Earnings Season

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Earnings season kicks off this week and we will start getting a glimpse of how we fared in Q1. While the expectations are for a weaker quarter, my real concerns are top-line revenue and sales. Of all the recent economic reports and data out there, there is one item that sticks out – China’s significant declines in both exports/imports.


Earnings Season

China
I am a firm believer that China’s growth over the last 10 years was a significant contributor in helping float the debt ridden West, mainly the U.S. While China has certainly created its own bubbles, it still has one of the most important parts of any economic engine, billions of people.

Consumption rates for the last two decades in China are phenomenal and will probably never be seen again in our life time. However, consumption growth rates – after reaching full market saturation – eventually decline as the nation moves into the first world. Sure things are still bought, but organic growth is about replacement value and stealing market share. Our research analyst, Roxanne Militaru wrote an excellent paper on it: The Economic Ferris Wheel

The question now is how is China’s growth slow down going to impact US earnings, but to answer that question we must understand how much we are reliant on China’s consumption rates. This is harder to ascertain and certainly some sectors/industries are far more reliant than others. Growth rates in McDonald’s over the last decade has been almost solely reliant on over-seas growth. China was opening up 100s of new franchises. One only had to look at domestic sales growth in McDonald’s to realize that if it was not for China and other over-seas growing markets, McDonald’s had fully stalled and in some cases saw actual decline in top-line sales/revenue.


courtesy of wikipedia


Earnings Drag

This week almost 10% of the S&P 500 companies will release their earnings and the initial review of top-line revenue / sales is not looking great. We have received a slew of earnings warnings in January and February, however all attention was focused on the Fed and their rate hike game.

The low commodity & energy prices are a two sided coin when it comes to earnings. Those companies in the energy and material sector are hurting as prices remain low. However, those offering the finished / durable goods are able to squeak out slightly better margins our costs (materials, shipping, etc.) are low.

Unfortunately, the drag in energy and materials is significant compared to other sectors. Energy earnings growth has declined over 40% in the 4th quarter (2015), it is expected to decline even further with estimates in the 50% to 60% range. Materials, which only saw slight declines in the 4th quarter (-1%) is expected to see rather larger declines, with some estimates over 15%.

The financial sector is also expected to see rather large earnings decline in the 1st quarter, by as much a 10%.

The growth side of the equation remains in the Consumer Discretionary and Health Care, but their growth is expected to be modest. Certainly not enough to make up for the declines in other sectors.


Priced into the market?

The big question is whether the declines are priced into the market. That is hard to say at this point, especially after the rally. Remember the market sold off significantly in the first quarter before the rebound. We were peppered with earnings concerns, while the Fed had just raised rates and expected to raise some more. There was even talk of a possible recession and indicators showed significant declines in GDP growth.

Perhaps if the market didn’t rally all the way back from the lows, then one could certainly argue that the weak earnings are priced into the market. However, after rallying back to unchanged and even (in some cases) hitting new highs – it is a little hard to get fired up that this market is underpriced when compared to what is expected to be almost a 10% decline in earnings for the S&P 500.


FED FACTOR

While earnings and fundamentals should rule the market forces, we are unfortunately tethered to Fed monetary policy of low rates, asset purchases, and an ever increase in money supply. Fed’s monetary policy is driving the trade weight dollar value and that of course is a rather significant factor in commodity and energy prices. And that all trickles down, whether we like it or not.

Regardless how well we beat expectations or not, it will ultimately be any shift in Fed monetary policy that will drive this market higher or lower.


Market Reaction

The market is starting to consolidate after the recent run, waiting for something to drive it higher or invoke panic. Earnings will certainly drive short-term volatility into the market and I believe we can see a break out of this consolidation during earnings season.


Support & Resistance

INDU 17,400 – 17,800
I am looking at 17,600 as the straddle strike. I would look for some volatility in this range and if we can’t hold 17,400 we are heading to 17,200 quickly. On the upside a strong close on volume above 17,800 means we could be in for another leg higher.

NDX 4400 – 4600
The tech heavy and highly volatile index is going to make a move and the energy is coiled up inside. A rocket move to 4600 or 4400 is certainly in the card. I would look at 4400 as an important support on any pull back. Gapping higher to 4600 is in the cards, before we see any selling pressure. This index is going to jerk around during earnings and expect volatility.

SPX 2020 – 2080
The 2040 area has some support and we could bounce off that level. I would look at some resistance just above 2060. If we can’t hold 2040 area, then are quick drop to 2020 is in the cards. The VIX is priced fairly low for the potential move (higher or lower) from these levels. So expect a pop in volatility.

RUT 1100
My eyes are locked on to the broad market and volume. I think a visit to 1080 under volatile earnings conditions is certainly in the cards, but if we can get a solid bounce off 1080 and back above 1100 then we could see this market move up to 1120.


I think whether one wants to believe that weaker earnings is priced into market or not, the perception is far different. We rallied significantly – very fast – and now we are waiting for earnings. The rally had nothing to do with the economy, but rather the Fed not raising rates and reverting back to their dovish tone.

The question is whether earnings can be a pivotal driver in this market and I am not sure (for good or bad). Ironically weaker earnings could drive the market higher, as it could drive perception that the Fed will become more dovish and not raise rates this year. In fact, if earnings are really bad it could spur talk of Negative Interest Rate Policy (NIRP) again and that could give the market a boost.

Bad news continues to remain good news for the market, because the Fed will continue to stimulate. I yearn for the day we can get back to the real economy, fundamentals, earnings, and reality.

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