow Jones Industrial Average (13610.15 - DJI), Standard & Poor's 500 Index (1460.93 - SPX) and the S&P 500 Nasdaq Composite Index (3136.19 - COMP) — all of which sit near multi-year highs in the wake of Friday’s encouraging payrolls data.
Corporate Earnings Influence in the Week Ahead
Expectations for the economy are fairly low, yet analysts still think corporate earnings will be supportive of more stock gains. The baseline forecast [for the economy] is more of the same, but in an environment in which earnings are still pretty good and interest rates are still very low, the baseline economic forecast does support higher equity prices from here.
The first test of that theory will come on Tuesday, when the third quarter earnings season kicks off in earnest. A clutch of companies, which include bellwether industry giants like Alcoa (AA), Costco (COST), and JP Morgan (JPM), will report on their earnings, which are likely set the tone for the coming quarter.
As investors continue to price in good news and more Fed easing, some are questioning how much higher equities can go.
Because the global economy continues to confront a host of challenges – from a slowing China to a crisis hit Europe and a still sluggish U.S. economy – a number of investors believe the stock market is due for further correction.
The Stock Market and the “Fiscal Cliff” in the Week Ahead
In an election year, most data is being sifted through a filter of politics.
Even in a booming economy, payrolls figures have both major political and economic implications. Yet even still, Friday’s jobs data managed to unleash an unusually fierce torrent of controversy and conspiracy theory.
Some Republicans openly accused the Obama administration of manipulating jobs data to achieve favorable results ahead of Election Day, which triggered pushback from Labor Secretary Hilda Solis. She declared herself “insulted” by the implication.
With only one more jobs report left to go before voters go to the polls in November, the political debate about the economy is expected to get more acrimonious. The outcome of the presidential election is of particular importance as the so-called ”fiscal cliff” draws nearer.
The resulting spending cuts and potential tax hikes is unnerving many companies, who have said they will delay hiring and investment decisions until a resolution has passed. With both Democrats and Republicans fixated on Election Day, many chief executives aren’t holding out much hope that the polarized climate will lift.
Stock Valuations vs. Earnings Estimates
Thanks to aggressive stimulus plans from central banks around the world, the Standard & Poor's 500 index gained 5.8 percent over the third quarter. That sharp rally occurred even as companies were struggling. Earnings for that period are forecast to fall 2.4 percent from the year-ago quarter. If that happens, this would be the first earnings decline in three years, according to Thomson Reuters data.
Market strategists and investors say U.S. stock valuations are broadly out of sync with earnings estimates. They forecast a pullback in stocks in the coming weeks as more companies report results and reduce expectations for the fourth quarter and beyond.
Fourth-quarter estimates for S&P 500 companies show a 9.5 percent gain in profit from a year ago, according to Thomson Reuters data. Analysts say that outlook is too high, given what investors are already hearing from the corporate world.
It's a divergence where the valuations as far as equity prices, are concerned, have soared, and are really putting in place a stronger economy and stronger fundamentals.
However, earnings will be the telltale sign and if the guidance isn't particularly strong, the market might be setting itself up for a little disappointment – maybe a further pullback.
European Influence on the Stock Market
Nearly half of S&P 500 companies guiding lower for third- quarter earnings blamed weakness in Europe, according to a Thomson Reuters survey. Another 11 percent blamed the weak global economy, 8 percent cited strength in the U.S. dollar, and 6 percent cited the slowdown in China, the survey showed.
Weakness in the U.S. economy hasn't helped. The final read on U.S. second-quarter gross domestic product last month showed growth of just 1.3 percent, weaker than an expected 1.7 percent.
On Thursday, software maker Informatica Corp issued a profit warning and said business conditions were worsening in Europe. The software company is considered a bellwether because its products are used alongside those made by larger software companies.
Technology Effected By China
While estimates have come down sharply in all 10 S&P 500 sectors since the start of the year, technology is one area where the lower expectations are most notable. Slower growth in China is a big factor in that trend.
Earnings growth in the tech sector is expected to be just 2.3 percent for the quarter, compared with a July 1 forecast of 13.1 percent. Apple Inc is a big driver of those gains.
