Strategy Report

3Q Earnings Season May Draw More Skeptics This Time Around

Few have forgotten the impact that the US second quarter earnings season had on the markets. Better-than-expected earnings reports were the norm and the impact on sentiment was clear. Risk appetite was feed and stocks rallied for the weeks afterwards. However, the accounting for that period was special as it confirmed the recovery was taking place for the corporate sector. This time around, enthusiasm will be generally more muted. No longer are we merely looking for a rebound from the worst of the crisis; instead, market participants will analyze the data for the pace of the recovery. And, should the market reflect on the numbers with a little more skepticism; they may very well be disappointed by what they see.

Taking a look at the general cut of the second quarter earnings numbers, it is safe to say that cash flows, revenue, invest and all other relevant measures of health are far below the figures we had come accustomed to up through 2007 and even 2008. The full brunt of the recession and financial seizure has severely stalled economic activity; and in turn demand for goods and services has naturally shriveled. With domestic US demand continuing to shrink as wages wither and unemployment marches higher, tight credit conditions prevents expansion and economic hardship and protectionist measures cool exports; the outlook for corporate earnings over the coming years (much less the past three months) looks anemic.

What should we look for specifically to gather a sense of direction from this data? The most important consideration is how the markets respond to the data. Better-than-expected or not, if the general consensus is one of skepticism for the future, sentiment can collapse under its own heights. At the same time, the surprises as compared to forecasts will act as a good catalyst for market activity either way. We should watch the numbers from the biggest corporations – those that represent the entire business sector. This is the first week for major releases; so expect the volatility to begin here (if at all).

It is especially important to watch the announcements from the four major US banks this week. While the rest of the firms’ numbers will be reasonable measures of economic health; the banks health is a necessary measure for growth, credit conditions and financial stability amongst other things. Write downs are especially important. The IMF has projected that the world’s banks have only accounted for half of their losses (and the US specifically 60 percent). Accounting rules may have allowed for roll over losses; but defaults and mortgage security-based losses will factor in sooner or later. Also, as the catalyst for the bullish drive during the second quarter season, Goldman Sachs will likely be under greater scrutiny than its peers.

Written by: John Kicklighter, Strategist for CFDTrading.com
Questions? Comments? Send them to John at jkicklighter@cfdtrading.com.