The Week Ahead in the Stock Market December 03, 2012

Week Ahead: More Political Wrangling!

Stock Market: Expectations for a December Rally!

Wall Street: Earnings Continue!

by Ian Harvey

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December 01, 2012

Introduction

The economic damage from Super Storm Sandy will show up in November’s jobs report and elsewhere in the coming week, but the markets will stay fixated on Washington’s “fiscal cliff” talks.

A string of economic indicators in the week ahead, which includes a key reading of the manufacturing sector on Monday, culminates with the November jobs report on Friday.

The cliff negotiations between the White House and Congressional Republicans seem to be going sideways with no progress on taxes or spending cuts, and markets have been somewhat patient so far with political posturing.

However, investors are becoming increasingly nervous about the ability of lawmakers to undo the $600 billion in tax increases and spending cuts that are set to begin in January; those changes, if they go into effect, could send the U.S. economy into a recession.

In normal times, the slew of U.S. economic data in the week ahead could be a springboard for a December rally in the stock market.

December is historically a strong month for markets. The S&P 500 has risen 16 times in the past 20 years during the month.

But the market hasn't been operating under normal circumstances since November 7 when a day after the U.S. election, investors' focus shifted squarely to the looming "fiscal cliff."


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The Past Week

The S&P 500 wrapped up its fifth positive month in the last six on Friday, although it ended the day flat as politicians remain at odds about how to avoid the so-called fiscal cliff.

Trading has been choppy in the last two weeks as investors react to statements from policymakers on the state of discussions on how to avert a series of tax hikes and spending cuts that could pull the economy back into recession.

For the week, though, all three major U.S. stock indexes advanced, with the Dow Jones Industrial Average (DJI) up 0.1 percent, the Standard & Poor's 500 Index (SPX) up 0.5 percent and the Nasdaq Composite Index (COMP) up 1.5 percent.

For the month of November, the S&P 500 rose 0.29 percent, its smallest monthly variation since March 2011. The Dow fell 0.5 percent and the Nasdaq gained 1.1 percent.

Even though the S&P 500 was up 0.29 percent in November, it suffered a slide of more than 6 percent from the month's high to its low.

Intel (INTC) was the worst monthly performer on the Dow, while Cisco (CSCO) soared.

For the month, utilitieslagged, while consumer discretionaries gained.

The Markets Ending November 30, 2012

In contrast to the apparent calm in equities, the CBOE Market Volatility Index (VIX) ), widely considered the best gauge of fear in the market, jumped 5.4 percent, its largest daily gain in two weeks.

The VIX also rose for the week, but posted a whopping 14.7 percent decline for November.

Economic News in the Past Week

The economic news was mixed last week with the S&P Case-Shiller showing another month of home price increases Tuesday while durable goods orders were better than expected, they weren’t great. Consumer Confidence was strong as it reached the highest level in over four years.

This was in contrast to the disappointing new home sales as there was a large downward revision of the September sales data. The following day better data was received on housing as pending home sales jumped over 5%. The GDP report also came in better than expected at 2.7%.

More important might be last Friday’s Chicago PMI Report, which came in at 50.4, which reflects slight growth for the first time in two months. An interesting article in the WSJ, ”Business Index Moving in Right Direction”, discussed the Markit Flash PMI, which looks at all of US manufacturing. In its latest reporting period, it rose to 52.4. It showed an expansion in orders, unlike the Chicago report, and the chart suggests it may be a leading indicator for the Chicago PMI.

Also, the German parliament approved the Greece debt deal last Friday, which should facilitate the disbursement of 44 billion euros. However, the Eurozone countries have delayed further debt relief as they have not worked out how to handle their Greek exposure to Greek debts.

The Week Ahead


The economic landscape has been dominated by the ‘Fiscal Cliff’ debate lately and the trend is unlikely to change in the week ahead even though we have a number of top-tier economic reports on deck. The most important report coming out in the week ahead is the November jobs report on Friday, but we also have the manufacturing and service-sector ISM surveys on this week’s calendar. Given the distortions created by Superstorm Sandy, it will be difficult to get a clear read on underlying economic trends from even these top-tier indicators.