Technology's profit growth has been crucial for the S&P 500. Minus technology, S&P 500 earnings are expected to be down 3.4 percent.
The tech sector is where the slowdown in China's economy is having the biggest impact as they consume a lot of U.S. technology products.
Recent data shows that the pace of growth in China, the world's second-largest economy, may slow for a seventh quarter, straining earnings in the tech and materials sectors.
• Applied Materials Inc lowered its third-quarter estimates in August, citing China and Europe. On Wednesday, the chip gear maker said it planned to cut its global work force by 6 percent to 9 percent.
• FedEx Corp, the world's second-largest package delivery company, cut its fiscal 2013 forecast on Sept. 18, saying a weakening global economy gives its customers a reason to switch to less expensive and slower shipping options. FedEx said its earnings could drop as much as 6 percent for its fiscal 2013 year, which will end in May.
• On Wednesday, shares of Hewlett-Packard Co fell a whopping 13 percent to a nine-year low after it forecast a far steeper-than-expected drop in 2013 profit. The slide in HP's stock price sharply cut the Dow industrials' gains for the day.
The S&P 500 sectors showing the biggest projected earnings decline are materials, forecast down 24 percent, and energy, expected down 18.8 percent, Thomson Reuters data show, with those declines tied largely to the global slowdown.
In contrast, consumer discretionary stocks are expected to have the strongest profit growth for the quarter, with Thomson Reuters data showing a gain of 7.7 percent. But in that sector, too, companies, including apparel retailer Express Inc - not an S&P 500 component - have warned about the third quarter.
The Revenue Outlook for the Stock Market
With tepid revenue growth, U.S. companies have been topping Wall Street's earnings expectations in recent quarters through cost reductions. That path to beating profit forecasts, however, will become increasingly difficult as many companies have already made most of the obvious cuts.
Revenue for the third quarter is expected to be down 0.1 percent from a year ago for S&P 500 companies, and down 0.4 percent minus Apple.
In all, the negative-to-positive ratio for earnings forecasts is 4.3 to 1, the most negative since the third quarter of 2001, he said.
Tech and materials were also among sectors with the most negative outlooks for the quarter, with tech's negative-to-positive guidance at 5.4 to 1 and materials at 7 to 1.
The Major ETFs in the Week Ahead
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With Alcoa Inc. (AA) scheduled to report quarterly results on Tuesday; the third-quarter earnings session should kick off in earnest in the week ahead. Wells Fargo & Co. (WFC) and J.P. Morgan Chase & Co. (JPM) are scheduled to report Friday.
Also, news for the economy in the week ahead, reports on small business and inflation, as well as the biggest group of initial public offerings in months, is expected.
Earnings in the Week Ahead
Alcoa’s (AA) release after the close on Tuesday will ‘unofficially’ kick-off the third reporting season, even though ‘officially’ results have been trickling in since last month. Companies like FedEx (FDX), Nike (NKE), Oracle (ORCL) and quite a few others have already reported third quarter results, but Alcoa’s report is typically considered as kick-starting the quarterly reporting cycle.
Also, in the week ahead there will be two major financial firms reporting earnings. As earnings session starts to heat up next week, two U.S. banking giants will weigh in with their latest third-quarter numbers on Friday. J.P. Morgan Chase & Co. (JPM) should give investors an early window into the recent strength of investment banking, while Wells Fargo & Co. (WFC) will provide a view of traditional banking strength.
Webster Financial Corp. (WBS) and Bank of the Ozarks Inc. (OZRK) also are expected to report their latest results.
Alcoa’s first-to-report status notwithstanding, there have been third-quarter results from 24 companies in the S&P 500 (as of Friday, October 5th) so far – however, these results have not been that inspiring.
Total earnings are down 4.7% from the same period last year and only 41.7% of the companies beat earnings expectations. This is a weaker performance than what these same companies did in each of the last five quarters. Performance on the revenue side is surprisingly not that bad for these 24 companies, with total revenues up 1.2% from the same period last year and 11 coming ahead of revenue expectations.
But the big story on the earnings front is not what has come out already, but rather what’s in store from the 476 companies still to report results. There are 9 S&P 500 companies reporting results this week, which includes, besides Alcoa, Yum! Brands (YUM), Costco (COST), JP Morgan (JPM) and Wells Fargo (WFC). Total earnings for these 476 companies are expected to drop 3.4% from the same period last year, with revenues declining 2.3%.
