Articles

By: Costas Bocelli — January 10, 2019

Will Earnings Season Save the Stock Market?

Stocks have been a nightmare during the holiday season.

Costas

While Santa was readying the sleigh on Christmas Eve, all the major stock market averages were plunging to new lows.

The S&P 500 was left teetering on the edge of a bear market…

Investor sentiment was the most pessimistic in years…

"Woe is me", investors thought.  "What next"?

How about a massive rally?

That is precisely what had occurred when the markets reopened the day after Christmas.  The S&P 500 rebounded sharply.

(Click any image to enlarge)

spx 6 month

The NASDAQ Composite, which had fallen into bear market territory, gained 5.8%.  It was the best day since March 2009 for the technology-heavy composite.

And as for the Dow Jones Industrial Average, the 1,086 point rise on December 26th was the biggest one-day gain ever.

Call it swoon, then boom or what have you…

The point here is the price action that bookended the Christmas Holiday is a textbook case on how bottoms are made.  It might also signal the end of the correction.

But none of that means we’re out of the woods just yet.

You see, the first bounce is typically strong.  It’s an oversold "relief rally" that's exacerbated by the “shorts” scrambling to cover their positions.  Those buyers will exhaust at a key technical level of resistance.

Referring to the S&P 500 chart, that level looks to be around 2,630, a key point that once served as support before it was broken, and the market corrected another leg lower.

On the bounce, this area of the price chart will likely emerge as the latest meaningful battlefield in the never-ending price war between the bulls and the bears.

Often, the bears will win out, sending stocks down to retest the prior lows.

This was the case in early 2016 when the market dealt with circumstances similar to those challenging the markets today.

spx 2016

In late-2015 to early-2016 Corporate America had a problem.  It was dealing with an earnings recession.

Don’t mistake that with an economic recession.  While the economy was still growing at that time, albeit at a sluggish pace, corporate profit growth was negative.

In fact, the fourth quarter of 2015 was the third straight quarter in which S&P 500 companies’ profits fell versus the prior year.  That was the first time that had happened since 2009.  In other words, it was a pretty scary time for investors.

What’s interesting is that after the first quarter of 2016, corporate profits began to accelerate again, marking the end to the earnings recession.

If you reference this chart of the S&P 500, the index fell to a low in January 2016, followed by a relief rally, then a retest of the lows in February which ultimately marked the end of the correction.

The S&P 500 bottomed ahead of the end to the earnings recession as it correctly priced in the shift to profit-growth acceleration.

Is 2019 Looking Like 2016?

The challenges faced during the correction in 2016 look very similar to the ones afflicting the markets today.  Plunging oil prices, recession fears, and falling profits are really what's weighing on the markets.

For sure the market is sensitive to ongoing trade talks with China and the political follies in Washington.  But when it comes to where stock prices are headed long-term, the trajectory of corporate profit growth is what really matters.

2018 was a banner year for corporate profits, yet stocks finished the year in the red.  Next week will kick-off the unofficial start to Q4 earnings and the last for a year that is likely to post 20% profit growth as compared to 2017.

The growth rate for Q4 earnings for the S&P 500 is 11.4%.

That’s pretty good, but not as good as the prior three quarters, and not as good as the projected rate that analysts were forecasting in September, when Q4 earnings were expected to grow 16.4%.

In other words, the January-through-September period was as good as it gets, and markets now face a “peak earnings” environment.  In other words what really unhinged stocks in early October was the fact that profit growth was inevitably going to decelerate. (And even get worse from here.)

You see, for Q1 2019 (the current quarter), analysts are forecasting earnings growth of 2.9%.  But that may mark a cycle low.  Because earnings growth is expected to reaccelerate in Q2 2019, and ultimately rise by low double-digits by Q4 2019.

So if earnings growth bottoms in Q1 like back in 2016, then stocks should rally as we move into the springtime.  Starting on Monday, we’ll hear from the biggest money center banks as they report Q4 results.

But forget about the numbers.  Listen instead to what management has to say about credit quality, credit growth, and the outlook for the economy.

One of the banks reporting is J.P. Morgan Chase (JPM), the largest bank in the U.S. and one with a good feel for the pulse of the economy.

In a recent interview ahead of earnings, Jamie Dimon, who is the CEO of J.P. Morgan, said…

“My view is that the consumer is in good shape and is continuing to grow, and they have backwinds with jobs and wages going up. Consumers were paying back credit card debts.”

Now that stocks have corrected, the market is priced at a more attractive level.

Based on current analyst earnings forecasts (which have been adjusted lower), the Forward 12-Month price-to-earnings ratio on the S&P 500 index is now 14.5, below the 5-year average of 16.4 according to FactSet.

Three Stocks to Put on Your Radar

While the stock market is rallying in the short-term, and alleviating the oversold conditions, there is a good chance that markets pull back or potentially retest the lows as we mentioned earlier.

To take advantage of any near-term weakness, investors should gain exposure to the sectors demonstrating long-term relative strength.

And while many stocks within the Technology Sector have seen some of the sharpest pullbacks since the start of the correction, the fact remains that Technology is the highest-rated broad sector in our relative strength rankings.

With that in mind, here are three technology stocks to put on your radar.  All are in a positive trend and possess strong qualities of technical strength: Xilinx (XLNX), Broadcom (AVGO) and Verisign (VRSN).

We're going to keep a close eye on earnings growth, and as we do, count on being in the loop.

See you soon!

Costas

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