There is an interesting dynamic playing out as we start Q3 earnings season. While investor expectations for the quarter may be high, analyst expectations are on the low side. Stocks have historically rallied during earnings season, but when analyst sentiment is negative heading into the reporting period, the odds of a rally increase.
We started earnings season last week with big banks reporting mostly stellar earnings. Regional bank earnings numbers were mixed with credit problems surfacing at a few major regionals, namely Zions Bancorp and Western Alliance. The S&P 500 sold off on fears that credit problems might turn into an economy-wide problem with more “cockroaches” likely to appear according to JP Morgan’s CEO, Jamie Dimon (see the following section for additional comments on private credit).
TWO RECENT NEWS ANNOUNCEMENTS SCARE INVESTORS
In our last commentary, we wrote that the stock market is overdue for a drawdown. The market is overbought and needs a break from its quick ascent off the April lows. We just didn’t know what the catalyst might be to trigger a sell-off. In fact there have been two major news stories since our last commentary that have tripped up the market:
1) The U.S.-China trade war has resumed and looks like it may get worse before it gets better. President Trump is trying to reverse comments he made on October 10th about the trade war that spooked markets.
2) The recent collapse of auto-parts maker First Brands and subprime auto lender Tricolor Holdings scared the market into thinking that private credit problems may be a systemic risk to the economy. This in spite of the fact that the big banks just announced in their earnings reports that their credit portfolios were performing well. Consumers and small businesses “remain resilient” according to JP Morgan’s finance chief, Jeremy Barnum.
There has been a lot of churning going on under the market’s surface. In fact, the average stock in the S&P 500 is down about 15% off its high according to Drach Market Research.
Our thinking remains the bull market will get back on track. Here are some positive points to remember while many stocks are in correction mode:
– Bull markets that make it to three years (as of October 12th) almost always make it to four years (eight out of the last nine times).
– Seasonally we have the best three months ahead of us (mid-October through early January). From a calendar perspective, this is as good as it gets.
– Oil prices and other commodity prices are falling which should help inflation numbers. If investors are so worried about inflation, why are longer-term Treasury yields falling?
– Consumer spending remains strong and is rising at a healthy clip. Labor market fears should be discounted given sales demand growth.
Of course, no one knows how long the current consolidation in share prices will last. We remain optimistic in the face of news shocks that have temporarily motivated investors to be net sellers.