Investors are desperate for an earnings fix to provide new life to the markets.
The major indexes posted gains last week but they were far from exciting even though there were some new highs. There were multiple reasons for the lethargic behavior and investors are hoping the coming earnings tsunami will push the indexes over resistance and create a new leg higher. Unfortunately, hope is not a strategy. Hope is what you have when positions are not working out the way you expected.
For this earnings cycle, the expectations are for 4.4% growth. They should come in higher than that but that is the official consensus. With prior quarters in double digits, this could be a letdown if that number does not improve significantly.
With a number that close to zero, there is always a danger that a string of earnings misses could push the consolidated growth back into negative territory. With the flurry of hurricanes already being blamed for some earnings misses and we are just into the first week of the cycle, that suggests there could be a lot of companies using the same excuse.
Normally, a weather related excuse is ignored. Everyone understands that is something out of the control of the company and just a temporary event. That works for single companies and their shares are not punished severely. However, if we get dozens or even a couple hundred companies using the hurricane excuse enough to push the consolidated earnings lower, it could also push the market lower.
The reasons for the market rally are improving economy, improving earnings, tax reform and accommodative Fed. Remove any one of those and the market could become unstable. Since the Fed is determined to hike again in December, that is a minor weakness. If tax reform looks like it will be pushed into 2018 that would be another destabilizing factor. If earnings for Q3 suddenly fall back to zero or slightly negative, that would be a major hurdle to continued gains.
Lastly, given the extremely partisan politics in Washington, the potential for getting a budget passed and debt ceiling raised, appears to be very unlikely. Those headlines will begin to heat up once we are into November.
The lackluster indexes last week could be telling us, investors are worried about all of those events. Add in the potential for a North Korean event this week and there was no reason for investors to add to existing positions.
On the positive side the A/D line for the S&P continues to rise. The S&P is showing no weakness other than the meager point additions. As long as the A/D line is positive, the index is not going to decline. If we saw the A/D line weakening and the index only gaining a couple points a day, that would be a major warning sign. As of Friday, the S&P is still positive.
Add in the weekend event risk and it is actually not surprising the index only gained a couple points. We should be thankful there were gains instead of losses.
There was some weakening on the MACD but it has not yet turned negative. The MACD is the product of two moving averages and the minimal point gain tends to bring the averages closer together.
The Dow chart is far less bullish than it would appear at first glance. The index has posted mostly gains for the last 12 days and it has reached overbought status. Major support is well back at 22,275. While I do not expect the Dow to return to that level, that is where support exists. With 9 Dow components reporting earnings this week, we could get some significant volatility. That volatility could convince investors of the need to take profits.
The Nasdaq has also reached the point where it is overbought. However, the slow pace of recent gains has allowed some consolidation in place over the last week. The index did squeeze over 6,600 on Friday and the next resistance is 6,700. The Nasdaq is powered by the top 15 big cap stocks and their trends have been mostly positive over the last two weeks. They are still choppy ahead of earnings and there is some real risk of major drops if the earnings are not perfect.
Netflix reports on Monday after the close and that could be a trigger for a Nasdaq move in either direction depending on the results.
The broader market as represented by the Russell 3000 has come to a dead stop at 1,516. The index has made no forward progress since August 5th. This index is THE market. As evidenced by the chart below the market has stalled after a long advance. This is troubling but this formation typically ends with a breakout. It does not happen always but often.
The R3K is the largest 3,000 investable stocks in the market. It is the combination of the Russell 1000 big caps and the Russell 2000 small caps. If we are going to see overall market weakness, it will appear here.
Before 2017, the VIX had closed under 10 only 9 times since 1990. In 2017, the VIX has closed under 10 on 32 days. That is nearly four times as many as in the prior 27 years.
The historic 24-year low close of 9.19 was October 5th. To say that volatility was at an all time low would be an understatement. What we do know from observing the VIX over the last 27 years is that low periods of volatility are always followed by periods of high volatility. This time is not likely to be different but there is no bell at the bottom. There is no starter's gun that fires when the race to higher levels begins. One day everything is calm and then something triggers the rocket ride to higher levels. That could be an event in North Korea or something as simple as a sudden flurry of missed earnings estimates.
We should not get lulled into a false sense of complacency that the market will just continue going up because there is nothing on the horizon that should change the trend. It is the events we do not see coming that cause the greatest impact. Always be prepared.
Assuming the earnings continue to be positive, the market could continue higher for a few more weeks. The real hurdle in our path is the political deadlines in early December. The headlines will start in mid November right around expiration week. That assumes nothing is resolved ahead of time but nothing ever happens in Congress until the last minute.
This coming week should be a proxy for the rest of the earnings cycle. If good things appear, the market could move higher. If too many earnings are missed for whatever reason, we are likely to see some early exits. There is a lot of uncaptured profit in the market and portfolio managers will be looking for any signs of weakness. They will want to capture those profits and lock in their performance bonuses for the year.
The trend is our friend until it ends but there is rarely any warning.
Enter passively and exit aggressively!
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