Economy in the Week Ahead

Sandy is beginning to influence the jobs data and many other sorts of data for the next couple of months … just at a time when the market is uncertain about the fiscal cliff, and the lingering uncertainties about Europe and China and elsewhere -- now that these other uncertainties exist, the data is going to be less relevant than normal – the stock market will need to adjust.

However, this does not make for a negative market environment, and it is expected that the fiscal cliff will be resolved. The cliff is the expiration of dozens of tax breaks and the onset of automatic spending cuts if Congress does not act.

Economists expect to see the impact of Sandy in the week ahead with Monday’s ISM manufacturing data, construction spending and car sales. Auto sales should see a positive impact, as tree damage and flooding destroyed many east coast vehicles. Other data in the week ahead have shown negative impacts, particularly jobless claims for the past three weeks. Chain-store sales for November were also affected, as was Friday’s report of personal spending.

Auto sales could surge above a 15 million annualized selling rate in November, up from 14.3 million on improvements in housing and pent-up demand, in addition to the Sandy replacement cars.

As for Friday’s jobs report, the consensus forecast among Wall Street economists is that 100,000 nonfarm payrolls were created in November and the unemployment rate stays unchanged at 7.9 percent, according to Thomson Reuters. That is down from 171,000 payrolls in October.

But some economists believe the report could be much weaker. Barclays Capital economists expect just 50,000 jobs were created in November, and the unemployment rate crept up to 8 percent.

Fourth-quarter GDP is now tracking at 1.8 percent, but some still forecast for 2.5 percent. Some economists expect first-quarter GDP to grow by 1.5 percent, due to the impact of fiscal tightening and higher taxes. They expect an outcome on the fiscal cliff that’s not overly disruptive to either markets or the economy. They look for about $200 billion of the $650 billion in tightening to go into effect. That would take about 1 percent off of growth in the first quarter.

One reason to see stocks as a good value in the week ahead is that the economy is gaining some traction – this is evident with the improvement in housing and the fact that household balance sheets have improved.

The worry that the pending impact of tax changes on stocks should be negligible. When the capital gains tax and dividend taxes were first cut, the benefit to stocks was only about two percent. Also note that only about half of stocks are owned by taxable investors.

Both capital gains and dividend tax rates are 15 percent, and if tax breaks are left to expire the highest capital gains tax rate would revert to 23.8 percent and the highest dividend rate could be 43.4 percent. Those would be the levels on the highest income earners, when including the new 3.8 percent Affordable Care Act tax on the top income brackets.


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Earnings and Company News in the Week Ahead

With the third quarter earnings season almost over and the fourth quarter reporting season still a few weeks away, we are at a relatively quiet phase in the earnings cycle. But the stock market is continuing to see downbeat guidance from management teams, as recent announcements from Yum Brands (YUM) and Tiffany (TIF) show.

In fact, a far bigger proportion of the companies have guided lower this time around than has been seen in any quarter since the post-recession earnings recovery got underway in 2009. As a result, estimates for the fourth quarter have been steadily coming down over the last months. At this stage, total earnings for companies in the S&P 500 are expected to be up 2.2% from the same period last year. This is significantly lower than the roughly 8% growth expected as the third quarter reporting season was getting underway two months back.

But while estimates for the fourth quarter have come down, we have not seen much downward adjustment to estimates for full-year 2013. Total earnings next year are still expected to be up 11%, which would follow the 4.7% growth in 2012.

Given the tough macroeconomic backdrop -- not just in the U.S. but all over the world -- next year’s growth expectations appear to be on the optimistic side. We will most likely see next year’s estimates start coming down as management teams discuss full-year outlooks on the fourth quarter earnings calls. The market will have to come to grip with this tepid earnings picture after it is through with the ‘Fiscal Cliff’ debate.

But before we can start thinking about the fourth quarter earnings season, we need to close the books on the third quarter reporting cycle. We are almost there, but still have a handful of companies still to report third quarter results in the week ahead.

