Game time for the markets

 

It is earnings season once again. Banks kick off second quarter earnings today; so far, so good.

Right now, investors are thinking that where the financials go, on a short-term basis, so goes the markets. The financial sector overall has rallied 7% so far this year and it is close to yearly highs. Why are financials suddenly key to the future?

A lot of that has to do with the Fed. Two weeks ago, the Fed gave the green light to most of the large, money-center banks to pay dividends and buy-back their stock after the group successfully passed the central bank’s latest “stress test.” The sector gained about 3% on the news.

This week, Janet Yellen, the Chair of the Federal Reserve Bank, testified twice during its semi-annual monetary policy report to Congress. The message was clearly slow-as-she-goes; moderate rate hikes, growing economy, and subdued (maybe too subdued) inflation. In short, a goldilocks picture of the U.S. economy.

Stocks rallied worldwide largely on her statements. Now, the hope is that banks will profit by the rise in interest rates. Earnings will grow, bad loans will shrink, and after years and years of ho-hum profit growth, financials will shine once again. These quarterly results were supposed to give us a taste of the future for financials.

Although the first few earnings reports have exceeded Street expectations, we have seen a classic “sell on the news” reaction from traders. Three of these money-center banks are all down 1-2% Friday morning. At the same time, the overall market is once again at the top of its trading range. The S&P 500 Index has been trading between 2,405 and 2,450 for a few weeks now. Every time we reach this level, the “algos” knock the averages back down.

It also doesn’t help that we are entering the notoriously slow season of decline between now and September. Bulls hope that corporate earnings can not only prop up the market through this slow season, but propel the averages to new highs. In the case of the S&P 500, that could mean a gain of another 50 points or so.

Readers are fully aware that earnings are a rigged game on Wall Street. Estimates are reduced enough that even a monkey could “beast” expectations. Revenues are more difficult to manipulate, however. Estimates are for second quarter earnings to grow by 6% or so, which is down from the first quarter’s big beat of 16%.

Earnings may not disappoint for one good reason—the weakness in the U.S. dollar. About half of the companies in the S&P 500 are impacted by the dollar’s strength (or weakness).   A weaker dollar means greater exports for American companies and this year the greenback has fallen 5.7%. That should certainly help the bottom line, as well as sales results, for many American corporations.

Right now, it is difficult to fathom the next move in the markets. I suspect we are closer to an interim top than a bottom, but we could easily continue to trade in a 50-point range for weeks to come. If we do succeed in breaking to the upside (a solid close above 2,455 on the S&P 500 Index over 2-3 days), then look for 2,500-2,550. I’ll give that a 50-50 likelihood right now. It’s the best guess I can give you for right now.

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