Earnings Season Begins
After finishing a terrible quarter, the fourth has nearly recovered all the losses. So what changed? Actually the global economy looks a bit worse, as does the US, based upon recent economic releases. The Fed Governors have spent much of their time chatting up the fact that a rate increase WILL happen by year-end. Like the coach hollering “nice play” for an ill-advised play that somehow goes right, the stock market rallied on news that should have sent equities lower. The US service sector reported worse than expected figures while the global indicator of manufacturing and services fell to its lowest level in nearly a year. The earnings season kicks off in earnest with banking in the spotlight. Over the past few months, analysts have cut their estimates for companies across the board as the dollar and slower global growth may have a negative impact. Company earnings and especially revenue will be watched closely, but most of the focus will be on comments regarding business conditions and expectations going forward. Of course, many Fed Governors will again be speaking on the economy and when interest rates may rise again. Just doing wrong right!
The better than 3% rally in the markets last week was the best since Christmas week last year and at the time put stocks within hailing distance of the market top seven months later. This past week’s rally had a few special characteristics that may mark at least a short-term bottom and could be a catalyst for further gains into year-end. Among some of the highlights was a noticeable pickup in volume during the rally. The huge net number of advancing to declining stocks for the week was rivaled only three other times over the past 20 years. If there is a minor footnote to the other instances, it marked the end of a rally phase, not the beginning of a new leg higher. What happens next? The key will likely be found in the response to earnings that will be flooding the markets in the coming weeks. If it is determined that we are in the “trough” part of the earnings cycle and an improvement will occur into 2016, stocks will continue their trek higher. If, however, earnings accompany poor comments regarding economic conditions, markets etc, stocks could easily retrace much of the recent gains. As mentioned last week, we are entering the best part of the calendar for stocks, which can assist stocks higher in an otherwise unfavorable environment, as we saw last week. How much is hot air? Only the very long look in the rear-view mirror will we be able to tell.
Zero interest rates have hit the US shores. In the most recent sale of 13-week Treasury notes, the rate they were sold was at 0.00%. It is the lowest on record. There has been an instance that they traded at a negative rate during the financial crisis, but never sold at auction. If the Fed is to be raising rates (as they have been telling everyone!) then why are short-term rates actually falling? Our best guess is that the markets are looking at the weaker economic data around the world and calling the Fed’s bluff on raising rates. Longer term rates are impacted by inflation expectations that over the past two years have been negligible at best. With long term rates still low and short rates at zero, investors are again reminded that investment alternatives to the riskier stock market promise very little in the way of return. However, the stock market has managed to also return zero so far this year!
Worst to first is not the rallying cry of Cub fans this year, but the behavior of the various industry and sector groups. The leader of the past few years has been healthcare, but since early August healthcare has tumbled over 10%, while the maligned energy and industrial sectors have been relatively flat over that same period. The rally last week took international and emerging markets higher, both up over 5% last week. As with sectors in the US, those that have been hurt the most saw the largest gains. Whether this is the beginning of a new trend or speculative bargain hunting, the next few weeks will be telling. Until pricing comes back to many of these companies (and inflation in general picks up), the rally may be just an opportunity to sell some of these beaten down sectors.
As exciting as the rally in stocks was last week, it comes on the heels of a very oversold market that is struggling with economic growth, earnings and interest rates. Volatility may ease some in the weeks ahead, but stocks may continue to be directionally challenged. Interest rates remain at odds with the comments from Fed officials about the desire to raise rates by year-end.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.