As of Friday, November 30th, we have third quarter results from 494 companies in the S&P 500. The week ahead brings us closer to the end point, with 61 companies reporting quarterly results, including 5 S&P 500 companies.

With respect to the scorecard for the 494 companies that have already reported results, total earnings are barely in the positive territory (up 0.1%) relative to the same period last year and only 62.8% of the companies came out with positive earnings surprises. Total revenues are down 0.6%, with only 38.9% of the companies beating revenue expectations. The numbers look even weaker once Finance is excluded. Excluding Finance, total earnings in the quarter were down 4%, while total revenues were down 1.3%.

Half of the sectors had negative year-over-year earnings growth, with only two sectors producing double-digit earnings growth – Finance (up 23.3%) and Construction (up 56.6%). Negative surprises from a host of tech giants this earnings season, including such reliable players as Apple (AAPL) and Microsoft (MSFT), are showing up in the Tech sector’s sub-par performance in the quarter. Total Tech sector earnings were barely in the positive, up only 0.5%. And the picture is expected to get even worse in the fourth quarter, with total Tech sector earnings expected to be down 4.4%.

Fiscal Cliff Continuing in the Week Ahead

The spotlight will be more firmly on signs from Washington that politicians can settle their differences on how to avoid the fiscal cliff in the week ahead.

Concerns about the cliff sent the Standard & Poor's 500 Index (SPX) into a two-week decline after the elections, dropping as much as 5.3 percent, only to rally back nearly 4 percent as the initial tone of talks offered hope that a compromise could be reached and investors snapped up stocks that were viewed as undervalued.

On Wednesday, the S&P 500 gained more than 20 points from its intraday low after House Speaker John Boehner said he was optimistic that a budget deal to avoid big spending cuts and tax hikes could be worked out. The next day, more pessimistic comments from Boehner, an Ohio Republican, briefly wiped out the day's gains in stocks.

On Friday, the sharp divide between the Democrats and the Republicans on taxes and spending was evident in comments from President Barack Obama, who favors raising taxes on the wealthy, and Boehner, the top Republican in Congress, who said Obama's plan was the wrong approach and declared that the talks had reached a stalemate.


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Sentiment Effect in the Week Ahead

The most recent survey by the American Association of Individual Investors reflected investor caution about the cliff. Although bullish sentiment rose above 40 percent for the first time since August 23, bearish sentiment remained above its historical average of 30.5 percent for the 14th straight week.

Conclusion for the Week Ahead

In terms of seasonality, the first two weeks of December normally bodes well for the market and if Washington can assuage fears that they’ll get something done, you could still see a nice move for the market in the week ahead, therefore keep an eye on the 10-year yield for “confirmation from the treasury market that the economy is improving and gaining traction.”

It is likely that investor attitudes and seasonality could also help spur a rally for the final month of the year.

December is a critical month for retailers such as Target Corp (TGT) and Macy's Inc (M). They saw monthly retail sales results dented by Sandy, although the start of the holiday shopping season fared better.

With consumer spending making up roughly 70 percent of the U.S. economy, a solid showing for retailers during the holiday season could help fuel any gains.

Also, the recent drop after the election could be a market bottom, with sentiment leaving stocks poised for a December rally. The concerns on the fiscal cliff - as valid as they might be - could be overblown – apparent when you look at a lot of the overriding sentiment, which has become extremely negative.

The historically bullish time frame of December may once again be setting itself up for a pretty nice end-of-year rally, based on lowered expectations.

There were some signs last week that the stock market was starting to ignore the periodic negative intra-day comments on the negotiations over the fiscal cliff. This does not mean that one should get complacent as the market is likely to receive more shocks in the week ahead and future weeks from both the fiscal cliff and the always festering Euro debt crisis.

Being complacent or panicking when it comes to your investments is almost always a bad idea. The panic-like selling over concerns about the fiscal cliff have been overdone and now that it appears that the worst of the selling is over, it is time to move positively forward!

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