Inside the Broker - Third quarter earnings season boosting stocks

Inside the Broker

Third quarter earnings season boosting stocks

Investors tend to get nervous as autumn approaches. This is because markets often experience a bit of turbulence in September and October, and this year has been no exception. Just focusing on the S&P 500, this key US stock index hit a fresh all-time high just under 4,550 on 6th September. Three weeks later it was 6% lower and traders were preparing themselves for further declines. As it has turned out, the intra-day low of 4,270 on 1st October has, so far, proven to be the bottom of the decline. Since then, the S&P has bounced back and retaken some significant technical levels including both the 100 and 50-day moving averages which come in around 4,375 and 4,440 respectively. This has convinced many traders that the pull-back is over and that US stock indices can resume their extraordinary bull run since the nadir of the pandemic sell-off in March 2020.

Are we done?

That may be so. But a pull-back of 6% is small beer. It doesn’t even qualify as a correction, which market analysts define as a decline of 10% or more. For this reason, there are traders out there who are treading cautiously, concerned that the sell-off isn’t over and that there’s still a possibility of a test of the 200-day moving average around 4,190 – or even worse. In September last year we had a 10% correction followed by an 8% pull-back in the following month, so no wonder traders are concerned this time round. But aside from these, all the selloffs in the current bull run have been 6% or less and have lasted a matter of days. Buy the dip has proved to be a winning strategy time after time. But like many things, the longer that a certain strategy persists, the bigger the fear that it will soon end. In a similar vein, Hyman Minsky stated that: “Stability breeds instability” in a warning for us all not to get too comfortable with the status quo.

 

 

Tapering bond purchases

In terms of the fundamental background to the markets, there are several factors at play. For a start, we have the extraordinary monetary and fiscal stimuli that central banks and governments have employed since the beginning of the pandemic. These are, of course, tailwinds for equities and bond markets. Now, these have always been viewed as temporary measures, although low interest rates and quantitative easing have been a fixture since the Great financial Crisis of 2008/9. But, in contrast to that stimulus which largely stayed in the financial sector and had little effect on headline inflation measures such as the CPI, this time we must add in government fiscal stimulus. Prices are rising, as are wages, and this time the CPI is picking them up. This puts pressure on central banks to slow down or end their bond purchase (quantitative easing) programmes and finally consider raising interest rates. This is despite a view that the current rise in inflation is purely transitory as it includes the base effect of the deflation we saw when whole economies were locked down last year. So, the fear is that central banks begin to taper monetary policy to counter inflation which will disappear anyway. This could be a big headwind for equities and bonds in the future.

Rising rates

The prevailing view is that markets are prepared for the US Federal Reserve to start tapering its monthly bond purchases as a precursor to raising rates. But even when rates do rise, they’ll be going up from an historically low base. And many central banks have already tightened monetary policy, including New Zealand, Poland, Brazil, Russia, Peru, and the Czech Republic. There’s even speculation that the Bank of England will move next month. So, traders are taking things in their stride – for now.

Earnings season in focus

Instead, the focus is on the third quarter earnings season. This kicked off last week with all the major US banks reporting better-than-expected earnings and revenues. In fact, 80% of S&P constituents that have reported so far have beaten expectations, and this helped to push the S&P up 1.8% last week for its biggest weekly gain since July. The season picks up a gear this week with Netflix, Johnson & Johnson, Procter & Gamble, IBM, Tesla, Intel and American Express amongst the big names reporting. But it won’t just be positive earnings and revenues which will influence market direction. Traders will be listening out for any comments concerning inflationary pressures and supply chain disruptions in case these are concerns for the rest of the year.

Smart News

Sometimes it can be difficult to keep up with all the latest financial events and releases. But our Smart News widget can really help you follow everything that happens in the markets. Smart News is available to all Trade Nation live account holders and includes curated news feeds from social media designed to keep you one step ahead of the regular financial press. So why not open the tab and have a look at the feeds? And don’t forget, you can create your own watchlists and follow all the news specific to those markets in them.