The actual growth rates will most likely be better than these 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 23.5% and 25.5%, 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 17.3%) and Construction (up 37.6%). 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 7.1%.
Also, PetSmart (PETM) will be added to the S&P 500 after the close on Thursday, replacing Sunoco (SUN) following the latter's buyout by ETP. Cabela's (CAB) will take PetSmart's position in the S&P MidCap 400, while Acorda Therapeutics (ACOR) will replace Cabela's in the S&P SmallCap 600.
Economy in the Week Ahead
The week ahead will present varied reports which will cover small business, the trade deficit and inflation.
Small business owners have been a prime focus of the presidential election given smaller firms' large share of job creation.
The state of small business will be reported Tuesday by the National Federation of Independent Business.
The U.S. trade deficit and inflation readings are due Thursday, and Friday, the producer price index is presented.
Also of interest, American Airlines pilots on Tuesday will make their case against an immediate and unilateral overhaul of their employment terms while they appeal the bankruptcy court ruling that gave the airline the right to implement the changes.
In fighting to delay the judge's ruling from taking effect, the pilots will square off against the unsecured creditors of American parent AMR Corp. (AAMRQ). The creditors say the pilots aren't likely to succeed in their appeal, so there is no need for any delay.
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Skepticism Regarding the Stock Market in Relation to the Economy!
The debate about the relationship of the stock market to the economy has gone on for many years, and many think that the current stock market strength is an aberration.
The popular belief is that stock prices top out around six months before the start of a recession. Therefore, many can't believe that the current strength in stock prices is forecasting a better economy in the next six months.
Since the market is dominated by professionals and not the public, the skeptics argue that the strength of the stock market can't be trusted. For the investing public, there are many recent events that make this view easy to accept.
The 1973-1975 recessions started in November 1973, but the Dow Industrials topped in March 1973 at 1,067. By the end of November, the index had already lost 23%. By the time the market bottomed in December, it was down over 46%.
Many technical analysts warned that the market was topping well before there were any clear signs of a recession. They were in the minority, as technical analysts in those days had about the same standing as fortune tellers.
In the current environment, there are very few analysts that are expecting stocks to still move significantly higher from current levels. However, if you take a look at the weekly chart of the NYSE Composite and its advance/decline (A/D) lines, one can make a case that stocks can still move significantly higher.
The chart shows a well “defined trading channel” (lines a and b) with the upper trend line currently at 9,063, which is 7.6% above current levels. But first, it has to overcome the resistance from the April 2011 high at 8,719.
Below the chart is the weekly NYSE A/D line, which broke through major resistance (line c), on July 27. A similar breakout in September 2010 resulted in a seven-month, 19% rally. A rally that was similar in length and time could take the NYSE Composite to above 9,200 by February.
The weekly A/D line looks ready to make new highs in the week ahead, as it is leading prices higher, a very positive sign.
Conclusion for the Week Ahead
There are quite a few stocks that appear to have completed their corrections last week, but other stocks still look weak, so one needs to be selective in the week ahead.
Buying stocks that have positive weekly and monthly trends and that have pulled back to chart and retracement support still looks to be a good strategy.
Though the mixed stock market close Friday was a bit disappointing the technical outlook did improve last week, and a move above the September highs in the week ahead would further support the bullish case. It would take a drop below the September 26 lows in the major stock market averages to weaken the outlook.
There are quite a few stocks that appear to have completed their corrections last week, but other stocks still look weak, so one needs to be selective in the week ahead.
Buying stocks that have positive weekly and monthly trends and that have pulled back to chart and retracement support still looks to be a good strategy.
Watch the tech sector, as it has a seasonal tendency to perform well in October, as do several other sectors including health care. Some of the retail stocks, like Macy's (M), also appear to have completed their corrections, and these stocks typically do well into the end of the year
Further Articles Relating to the Week Ahead
1. The Economy and Earnings in the Week Ahead – October 08, 2012
2. The Past Week Stock Market Results – October 08, 2012
3. The Major ETFs in the Week Ahead – October 08, 2012
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