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Can S&P 500 Defy Another Quarter Marked for a Projected Earnings Slump?

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October 5, 2015

Friday was one of the wildest trading days in recent memory. Major stock averages were hammered after a September jobs report miss, only to bounce back in the final ticks of the trading day. Does anyone think that volatility will quiet down anytime soon, especially with earnings season on its way? Not likely.

In fact, last week kicked off with the worst single-day drop in a month. Mid-week, the books also closed on Q3—the ugliest quarterly performance for the broader stock market in four years. Yet when last week finished, the S&P 500 (SPX), in figure 1 below, and the Dow Jones Industrial Average ($DJY) logged 1% weekly gains, snapping back-to-back weekly drops. The tech-heavy NASDAQ Composite (COMP) scratched out a 0.5% gain last week.

The yield on the benchmark 10-year Treasury note fell below 2% on Friday for the first time since late August. Investors pushed up bond prices, dropping yields, on concerns about growth in the U.S. economy and amid fresh questions about how soon the Federal Reserve might act to reverse easy monetary policy.

Traders are rejoicing in volume and volatility, combining for what some see as a highly tradable market after narrow daily price bands and historically low volatility for much of the year. For traders and longer-term investors alike, this earnings round may well determine the next leg for stocks.

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FIGURE 1: AND AFTER THAT BOUNCE?

A one-year view of the S&P 500 (SPX) charted on the new-look thinkorswim® platform. Friday’s wild swing may set up a new range for the SPX. The SPX had fallen more than 10% from the record high it reached May 20. After starting with a payrolls report-triggered selloff on Friday, it closed up 1.4%, still down 8.6% from its recent high. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

‘Tis the Season

As historically volatile October begins, so does another earnings season. Alcoa (AA) unofficially kicks off the Q3 reporting period after Thursday’s closing bell. Johnson & Johnson (JNJ), Intel (INTC), Netflix (NFLX), and a number of big financial names release results next week and then the heart of earnings season begins.

Most market observers have said major averages are on firm but vulnerable ground as another round of earnings news begins with Alcoa’s (AA) October 8 post-close release. Broadly speaking, earnings are still expected to reflect a China-led global economic slowdown, weak commodities prices, and a stronger dollar.

In the past couple of quarters, forecasters called for the first year-over-year decline in S&P 500 earnings in five years only for companies to turnaround and beat lowered forecasts and show a net year-over-year rise. Forecasters aren’t deterred. Overall, this reporting period’s corporate earnings are expected to fall by 4.1% over the same period a year ago, according to Thomson Reuters data. That figure is skewed, however, by an expected 65% fall in energy sector results.

Earnings have been a moving target. Company executives and Wall Street analysts have done their best to handicap the tug of global economic shifts and currencies; they’ve lowered expectations repeatedly, although some analysts note that this season kicks off with fewer earnings warnings than in the past couple of quarters. As the Street braced for bad news, actual earnings results have outperformed Street forecasts by an average of four percentage points over the past 14 quarters.

Big Inflation Mystery

Back to last Friday’s employment report for one moment. There was little to be excited about in that report, including the details: zero hints of a pickup in inflation. That’s good news to a degree, but nonexistent inflation when the economy needs some pricing traction to return to the “normal” conditions desired at the Federal Reserve is not sustainable “good” news.

Thursday’s release of Federal Reserve meeting minutes may shed some light on the Fed’s inflation/no inflation quandary. The minutes are also hitting during a fairly light week for economic news (see the full calendar below), which means that Wall Street may be hungry for clues.

Maybe we have to dig deeper for hints of inflation? Hey, on Tuesday, McDonald’s (MCD) starts serving breakfast all day. For those of us who enjoy a Sausage McMuffin, it’s good news. And it may be one of the first hints of inflation we’ve had in some time. Egg prices have already started increasing in anticipation of the extended McDonald’s breakfast hours and other factors. Not sure who on the Fed eats at Mickey D’s, but a price change there might be just what they ordered. 

Good trading,
JJ
@TDAJJKinahan

economic-report-calendar

FIGURE 2: ECONOMIC AGENDA.

This week’s U.S. economic report calendar. Source: Briefing.com.

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