US equity markets rallied smartly into the closing bell yesterday reversing a three day slide that spoke more to investor fatigue and apathy than it did anything else. Further, concern over a confusing interest rate flight path in recent days helped establish a decidedly unenthusiastic tone for equities by investors. Volume was mixed on the day, rising on the Nasdaq (+2.58%) while falling on the NYSE (-7.27%). All three major US equity market indices traded higher. The Nasdaq led the way gaining 1.59% while the S&P 500 added 1.05% and the Dow Industrials tacked on a more modest 0.65%.
The recent tone and weakness in equity prices changed yesterday for two principle reasons. The release of the most recent FOMC Minutes provided some insight into committee division and an increasingly vocal and strident division at the Fed over the timeline for the next interest rate hike. It was also clear from the FOMC Minutes that the global theatre of economic challenges has begun to play a increasingly central role in policy, effectively confirming a predictably dovish monetary tone moving forward. Secondly, crude oil rallied sharply on the day gaining nearly 5% in active trading in large part due to a larger than expected draw on North American inventories as outlined the EIA Petroleum Status Report.
Neither of the drivers of yesterday’s rally have legs. Both are transient forces at best in terms of forecasting the near term direction of equity prices. That direction will be dominated by earnings. Given the fact that S&P 500 earnings for Q1 are expected to contract by 7.1% on a YoY basis in Q1, and given the 4.2% decline in EPS for the S&P 500 that was posted in Q4 of 2015 on a YoY basis, the bar has been set fairly low for this earnings season which commences in full next week.
The economic, interest rate and corporate revenues/profits narrative have been so disappointing in recent weeks that investors have begun to doubt the potential for any follow through for the rally that marked one of the largest intra-quarter reversals in recent memory. Investors are right to be cautious even if the low bar set for earnings would suggest we receive better than expected corporate results in coming weeks. The street is famous for setting low expectations for earnings only to have results come in better than expected and in the process allow for a tick higher in trading volume as traders play catch up. From a sector stand point, look for energy, materials and industrials to post the most challenging performance figures for Q1 while consumer discretionary and health care should be the best performing sectors.
This earnings season, more than any in recent history, guidance will play an enormously important role for investors.
Expect earnings by financials next week to be inline for Q1, but also expect guidance to remain subdued as financials continue to manage challenges posed by anemic domestic growth, stalled NIM expansion and the ever escalating costs associated with increasing regulatory oversight and compliance. Other themes that will likely play a significant role in the guidance component of earnings season include the potential for a stronger dollar in a rising rate environment later in the year, weak global demand, geo-political concerns focused on Greece, Brexit and the South China Sea among others.
How I See It:
We are basically back to even on the year after a tumultuous start but economic data, both domestically and internationally, leave a great deal to be desired.
Further, even at these levels, despite only being even on the year, the major US equity market indices are a bit stretched and certainly will need earnings to come in better than expected to support current valuations Even if they do, guidance will have to be very encouraging. It will not. The sledding predicated upon Q1 earnings will not likely support the market as it is currently priced. Look for an anemic session today followed by an early earnings season that is decidedly less than rosy.