Whoa. It seems a three-day Thanksgiving weekend was all it took for investors’ sentiment to shift dramatically from pessimism to optimism. When sentiment shifts it usually does so in a hurry. A generally positive start to corporate earnings season coupled with positive news out of Europe pushed bond yields higher and helped stocks extend their rally to three consecutive weeks.
Signs that European policymakers may finalize a comprehensive response to the euro-zone debt crisis at the European Council meeting on October 23rd prompted the euro to climb sharply against the U.S. dollar. The Canadian dollar bounded higher this week as the ‘risk-on’ trade returned despite the fact there is still much work to do to fix the problems in Europe.
Chinese officials gave little sign they are worried that the euro-zone crisis will hurt China’s economy. Trade figures showing one of the biggest monthly falls in exports to Europe in years may change their view. In other Chinese developments, China’s sovereign wealth fund reportedly bought shares in four of China’s major banks. A similar announcement was made in 2008 just a few months before China’s stock market made a bottom. The buying of the bank shares coincided with the massive Chinese fiscal stimulus and a major upturn in the U.S. and Canadian stock markets. While a similar fiscal expansion remains a possibility today, China has less room to introduce a major stimulus package now compared to 2008. A key reason is inflation which continues to track well above government targets.
Economic data in North America seemed to also ease investors’ concerns about the economy slipping back in to recession. The minutes of the most recent Federal Reserve meeting show that while the Fed has become a lot more concerned about the economic outlook, it doesn’t expect another recession. In addition, data showed American consumers are helping fend off a recession. September retail sales jumped by the most in seven months despite horrible equity markets and low household confidence. In Canada, stronger than expected housing starts and manufacturing sales are both encouraging and provides further evidence that our economy continued to rebound in the third quarter.
The trading week ahead
Could this be the week where markets are driven by the fundamentals rather than the macro-event themes out of Europe? Unfortunately Europe’s problems do not have a quick fix solution and so we expect euro-zone related issues to remain with us for some time. That said, Q3 Earnings Season kicks into full gear with 493 U.S. companies set to report how they did during the difficult third quarter.
Earnings from Bank of America, Goldman Sachs, and Wells Fargo will be examined following last week’s disappointing results out of JP Morgan. It’s hard to have a lot of faith in the banks going into this earnings season, but it’s possible the sour news is largely priced in. If these banks are able to show an upside surprise, it could send their shares soaring higher in a heartbeat.
Results from Tech stock giants Apple and IBM should help drive sentiment in much the same way Google did last week. For Apple, this will be the first quarterly report since Steve Jobs stepped down as CEO in August, and his passing away. Investors will be listening to hear what new CEO Tim Cook has to say about the company going forward.
Investors will also have plenty of U.S. data to scrutinize as they look for clues on the health of the world’s largest economy. Industrial Production and Capacity Utilization have been doing quite well in recent months, but in September we should see a modest pullback with auto manufacturers having slowed output compared to recent months. Core Producer and Consumer Prices are expected to be unchanged but the headline data (including food and fuel) is expected to be up slightly.
The rebound in energy, specifically gasoline prices is to blame. The October Beige Book will be used at the next Federal Open Market Committee (FOMC) meeting and is likely to show modest improvements in business sentiment from rather depressed summer levels. The report is unlikely to suggest a renewed recession is imminent, but it will likely show the U.S. recovery remains weak and vulnerable to shocks. Home sales are likely to remain unchanged at the rate at which they have been stuck since February.
Question of the week
Alcoa kicked off Q3 2011 earnings season this week with a rather big earnings disappointment, but the news didn’t seem to matter to the markets. Europe remains the driving force at the moment. In the very early going, the small number of S&P500 companies that have reported so far have seen earnings growth of 9.6%. Almost 80% of reporting issuers have positively surprised the market, with most of those surprises beating expectations by up to 20%. About one quarter of reporting issuers have had negative surprises, missing expectations by less than 10%. In the week ahead, we will see a number of key bellwether Financial and Technology stocks will set the tone for the quarter.
Corporate profits have likely held up relatively well in this most recent quarter as domestic revenues remain stable, international revenues remain strong and corporations continue to benefit from the massive (employment) costs cuts. The concern, however, is that these trends are increasingly unstable. We think we’ll see much more caution in terms of corporate outlooks as this earnings season progresses. Expect to hear a far more cautious tone over the course of the coming eight weeks as earnings roll out. Estimates have come down in recent weeks but the risk is that estimates are still too high.
@David_RGMP